I’ve seen the statement that fiat is valuable because the government says you have to use it and has a monopoly on violence to enable them to require you to do so as well as requiring you to pay taxes with it repeated so many times it clearly must have been presented as one of the commandments of economics by one of the prophets.
I find Economists notoriously weak when it comes to science, maths and logic though so let’s see how well that statement holds up to some critical thought.
The scientific method tells us we should take this hypothesis and run some experiments to see if it is confirmed or not. Given it is mighty hard to run an experiment at the scale of an economy it’s lucky a lot of countries have already run this experiment for us.
Wikipedia provides us with a list of cases that prove interesting in this regard. These are fiats that have hyperinflated away to minimal value. The question is can we find a case in that list where the government still maintained it’s monopoly on violence and was still collecting taxes but the value of their fiat collapsed? I’d say most if not all of those cases fit that bill so a little application of the scientific method and some basic logic tells us that it isn’t actually either the power of the government or requirement to pay taxes that gives fiat it’s value.
Still not convinced? How about we try a thought experiment then. The ATO announces that it will now also accept any old piece of paper with 10,000 written on it as equivalent to AUD$10,000 for the purposes of paying tax debts. Government still has it’s monopoly on power and is requiring you to pay tax with it. So what would you be willing to swap for a piece of paper with 10,000 written on it in this situation? Personally, I’d be willing to swap about the same as I would if this wasn’t the case as I have enough pieces of paper to be able to “print” myself enough to pay a lifetime of tax liabilities.
So what’s the actual reason that the $AUD has value but a piece of paper with 10,000 written on it doesn’t? It’s all contained in that little phrase “print myself enough”. The supply of pieces of paper to write 10,000 onto is near enough to infinite that it doesn’t matter while the amount of AUD printed is VERY strictly controlled. The thing all the cases of hyper inflation have in common is that the government had started printing large amounts of fiat and feeding it into the economy.
So why does fiat have value? I’d say it seems fairly conclusive that it is because the government strictly controls it’s production resulting in a limited supply which I guess could be argued is done through it’s monopoly on violence using counterfeiting laws, but not in the spirit intended by the inital theory.
Is that the only reason a fiat has value? Almost certainly not. I’d say people’s faith that it has value and will continue to tomorrow is the primary reason, but this is dependent on a limit to the supply and interrelated.
If you’ve got a better reason, let me know. But be prepared to justify it.