Fiat dollars explained
October 26, 2015 § 46 Comments
The king has legitimate authority to levy taxes. As with all human authorities this particular authority is inherently limited. (We’ve discussed some possible moral limitations on the sovereign’s authority to tax before).
Suppose that initially the king decides to levy taxes in gold. Gold is a useful industrial commodity and is relatively portable, which makes it convenient, and people are already using it for marketplace exchanges for those reasons. So when a citizen comes to the king to pay his taxes, that citizen has to first get some gold. Perhaps the farmer sells some of his wheat in the marketplace for gold, and he brings some of that gold to the publican to pay his tax liability.
The king has many things that he has to pay for himself. For example he has to pay wages to his soldiers. He pays them with gold, which he acquires in all sorts of different ways, only one of which is through taxation.
But dealing directly in gold is rather unwieldy, for a variety of reasons. The problems of physical transfer and security can be mitigated by keeping the gold stockpiled and, instead of physically transferring gold around, using a system of ‘banking’ to transfer title to gold around. We call these titles-to-gold ‘dollars’, and everything proceeds as before except that now we don’t have to take unnecessary risks and waste resources moving lots of physical gold around.
(This ‘banking’ system will later develop into a system of fractional reserve lending, which I’ll probably discuss again in a later post. For the time being and for the purposes of the present post the banks simply hold the gold for us and transfer title – ‘dollars’ – around, for a fee which we pay. It is worth it to ‘depositors’ to pay the banker’s fees, because using the ‘bank’ is both more convenient and more secure. Taking care of real property always and without exception carries risks and costs).
However, the king notices that using gold and titles to gold (‘dollars’) in this way for transactions creates market distortions. Some people in niche markets still value gold for its usefulness as an industrial commodity, of course, but most people also value it as a means for settling tax liabilities and as a general currency for buying and selling in the marketplace. The settlement of public and private debts via gold and gold-titles however is itself distorted by the gold-qua-gold niche market: most people as it turns out have a lot more use for food, clothes, shelter, land, tools, etc than they do for gold, but a shortage (or overabundance) of gold can still cause all sorts of problems for a town or city or region when fluctuations occur. Large numbers of people whose lives objectively depend not a bit on this one niche industrial commodity nevertheless find their flourishing has become slave to this one narrow market: the use of gold as universal currency distorts both the gold market qua industrial commodity and the markets in all sorts of other things.
So the king decides to issue tax vouchers, entirely independent of gold or other industrial commodities, which he pledges to accept from citizens to settle their tax liabilities. Just to be confusing he calls these tax vouchers ‘dollars’, the same label which was previously given to gold-titles. These fiat dollars have value, not because they entitle the bearer to some quantity of gold, but because they entitle the bearer to settlement of tax liability in the denominated amount. These tax vouchers (fiat dollars) then replace the use of gold titles (so-called ‘hard currency’) as a convenient marketplace currency, precisely because using them to temporarily store and carry value is very convenient. People are of course welcome to use whatever currency they like in private transactions, but when tax liabilities arise they must be valued in fiat dollars and settled by giving the king back the vouchers that he issued.
Because these tax vouchers have intrinsic value to the bearer, the king himself can use them to pay for things — the wages of soldiers, for example. And like a corporation with theoretically plenary power to issue capital stock, the king has theoretically plenary power to issue more vouchers whenever he chooses. However this power is, like the aforesaid corporation, limited by numerous practical and moral considerations. If he issues too many at once (for example) then they become worth less, and his outstanding tax claims against citizens become correspondingly worth less. In general the stability of the king’s fiat currency will reflect the supply of his tax vouchers (‘dollars’) in the marketplace and the public’s faith in his long term viability as a tax authority.
Zippy Catholic 
However this power is, like the aforesaid corporation, limited by numerous practical and moral considerations.
Having replaced the old gold and title to gold system with his own system, the king now has a moral duty to take reasonable care to avoid introducing the same old distortions into the economy via his own behavior. In our case, most of the emission of new dollars comes down primarily to a refusal to accept that we don’t have the wealth to pursue the goals of our politicians. They know that taxing properly would lead to a revolt by the tax payers, so live in denial via inflationary practices.
There is an embarrassingly broad buffet of kinds of property that folks can own for the purpose of investment or wealth preservation. People who choose to use tax vouchers (that is, dollars or financial contracts fixed to dollars) for long term wealth storage are themselves responsible for the consequences to themselves, just like people who choose to hang on to capital stock for long term wealth storage, or gold, or real estate, or whatever. Anyone who thinks that gold is a better asset than dollars for long term wealth preservation can easily convert his dollars into gold.
Modern entitlement attitudes about currency in particular and wealth preservation more generally are just as bad as modern entitlement attitudes about all sorts of other things; and in fact the latter are the bastard thugspawn of the former. Objectively we should have approximately equivalent sympathy for welfare queens and dollar hoarding usurers.
There is an embarrassingly broad buffet of kinds of property that folks can own for the purpose of investment or wealth preservation.
There’s also a broad range of people who don’t make enough money to really invest much, and deliberate, irresponsible levels of inflation push them further away from being able to do so.
Mike T:
This is self contradictory.
If some demographic doesn’t earn enough to put excess earnings into property (savings) then that demographic isn’t holding any property at all long term, including dollars. On the other hand a demographic which has excess earnings going into savings can easily buy (e.g.) gold with those excess earnings rather than leaving them in dollars, if they so choose.
As a practical matter lots of middle class excess earnings go into real estate, as folks make payments on mortgages. Many of those no doubt wish they had put those excess earnings into fiat dollars or gold or capital stock instead.
But that is the inherent nature of purchasing property: when you choose to own something, you choose to bear the risks of owning that thing. Modern people feel entitled to own property without risk, and that is directly a result of centuries of rampant usury.
Heck, modern people don’t just feel entitled to own property without risk. They feel entitled to own property without risk and without even understanding the thing that they own.
The parallel to usury is no accident. The usurer doesn’t care about the ‘pound of flesh’ he ‘owns’, and doesn’t want to understand ‘it’ or ‘its’ fortunes.
He just cares that it keeps making payments.
This is self contradictory.
I made a broad comment about the moral issues surrounding policies that lead to unnecessary inflation of the currency. You reduced it to people who hold dollars as a main investment instrument. I then pointed out that the issues don’t affect just them, and that there is a very large part of the population that is perfectly entitled to be pissed at such policies: namely people who live paycheck to paycheck due to low income.
Mike T:
You’d need to do more dot connecting to show … well, to show anything besides unreasoning populist outrage. My guess based on prior discussions is that we don’t even agree on what is rationally coherent, let alone real and possible, let alone morally required of the sovereign. None of which is a defense of any particular current policy of any particular government, of course.
[…] Source: Zippy Catholic […]
Zippy,
My position is that pursuant to the common good, governments have a general obligation to function within their means and to not immediately act upon tax authority or go into debt whenever financial issues arise. That’s even more the case when the currency is a fiat currency, not a market-based currency like a gold standard where the sovereign only sets the denominations of the currency standard. That’s simply due to the fact that the sovereign has assumed a great deal of control over the currency and thus has a duty to shepherd it wisely given its impact on society.
I don’t think a balanced budget is intrinsically obligatory, as there are times like a great disaster or war when the rules can be loosened. However, I don’t think a recession justifies the policies our government has taken on which have introduced a lot more inflation than is ordinary and reasonable in our particular circumstances.
The populist outrage over federal profligacy is perfectly justifiable given that we have an elected government so broken and useless that it cannot even formulate a budget. Rather than make the most basic hard decisions that leaders must make, they keep kicking the can down the road and ask the Fed for more money. The increased money supply has watered down the wages of the average worker, but the impact is felt most severely at the lower end.
It’s unreasonable for people to hold usurious views about money in the bank, to hold a fiat currency and be shocked at ordinary inflation and similar things. It’s perfectly justifiable for lower wage earners to want to knock Congress’s collective head in for not being able to issue basic reform bills and a new budget that bears some half-assed attempt at fiscal responsibility.
Mike T:
Again, there are so many assumptions with which I disagree baked into what you are saying that it isn’t even possible for me to reasonably discuss it without allowing you to beg the question.
Printing money is a variety of stealing–the king is stealing from his subjects. It is not usury to be sure but an intrinsic evil nevertheless.
vishmehr24:
I find it ironic though all too human that, in what can only be described as a target-rich environment of despicably immoral government actions, all too many government critics fixate on attacking things they demonstrably don’t understand.
As is true of all human authorities, the sovereign’s authority to issue tax vouchers (“print money”) is limited — and he may himself fail to recognize those limits. But a declaration that issuing tax vouchers is per se immoral (as theft is per se immoral) is simply a declaration of ignorance.
Again, there are so many assumptions with which I disagree baked into what you are saying
Like what? I don’t think my position is that radical. It mainly comes down to the principle that in the absence of extenuating circumstances, the sovereign has a duty to not print money to just to pay for things, but to use his tax powers to run a balanced budget to ensure that inflation happens naturally, not because he said “I don’t want to anger the tax payers, so I’ll just throw a bunch of new money at the problem.”
Mike T:
Like not only everything you just said, but the unspoken assumptions behind it; e.g. and just for starters that there is some meaningful, knowable and actually-known-by-populists sense in which it is possible for e.g. USG to “use his tax powers to run a balanced budget”. You are assuming that the conceptual accounting exists to do such a thing (it doesn’t), that the data to feed into the conceptually nonexistent accounting structure gets collected (it doesn’t), and that those words you just used are therefore meaningful and are popularly knowable and known to correlate to financial health (they aren’t and don’t).
Even if accounting for the finances of USG were ontologically similar to accounting for the finances of a corporation (it isn’t), the data required to act as a fiduciarily responsible CFO for “USA Inc” isn’t even collected. For example there is no balance sheet for “USA Inc”. How the f*** (again just for example as not even the tip of one of many icebergs) can you tell if even a private, normal institution (let alone a sovereign, which is financially a different kind of animal entirely) is running a financially healthy level of debt without a balance sheet? How can you tell if issuing options — any kind of options — is financially wise, without any cap table? How can you run an even modestly complex business without a business model?
You. Can’t.
All the populist ranting in the world can’t conjure knowledge where there is no information and no coherent reality-based conceptual framework into which to put that information; and neither of those things exist. As in our earlier discussions of liberalism you are simply importing your ‘common sense’ intuitions, which I guarantee do not apply, and begging the question that what you propose even makes coherent sense let alone is actually good. If I said “a responsible sovereign must fight off the jabberwocky and regularly brillig the slithy toves” it would be no less meaningful.
Mike T:
Mind you, I don’t think you are alone. I think it is I who am alone. I think most people make the same sorts of wrong assumptions you do. The problem isn’t the radicalness or popularity of our different understandings. The problem is that the populist view is so ignorant that it isn’t even wrong, and the more sophisticated macroeconomic views (e.g. Keynsian, MMT, Chicago school, etc) are just politics dressed up in economicish-looking anti-realist claptrap.
There is no metaphysically realist way of understanding the operations and finances of an institution like the USG. It does not exist.
I mean, Hell, look at how much work I had to do to explain something as trivially simple as usury in a simple contract between two parties. Look at how difficult it was in the W4 discussions trying to get reasonably smart people to understand what deposit accounts actually are — and they still don’t get it! I break these things down into the tiniest bite-sized easily understandable chunks and it is still like pushing on a rope.
Modern minds are dominated by metaphysical anti-realism, and just getting to square one on fairly trivial financial matters from a metaphysically realist perspective is promethean. A business model for USG that corresponds well enough with reality so I can tell what level of ‘debt’ or options issuance is healthy, and how that ties into the relative prices of tax vouchers (fiat currency) versus loaves of bread?
Fuggheadaboudit. People who claim to know are projecting the opposite: that they don’t even know enough to honestly declare their own ignorance.
Like not only everything you just said, but the unspoken assumptions behind it; e.g. and just for starters that there is some meaningful, knowable and actually-known-by-populists sense in which it is possible for e.g. USG to “use his tax powers to run a balanced budget”.
You’ve never explained why it is difficult for Congress to simply not allocate any funds beyond what is collected by the Treasury Department in ordinary circumstances. I fail to see how it is ignorant or populist for Congress to restrain itself to the monies reported by the Treasury.
I grant you that there are difficulties like what you said. Indeed, tax authority is materially different in relation to fiat currency than anything a corporation has with respect to issuance of bonds and stock. However, the government has the means to create a balance sheet of its actual assets available independent of the tax power. In fact, it already has one, just not well-organized and filtered for inaccuracy via GSA and every agency’s property management records.
Mind you, I don’t think you are alone. I think it is I who am alone.
Which is usually a sign of a stark dichotomy: either you are completely out in left field or you are an unrecognized genius.
Mike T:
It is of course possible to do all sorts of simple, arbitrary things. What is not possible is making financial choices which we know to be sound.
(Another example of an assumption you and most people are making which I do not share is that the operating purchasing power of USG is simply whatever it collects of its own fiat dollars through various taxes. I don’t have a ‘one right way’ to look at the purchasing power of USG, but that is definitely a wrong or at best radically inadequate way, despite the appeal of that model to folks used to thinking of tax receipts as analogous to business revenues. The primary function of taxes is to create demand for dollars at various touch points in the economy, not to produce revenues).
Whether it could do so in theory in a way which makes financial sense is debatable, but that it does not in fact do so is indisputable fact. So particular judgments recommended right now have no basis in any balance sheet.
And again, even this is stipulating that an institution like USG can reasonably use accounting similar to a corporation, which is almost certainly false.
I don’t think it is either. I think it is just the same combination of (almost always mutually exclusive these days) factors which made the usury doctrine obvious to me once I read Aquinas and the Popes. I am a self-conscious metaphysical realist (already rare in itself) who understands finance (not economics — the relationship between finance and economics is like the relationship between farming and weather forecasting).
Though maybe that odd combination counts as ‘left field’.
I’m struggling to see how it’s financially sound for Congress to consider it acceptable, in ordinary circumstances, to borrow or authorize the printing of new money, simply because there is no political will to restrain the USG to expenditures that can be fulfilled by its tax revenues. At a bare minimum, that promotes a culture of so-called leaders being unaccustomed to not making hard choices and just kicking the can down the road, consequences be damned.
Mike T:
That is because you still think that you understand what those words you are using refer to ontologically, and further understand how the various objects they describe fit into an accurate-if-rough financial model that you have in your head.
My position is one of ‘strong ignorance’ on the question, similar to a ‘strong atheism’ if you will. It isn’t just that I acknowledge my own ignorance w.r.t. an accurate understanding of the financial reality; I insist that (barring some private research and theory to which I am not privvy) nobody can possibly understand it.
As far as I can tell, this is pretty much correct as far as it goes. We shall see how you incorporate banking.
My position is one of ‘strong ignorance’ on the question, similar to a ‘strong atheism’ if you will. It isn’t just that I acknowledge my own ignorance w.r.t. an accurate understanding of the financial reality; I insist that (barring some private research and theory to which I am not privvy) nobody can possibly understand it.
If I’m following you correctly Zippy this is what makes my job (public accounting with strong focus on income tax) almost intolerable. It’s the underlying reality that it’s all smoke and mirrors. It’s the mundaneness and knowledge of participation in arbitrary meaninglessness in trying seriously to answer the question of how one might write off one’s personal timeshare in Florida somehow that is extremely wearying.
It is amazing what having a wife and children to take care of will motivate you to do.
Zippy is actually wrong about the purpose of our tax system. It’s not even to create demand for dollars per se, but to get people to behave in ways the elites approve. How else can you explain a tax code that is over 7m lines long and conceptually more complicated than many pieces of non-trivial software to fully understand/model in one’s head?
I said “function” rather than “purpose” quite deliberately. Understanding how something functions is different from understanding the intentions of its designers. As another example which I point out regularly, while the intended purpose of elections may be for citizens to have their say in government the actual function of elections is to get citizens to make a personal ritual endorsement of our ruling class and the governing philosophy of our ruling class.
Doesn’t the sovereign oblige his subjects to honor the fiat currency for settling private debts?
One would think that it is this obligation, that falls on everyone, that creates value for the fiat currency rather than taxes, that not everyone has to pay.
Also, wasn’t direct taxation, that you imagine creates the value of fiat currency, pretty small for most of the history? Income tax has been introduced only a century ago.
So, I indeed agree that fiat currency goes hand-in-hand with all sorts of progressive things such as income taxes, welfare etc etc. It hardly makes fiat currency as ideal thing though.
Thing is the fiat currency changes relation between sovereign and the people in direction of the sovereign. As a subject, I do not find it ideal.
“actual function of elections is to get citizens to make a personal ritual endorsement of our ruling class and the governing philosophy of our ruling class”
Absolutely so.
vishmehr24:
Barter is perfectly legal, and as party to a trade I can legally insist (and in fact have insisted on occasion) on a barter as opposed to cash. The value of transactions however often must be stated in dollars for tax purposes – sales and income taxes make this requirement ubiquitous. So as a practical matter – though not a matter of legal requirement – there are dollar-denominated assets (often not actual dollars though – more later) involved in most transactions.
vishmehr24:
Yes. The sovereign’s economic power grows with the pervasiveness of his taxes, to be sure, which comports with intuition. But most folks have the further common-sense-but-wrong belief that this is because taxes produce income for the sovereign; income which he can then spend, etc.
This ‘common sense’ view of things is simply wrong. One of the consequences of being a metaphysical realist is that I have to accept the way reality is on its own terms, independent of the subjective meanings that human beings assign to reality. That most people think of the sovereign as ‘just a big corporation’ financially doesn’t mean that it actually is ‘just a big corporation’ financially.
It isn’t. It is an entirely different kind of thing and must be understood on its own terms before it is even possible to start making moral evaluations.
[…] the previous post I gave a basic explanation of fiat dollars. In this post I will argue that gold backed currency (or other sovereign-issued commodity-backed […]
We have only your assertion that the sovereign finances are per se inscrutable. Surely, it is doubtful–were all those Chancellors of Exchequers deceiving their king? Was the French Revolution based upon this simple mistake?
Louis XVI was obliged to call the Estates-General because the treasury was empty. He must have been deluded–it is not possible to assert anything about sovereign finances.
Other European monarchs that were obliged to grant concessions to commoners were also victims of this delusion that their tresury was empty. Why, they could have issued “tax vouchers” to their soldiery.
vishmehr24:
Let me make sure I understand your contentions.
The fact that people went to war is proof that they had an accurate financial understanding?
The fact that ‘the treasury was empty’ is evidence against my contention that the sovereign’s economic power arises from his power to tax?
[…] else – something other than the currency itself – which is (that something else) of value. Fiat currency entitles the bearer to settlement of tax liabilities. Bank deposits entitle the owner to on-demand […]
[…] demand deposit account entitles the owner to fiat currency on demand from the bank, up to the amount of the deposit account — backed by the bank’s […]
[…] capacity to provide it from the base of property in which the bank has a stake); and fiat currency is itself a kind of security. Folks who comment on this kind of structure, where one security represents entitlement to another […]
[…] you’ve followed along with my recent posts you now know that fiat currency is a kind of financial security issued by the government: a tax voucher which entitles the bearer […]
[…] of industries, markets, and property in general doesn’t exist. And sovereign currency is mere fiat not a security against actual valuable property[2], even though it actually does entitle the […]
[…] a sovereign dollar entitles you to make a transaction, in the sovereign’s marketplaces, for which the tax is one […]
[…] movie called Predator. (Modern industry, in its ruthless efficiency, will squeeze every last fiat dollar out of every last pop-cultural object: the banality-recycling machine known as Hollywood […]
[…] into existence by magical incantation and pagan circle dances. Contrariwise, securities granting specific rights issued by the most powerful economic institution on earth against its real economic assets have no […]
[…] off topic from the subject of usury. (Note: see also more recent discussion on related subjects here, here, and […]
[…] explain what fiat money is here and here. I explain why fiat dollars are (counterintuitively) more transparent and honest than […]
[…] property has similarities to cash — once we have an adequate grasp of what cash actually is and is […]
[…] would then bring in the question of currency exchanges and how this is determined. Zippy has some notes about the value of fiat currency being determined as a means of tax settlement, but […]
[…] poetry about money representing human life probably obscures more than it reveals here. Burning cash or destroying other kinds of property isn’t […]
[…] you don’t like monetary inflation – the fact that the number of fiat dollars which trades for a loaf of bread changes gradually over time – then by all means buy […]
[…] but in it we are going to unbox a fiat dollar. I’ve explained the nature of fiat dollars at a high level before; and I’ve given descriptions of what securities are more generally and how that relates to […]