[thetwiceler]

> A currency only has value because we, as a society, decide that it does.

For some reason, many people believe that this is true. I believe that it is not.

Technically, yes, if people all decide the currency has value, then it will have value. But this is a ridiculous argument! How much is this currency supposed to be worth? According to this argument, any number is potentially valid! This means that there is absolutely nothing that should hold the value of the currency fixed, and with a few "no free lunch" arguments (anyone can claim any random thing has value and try to trade with it), we see that things with no intrinsic value should NOT have value.

So why does the US Dollar have value? It's just paper (cotton), right? Not true! If the exchange rate of the dollar decreases, you'll see the Federal Reserve will start trading some of its goodies from Fort Knox (gold, etc.) for US Dollars, in order to maintain the dollar's exchange rate/value.

So in reality, the US Dollar is backed by holdings that have intrinsic value.

EDIT: As pointed out, I should mention that another important backing of the USD is taxation.

Also, what I said about the Federal Reserve isn't technically true. What's important is that they have a mission to moderate the rate of inflation of the USD (i.e., maintain its value), and their asset holdings are critical in allowing them to do this.

[simplefish]

I'm confused by the way you say something is "technically" true, then claim you believe it isn not true. Are you really saying that you believe things you know aren't true?

> How much is this currency supposed to be worth?

Whatever we agree it to be worth.

> According to this argument, any number is potentially valid!

Yep. And the value of US dollars, for example, has changed hugely.

> This means that there is absolutely nothing that should hold the value of the currency fixed

Accurate. Note the demise of fixed exchange rate regimes.

> Not true! If the exchange rate of the dollar decreases, you'll see the Federal Reserve will start trading some of its goodies from Fort Knox (gold, etc.) for US Dollars, in order to maintain the dollar's exchange rate/value.

That's not how the Federal Reserve works. Nor exchange rates. Nor US dollars. There's so many errors packed into that sentence, I'm not sure where to begin. There was a time when US dollars were backed by gold, including the gold in Fort Knox; this is no longer the case. And while the Fed does intervene in the markets from time to time, that's not how they do it. Further, the mere fact that interventions are necessary underscores just how arbitrary the valuation is. If, as you argue, USD were backed by gold, the aggregate value of all USD would be US gold reserves; no intervention would be possible, and selling gold reserves would actually lower the value of the dollar. Think about the implications of your argument.

[thetwiceler]

Yes, what I described is not actually how the Federal Reserve works. I was trying to give the essence of what it does in a single sentence.

The USD is not literally backed by gold, but part of the Federal Reserve's mission is to moderate the rate of inflation; that means holding the value of the USD steady. And the way they do it is beyond the scope of this discussion, but it certainly depends on the Federal Reserve trading its holdings on the market (which, as you point out, is mainly debt (in terms of USD), not gold).

[Theodores]

You write as if the Federal Reserve is like a benevolent uncle, just doing its best for us, all of us, so we may live long and prosper!

The Federal Reserve is a privately owned entity, it has its stash of gold in New York and the actual government has its smaller stash of gold in Fort Knox.

[thetwiceler]

Think of it like this:

Let's say that Apple sees the price of its stock drop to something that it thinks is unreasonably low. They may choose to spend some of their cash on hand to buy back some of their stock. This is a wise investment that shareholders would applaud - Apple is getting a good deal.

Same deal with the Federal Reserve. Federal Reserve notes are nominally liabilities for the Fed, and are much like the concept of Apple stock. If the Fed notices the price of the dollar drops, it's in their best interest to trade some of their holdings to buy back some dollars.

[fennecfoxen]

> How much is this currency supposed to be worth? According to this argument, any number is potentially valid!

Well, I guess the number is whatever supply-and-demand should happen to say that day. Mostly that'll mean asking "how much do people want gold today?" because the supply is relatively inelastic.

That said, fluctuations in the supply of gold and the price of gold would in fact be catastrophic if the price of gold radically changed. See also: the impact of gold rushes on the US economy (tip: it was inflationary). See also: Bimetallism, William Jennings Bryant, "you shall not crucify mankind upon a cross of gold!"

> If the exchange rate of the dollar decreases, you'll see the Federal Reserve will start trading some of its goodies from Fort Knox (gold, etc.) for US Dollars, in order to maintain the dollar's exchange rate/value.

... No? Wrong? Lies? What the Federal Reserve does is buy and sell federal debt, creating and destroying dollars such that the supply of dollars matches the demand for dollars and prices are consistent. You could say the dollar is loosely pegged to the value of the consumer bundle, maybe. (See also: http://bls.gov for CPI information.)

[6d0debc071]

The US is trillions of dollars in debt. The gold holdings in Fort Knox are a few hundred billion at most. You can't prop the dollar up with gold if there's a major economic boo-boo - the value just isn't there to offset such massive deficiencies. When they tried exchanging dollars for gold under the BW system they started to run out of gold.

#

If anything's propping up the American Dollar, I suspect a far more likely culprit would be that OPEC primarily uses dollars - creating a demand for dollars in the international exchange markets.

[ashray]

Spot on. Every single month there is a drop in Indian Rupee value when oil importers sell rupees to buy dollars. It's possibly one of the main things that drives rupee value down and dollar value up. We had managed to reach a deal with Iran to buy oil in rupees but it's started happening only recently and in small percentages.

[jbooth]

China's Yuan peg is doing more to prop up the dollar's value than anything else. To maintain their low exchange rate which makes their exports relatively cheaper, they have to continually buy dollars with yuan.

[nhaehnle]

The more important backing of the USD is the fact that the US federal and state governments demand that you pay your taxes in USD.

The (exchange) value of anything depends on supply and demand. Demand for USD comes from many places, but most of those are based on circular reasoning: Employees want to be paid in USD because they need USD for their shopping, the shops want to be paid in USD because they need USD to pay their employees.

Taxations is the only entirely non-circular source of demand.

(Bank loans are a secondary somewhat non-circular source of demand for USD, and that explains why bank loans can increase the amount of money in circulation without increasing inflation.)

[thetwiceler]

I pretty much agree - taxation could be the only non-circular source of demand for the USD. But there is also the fact that the Federal Reserve generates demand by offering to buy USDs for other things when the exchange rate of the USD gets low.

If taxation were the only form of backing, things would be a little more strange. The currency could work, but taxes would have to be defined differently. Somewhere in the tax rules, there would have to be some statement that pins the value of the USD.

[nhaehnle]

You only really have that problem when you want to start with a currency out of nothing. In that context, it might be interesting to study Hut Taxes: http://en.wikipedia.org/wiki/Hut_tax

It is a fascinating problem though, because the price level is really just an arbitrary number when you look at it from a global perspective: If all price tags were removed from everything, an alien observer would have no way of telling it.

This makes a lot of people very uncomfortable, and I suspect that is what underlies a lot of the ultimately romantic desire to tie currency to something "real".

[notahacker]

I doubt it would be that strange.

Presumably you'd control the value of currency through the same channels as under the existing system: indirectly by influencing interest rates, and instead of doing it by the Fed buying and selling bonds, you'd do it by imposing a new variable tax on leverage created by the banking system. It would be painful to adjust to (the base interest rate would be a direct cost rather than an opportunity cost, making banks' margins thinner) but ultimately work in a similar manner to the existing system.

[Daniel_Newby]

There is another source of demand: debtors can force creditors to accept currency as repayment.

[betterunix]

You have that backwards: creditors can take possession of debtors' property if the debtors fail to repay (in terms of fiat currency). Basically, whatever currency the courts deal in will be the preferred currency of creditors, and by extension of debtors.

[judk]

No, if I borrow your car (as a loan, with 100% interest) and refuse to pay it back, the court can seize the one car car, or order me to pay restitution in dollars. If I offer the dollars, it can't compel me to produce another car or give you a piece of my house instead.

[betterunix]

"If I offer the dollars, it can't compel me to produce another car or give you a piece of my house instead."

Sure, but if you cannot (or simply do not) pay your creditors with dollars, the courts can give them a (figurative) piece of your house/car/computer/etc.:

https://en.wikipedia.org/wiki/Lien

[judk]

Yes, figurative. A lien is an attachment, payable in DOLLARS when the encumbered item is sold.

Siezing property happens as a last resort, but doesn't undermine the fact that a debtor can ALWAYS choose to settle a debt in dollars, and can NEVER compel the lender to accept payback in gold or BTC or potatoes.

[Daniel_Newby]

The other comment is not quite right. Suppose I break your iPad without permission. This creates a debt for the cost of replacing it and the incidental losses arising from its absence. If I offer the appropriate number of dollars in repayment, the debt is cancelled, even if the payment is refused.

[JoeAltmaier]

There is no gold in Ft Knox, right? Our currency hasn't been back in 40 years.

Currency has a value because the goods we trade it for have value. Inertia?

[thetwiceler]

There is plenty of gold in Fort Knox!

Our currency has not been pinned to gold for 40 years (when the Bretton Woods system collapse), but the Federal Reserve still maintains the holdings.

Before the Bretton Woods system collapsed, the US government was required to allow large entities to exchange their USDs for gold. Now, it isn't required to. But the fact that the Federal Reserve holds the gold, and that it is well known that they would use it to support the value of the USD, helps maintain the value of the USD.

[fennecfoxen]

Money is money because people believe it is money.

Right now, you can turn in a $20 for food and booze and whatever. I'll believe that's money. And if people don't have a reason to stop believing, it'll continue to be money.

[bradleyland]

The whole "money has value because people believe in it" thing isn't exactly correct. Money has value because somewhere along the line, someone accepted US dollars for something valueable to them. If you're hungry, you value food. When you produce food and allow someone to pay you in US dollars, you've injected value in to the US dollar. The dollars you hold are an abstract representation of the value you provided that you can then exchange for something else of value in the future. The US dollar is a means of accounting.

The term "has value" is used loosely when it comes to currency. It's true that the currency itself is valueless outside the context of trade, but most modern economic theory is predicated on the axiom that this is OK.

Think of it in math terms. Arabic numerals are a means of specifying quantity.

* * * * *

How many asterisks are there? There are 5. The numeral 5 describes the quantity. The number 5 is not literally five asterisks. It only describes the quantity. The same is true of modern currency. $3.50 is not literally a gallon of milk, it merely represents the economic quantity of milk. If I agree to sell you milk for dollars, I'm adding value to the dollar.

When viewed in this way, something else becomes clear. One of the basic values of currency is trust, not "intrinsic value" (which is a euphemism for intrinsic utility). When I add value to the dollar by exchaning valuable goods or services for dollars, I trust that everyone will play by the rules. Specifically, I'm trusting that the value of my trade will be preserved over the term that I hold the dollars.

[fennecfoxen]

That's actually backwards. Money has value because somewhere DOWN THE LINE someone anticipates turning those dollars into something valuable to them. As such they accept it in the stead of that valuable thing.

[judk]

...that's what "believing in it" means.

[bradleyland]

Belief and trust are completely different things.

[JoeAltmaier]

I guess I'm not clear on that.

[nhaehnle]

Taxation is a non-circular source for demand for fiat currency. The value of fiat currency is backed by taxation.