[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.