Home > Macro/Monetary Theory > Is Fiat Money an IOU?

Is Fiat Money an IOU?

J.P. Koning has a post (make that two posts) about the IOU nature of bank notes.  While I agree that bank notes (fiat money) are not a Samuelsonian bubble asset, I think he still comes up short of the full explanation of why these are valuable.  Of course I think that I have that explanation but first let me explain why I think his is not fully satisfactory.

The meat of his argument is this.

So in the case of the two central banks that I’m most familiar with, banknotes are ultimately claims on whatever stuff the central bank happens to have in its vaults. This means that on the occasion of the winding down of the Fed or the BoC, note holders are entitled to receive real assets, in the same way that a bond holder or stock holder would have a claim on a company’s property, plant, & other assets upon the dissolution of that company. Banknote holders have an added bonus of being senior to other claimants, since notes provide a “first claim” in the case of the BoC, and a “first and paramount lien” in the case of the Fed.

But this does not fully address the problem.  This is because the process of unwinding a central bank, along with a currency, is fundamentally different from unwinding another type of entity.  Consider an individual bank that issues dollar-denominated bonds and uses the money to buy assets including some “real assets” (land, buildings, gold bars etc.) and some financial assets (loans) and imagine that the default rate on the loans is unexpectedly high and this causes the bank to become insolvent and need to be unwound.

The bonds, in this case represent a senior claim on the remaining assets of the bank.  The question is how much of those assets are the bondholders entitled to?  The answer in this case is straightforward because the bonds are denominated in dollars and the value of a dollar is determined independently from the state of this individual bank.  In other words, you can just liquidate all of the assets (convert them into dollar terms) and then assign that value to the various claimants in the order of seniority relative to the size of their claims in dollars.

If you are unwinding the central bank, you are unwinding the dollar itself.  So let’s imagine that the CB has some amount of gold in its vaults and it has some amount of notes outstanding which are denominated in dollars.  Those dollars are said to be a senior claim on the assets of the bank (the gold) and let us assume that there are some other claims (these may be dollar denominated debt or undenominated equity).  But the notes do not entitle the bearers to a specific quantity of gold.  So how much of those assets are they entitled to?

In this case the assets cannot be converted into dollar terms and divvied up in the same way as with an individual bank because the value of a dollar is not clear.  The whole market for dollars which forms the basis for the valuation of the assets relative to the various claims in the former case is the very thing being unwound in the latter case.  So how much of the gold goes to note holders versus other claimants?  The answer is not at all clear.  So it is hard to see how this claim serves as any kind of foundation for determining the value of a dollar.

The actual explanation for the value of fiat currency, which I have been trying to argue, (also here) I think is actually fairly simple but seems to be absent from all discussion of the topic.  One dollar is precisely what is required to extinguish one dollar worth of debt.  When money is created, there is always a corresponding debt created.  The central bank creates base money by buying government debt or MBS or lending to banks.  Banks then “multiply” this money (create additional money) by making loans to businesses and consumers.  But these loans eventually need to be paid back.

When a person takes out a mortgage the money supply (some measure of the money supply at least) increases.  But this also sets in motion a 30-year process by which that person must grab money back out of the economy and pay back the loan.  If they don’t do this, they will lose their house.  In this way the increase in money is accompanied by a built-in increase in demand for money in the future.  And in this sense money is “backed” by real assets.  In this case the borrower is able to “convert” dollars into his house at a specific rate.  It is just that this rate, and the convertible asset, varies from person to person rather than applying uniformly to everyone.

This demand for money to repay loans is fundamentally different and separate from the demand for liquidity (though demand for liquidity also factors into the value of a dollar).  It is also not based on any kind of “greater fool” or “bubble” mentality.  It is (at least to some degree) stable in the sense that it does not depend on mysterious, arbitrary feelings about the value of a dollar.  The amount of debt owed is a real number that is denominated in dollars.  It is the product of actions that have taken place over a long period of time and it doesn’t suddenly change drastically or disappear because people “lost confidence” in the dollar.

This in fact explains why people don’t lose confidence in the dollar.  If the value of the dollar were based only on the expectation that someone in the future would accept the dollar at a given rate in exchange for goods and services and that belief were suddenly called into question for some reason, the “bubble theory” leads us to believe that everyone would start trying to get rid of the dollars and the value would plummet.  But if this happened, we would find that many (most) people would actually try to take advantage of the newly weak dollar by exchanging newly valuable (in dollar terms) goods and services to get the dollars to pay off their debt.  In this sense, that demand is backstopping the real value of the dollar and because of this, that scenario never occurs (at least in major “developed” economies).

This also solves the unwinding issue.  Imagine that we wanted to abandon the entire system of central banking we currently have and replace it with nothing, no new fiat currency, just whatever the market wanted to use.  We stop creating new dollars and set a date by which all current debt obligations have to be settled using the current supply of dollars.  These dollars would not become worthless, people would be trying to get them before that date to pay off their debts and keep their homes, cars, boats, businesses, etc.  This would mean that there would still be a market for them in terms of other (real) goods.  You might have to refinance your mortgage in some other terms (gold, silver, Yen, whatever) but this would be better than defaulting and losing it all together.  The quantity of dollars would not exactly match the quantity of debt (I suspect it would actually be much less but haven’t been able to quite figure out the right way to observe this) so there would probably need to be some method of settling the excess dollars/repossessed property, and the whole thing would admittedly be pretty messy, especially the issue of how to treat government debt which is not collateralized and makes up the bulk of CB balance sheets, but when you look at it this way, I think you can see that dollar denominated debt (and the collateral backing it) is the main factor guaranteeing the value of the dollar.

In this way a dollar can be said to represent an IOU but I see it as exactly the opposite.  Rather than an IOU from the bank, it is a means of extinguishing an IOU to the bank.  It can be seen either way because the two look the same on the bank’s balance sheet.  If the bank takes in gold and hands you an IOU redeemable in gold the gold goes on its balance sheet as an asset and the IOU as a liability.  If you take out a loan, you are essentially writing an IOU to the bank for a quantity of dollars and the bank hands you the dollars.  In this case, the loan goes on as an asset (account receivable) and the dollars go on as a liability to balance out the new asset.  The gold IOU in the first case is a liability because it can be brought back and redeemed for the asset (gold).  In the second case, the dollar is a liability because it can be brought back and redeemed for the asset (debt).  In both cases the rate at which this redemption occurs is fixed and not subject to market fluctuations.  The accounting is the same but the meaning is somewhat different and this seems to me to be why people have difficulty seeing dollars as an IOU.

  1. March 1, 2014 at 9:52 am

    You are right but there is a big problem you have not mentioned. If you are backing a currency with long term bonds, then you are really backing the current value of the currency with the future value of the currency. If people begin to think there will not be a future value of the currency, then the bonds can drop in value and so the current value of the currency goes down too. And the more this happens, then the more the bonds drop in value. And the more the bonds drop, the more the current value drops. You can get a death spiral that is hyperinflation.


    • Free Radical
      March 2, 2014 at 7:07 am

      This is actually a criticism I have made of other theories. I am not arguing that it is just long term bonds backing the currency. It is ultimately the assets backing all of the debt (the collateral) which is backing it. Like I said, when someone takes out a mortgage they are locking themselves into a position where dollars are “convertible” into their house at a fixed rate. This is a direct connection between dollars and real assets that is fixed and does not fluctuate with market conditions.

      • May 15, 2017 at 1:58 pm

        I’m amazed, I must say. Rarely do I encounter a blog that’s both educative and interesting, and without a doubt, you’ve hit the nail on the head. The problem is something that not enough men and women are speaking innltligeetly about. I am very happy that I came across this in my search for something relating to this.

      • May 31, 2017 at 6:14 pm

        he was out of work. I’ve read studies that men sometimes kill their families when faced with being unable to support them. They’d rather they be dead than have to struggle to survive. And it’s rare that a baby that young is killed unless it was by a relative. Still, what a sad, sad story. These types of stories always make me hug my daughter a little tighter.

  2. March 2, 2014 at 2:57 am

    Just a few thoughts.

    I like John’s description of your idea as private debt chartalism. Bits of paper can earn value intrinsically or extrinsically. Backing is intrinsic while chartalism is extrinsic. In the case of chartalism some external body, say the the sovereign, sets a liability that can only be extinguised by proferring a certain piece of paper. Your debt story is the same, except the external institution that requires settlement with notes is the private debt market.

    I wrote a post a while back on how the requirement to settle debts (legal tender laws) might give bits of paper some positive value. In theory it makes sense, but I don’t think that the value of modern banknotes are actually determined in this way. I do think that the requirement to settle debts with banknotes does add a liquidity premium to the value of modern banknotes.

    Some criticisms:

    1) So why do we observe central banks holding assets? If the value of banknotes is maintained by the demand to settle debts, then it would be redundant to own assets. Your theory would seem to imply that the world’s 170+ central banks are acting irrationally.

    2) What anchors the price level? Why does $1 buy one apple and not $10 apples? Does a Canadian dollar by 0.98 US dollars because there are less debts to settle in Canada?

    3) How do you explain inflation? I can explain it by saying that the central bank targets a 2% rate of decline in banknotes, and that it reduces the backing of notes. Your route will be much harder. Does a currency inflate because there are fewer debts that must be settled? Does it deflate because more debts come into existence?

    4) Why are deutsche marks still valuable? There are no longer any mark-denominated debts, so according to your theory, marks should be worthless, or close to it. Yet if I offered to unburden someone of their deutsche marks without offering anything in return, they’d laugh at me. That they remain an IOU is the most likely explanation for this.

    5) How do you explain the debut of a new currency? Perhaps the demand to settle debts with a certain brand of note would give an initial value to those notes, but why would anyone denominate debts in a currency that as-yet has no value? There’s a circularity problem here. There’s no way to kickstart a new banknote into existence if it doesn’t already have some positive value.

    [Cross posted at http://jpkoning.blogspot.ca/2014/02/when-money-ceases-to-be-iou.html%5D

    • Free Radical
      March 2, 2014 at 6:54 am


      Firs, thanks for reading. I think I can answer all of these critiques but I will probably have to write a longer post, I will try to do so briefly here. I agree that it is similar to chartalism, I also think they are close to the truth but missing too focused on taxes and missing the more significant issue of debt.

      4) One of these two explanations: Either they are still convertible into Euros (I recall that you showed some currencies are, don’t remember which ones) and Euros are the current medium of settling debt. Alternatively, they may have some collectible value.

      1, 5) You start by issuing notes backed by a hard asset and when there is enough debt built up relative to outstanding notes, you withdraw the backing (with the help of the government). Does this require more explanation? Yes. Is that how fiat currencies have actually come about? Also yes. Do CBs actually need to hold gold to maintain the value of fiat currencies? Probably not but this may not be the only reason for them to do so.

      2, 3) When debt expands, it creates more money immediately but creates demand for money to pay off debt in the future. The people who take out this debt do so based on the expectations about the ease of getting money in the future to pay off the debt (for instance 2% inflation). In order to create this, the CB has to continuously create more and more money by creating more and more debt. The debt someone undertakes today creates “new” money which someone who undertook debt in the past tries to get in order to repay. The CB uses monetary policy to balance the new debt/money being created today relative to the debt owed from previous periods. This is why the money supply has to grow exponentially or else the whole economy collapses. There is a an explanation of business cycles here and also liquidity traps. Again, these require more explanation, I realize that.

      I think you can also pin down the value of a dollar here but it requires a fairly big model. Does your backing theory really pin down the value of a dollar? I do think that the value of a U.S. dollar relative to a Canadian dollar is related to the respective quantities of debt and dollars in each country. Do you think it is directly related to the quantity of gold each central bank has in their vaults? That seems like a much more difficult case to make to me. (For the record I suspect the gold they have is roughly proportional to the quantity of currency they have in circulation anyway so an empirical test that clearly distinguished between these two models would have to be carefully designed)

      • March 2, 2014 at 11:38 am

        “Do you think it is directly related to the quantity of gold each central bank has in their vaults?”

        No, of course not. As I’ve said a few times, the key IOU attached to a banknote is the promise of a guaranteed price in the secondary market (ie. about -2% a year return), a promise enforced by sales of assets that the bank keeps in its vaults (or purchases that add to those assets).

      • Free Radical
        March 2, 2014 at 7:23 pm

        So we both agree that the CB determines the value of a dollar by buying and selling assets (changing the quantity of dollars). But I don’t see how your theory pins down a specific value of the dollar better than mine does. I think the opposite is true. But in reality, I think we both essentially believe that this value is determined by the supply and demand for dollars, the only question is “why is the demand what it is?” I believe you can construct a realistic looking demand for money (not currency but money more broadly defined) based on outstanding debt (along with the other obvious stuff like output, interest rates, inflation expectations and liquidity preference). If you only talk about the real assets of the CB or the gov. bonds on their balance sheet, I don’t see how you get to such a demand curve without resorting to some sort of “bubble-mentality” (it is valuable because people assume that the CB will maintain its value).

      • Free Radical
        March 2, 2014 at 8:49 pm

        For the record JP, I didn’t think that you thought the value of a dollar is directly related to the quantity of gold in the vault, I just though that your criticism regarding determining a specific value of a dollar was odd. I will respond to this in more detail shortly.

      • March 3, 2014 at 2:36 am

        “I will respond to this in more detail shortly.”

        Look forward to it.

    • Free Radical
      March 2, 2014 at 7:01 am

      For the record, this type of money wouldn’t necessarily have to start out being backed by real goods (theoretically). I tried to explain a hypothetical case of impromptu fiat money in this post.


      “Same community, same person A, but now instead of printing his own widget-notes, he goes to his neighbor (person B) and says he needs a loan. Person B has no money of course, since none exists yet, but he has an idea. He prints some notes of an arbitrary denomination and gives them to person A. In return, person A promises in writing to return all of the notes to person B in one year or else person B gets the factory. Person B then takes the notes and offers them in return for the labor and materials required to build the factory.

      The question of course, is: why would anyone accept these notes in return for real goods? After all, they do not legally entitle the bearer to any specific quantity of any good. However, they are still backed by real goods. To see how, consider what will happen in one year. Person A will need to get the notes in order to keep his factory. This means that he will be willing to trade real goods (most likely widgets but possibly other goods as well) in order to get the notes back to pay his loan. Therefore the notes will be valuable.”

      However, as far as I know such a thing has never occurred. But the answer to “how does it happen” is the same no matter what your explanation is for how fiat money has value. It used to be backed by gold and then one day they said it isn’t any more. The question is why did that work? I think the theory I am describing here explains that.

  3. J Thomas
    March 2, 2014 at 3:20 pm

    Why do people accept fiat money? For the exact same reason they buy MicroSoft products. Because everybody else does.

    That’s all it takes. When you use money you have to maintain compatibility with everybody else. And so does everybody else. Even if there are some big annoying flaws, you can’t switch to something else until the people you have to be compatible with switch.

    Imagine you go to the grocery store and you want to pay with Krugerrands. Can you do it? Of course you can. There will be somebody in the store who will trade you dollars for Krugerrands at some rate, and so you can buy. Likely you can make some kind of deal with the store manager. You probably won’t get as good a deal as you’d get on a gold exchange (or maybe you’ll get a much better deal!). But of course nobody tries to spend Krugerrands. They’re an investment, not a medium-of-exchange.

    How do people get started accepting a fiat currency? It depends. It varies. Americans accepted Continentals backed by nothing when the Continental Congress could not tax, because they were patriotic or something. Then as the war dragged on and supplies got tight the things bought less and less.

    Southerners accepted Confederate money backed by nothing when the Confederacy could not tax, because they were patriotic or something. It worked fine for awhile. Then as the war dragged on and supplies got tight the things bought less and less.

    Starting points don’t have to follow any particular rules. Sometimes people will do things for irrational or at least uneconomic reasons. And once they settle in they keep doing stuff that works. Continentals and Confederate money didn’t keep working because the physical economy was collapsing and there wasn’t enough to go around.

    Why do people stop using a currency? Because it stops working. For example, they depend on imports that stop arriving, and their economy collapses. When you don’t want to sell, no amount of money is enough to get you to sell, and having astronomical amounts of money available just makes the money seem worthless. There are multiple ways for it to stop working, but the point is that people will keep using a currency while it does work.

    Something like Gresham’s law applies. Given two currencies, where one of them holds value better, people prefer to trade the one that inflates faster and hold onto the other as something like an investment. But at some point some commodities won’t sell at all for the inflating currency. You wind up with a two-tier economy, where people who can only get the trash money can only buy cheap trashy stuff with it; they are locked out of the luxury economy which runs on elite money.

    But as long as the cheaper currency is acceptable, the better money is an investment and not really a currency. It’s like spending Krugerrands.

    I don’t think it takes a lot more analysis than this.

  4. Free Radical
    March 2, 2014 at 8:01 pm

    J Thomas,

    “Sometimes people will do things for irrational or at least uneconomic reasons” is an incredibly unappealing explanation if you are an economist. This is like saying “things just happen, they can’t be explained.” If that is the case, there is no point in doing economics at all. People have imperfect perception and their motivation is not always obvious but it’s essentially impossible to conceive of a fundamentally “irrational” or “uneconomic” actor. The theory you are putting forward is not a theory of irrationality, it is basically a “network effect”/”greater fool” theory in which money is essentially a bubble asset. This is exactly the type of theory that both Koning and I find uncompelling.

    • J Thomas
      March 2, 2014 at 9:28 pm

      ““Sometimes people will do things for irrational or at least uneconomic reasons” is an incredibly unappealing explanation if you are an economist.”

      Yes, I can understand that. At least, I’m positing that people are doing that in unusual conditions, when a new currency is established or when people desert it. Most of the time people accept an existing currency because they know most other people accept it, which is a rational and workable reason.

      I have examples where people accept money that by any economic standard I would expect they should not — continentals and confederate dollars. Then over a period of years as they find that it does not work for them, they stop, and they tend to stop kind of suddenly — people stop accepting bad money about the same time everybody else does.

      About the same time they did other things that seem irrational — like get into a war they are likely to suffer from, that they might lose entirely — they also accepted money with no backing except the word of a nation that in neither case lasted long after the war.

      So I say currencies can get started or ended in unusual circumstances when people may choose to do things for uneconomic reasons. It happens. It may seem unappealing but you can live with it or pretend it isn’t there.

      But in the usual case people accept the currency that everybody else is accepting because everybody else accepts it. This is rational and economic. You use the medium of exchange that other people feel comfortable exchanging with you. Why would you use anything else? So long as the currency that everybody else is using is adequate, everybody will go on using it. That’s almost the end of the story.

      But it should be interesting to look at cases where people stopped using a currency, and look at what happened to make it so unsatisfactory that people stopped using it. We have examples. Often it is a nation is losing or has lost a war. They have no good choices. The local economy cannot make much or it is forced to export much of what it does make. There is not enough to go around at the same time that there is lots of scrip and also people lack trust in the government which is losing or has lost.

      Doesn’t it make sense? Sometimes people successfully ignore the economic realities for awhile. If those realities intrude too much then people are eventually forced to accept them. People accept new currencies when they are ready to believe the new currencies will work. Then as long as it does work they keep using them.

  5. J Thomas
    March 4, 2014 at 9:28 pm

    After reading more of your material, I see that I have been talking past you. You asked why money is valuable. I answered that people find money valuable as a medium for exchange because other people accept it as a medium for exchange. They’ll keep doing it as long as it works.” This is correct, but it is not really the question you were asking.

    You ask something more like “What are the objective realities that let the money keep working as a medium for exchange? Is this more than a Ponzi scheme? *Are* there objective realities involved beyond everybody’s acceptance of the status quo?” And I did nothing at all to answer that.

    Your answer is first, that there is a buffer. Lots of people owe lots of money, and if the value of money starts to decline then they will grab as much as they can so they can pay off their debts. Since they want to pay their debts cheaply, they will drive up the value of money if it starts to fall too low. That sounds plausible.

    Except — if I think inflation will be high relative to the interest rate I can lock in now, then I want to take out more loans, not less. I want to pay off my loans if I have money now and I’m not confident I’ll have money later. Then I cut my consumption and pay.

    If I think there’s a chance that people will reject the currency altogether? Then I spend as fast as I can! Later if I want to pay off my dollar-denominated loans I can sweep up the money off the streets where other people have dumped it. If I think the value will go way down then I don’t worry about my loans. I want to buy portraits of Elvis on black velvet and cans of tuna fish, things I can barter with later.

    I think maybe it isn’t consumers who pay off their loans fast when the value of the money starts dropping.

    Businesses? Say you run a business and you have some profits, and the money is inflating. Do you use your profits to pay off loans? If you have low-interest loans locked in, then no. Do you distribute it as dividends? Maybe. You will have to spend more money to make the same amount of stuff, and hope you can sell it later at a high enough price to justify the expense. With inflation it’s predictable your interest rates will rise, so if you’re taking out loans to meet expenses and then paying the loans back out of revenues, it might make sense to retain your profits for that. If interest rates rise too much then you’ll wind up paying a higher real rate, and how much do you trust your estimates of how much inflation will rise? Safer to keep some of your expenses within your own control.

    I’m not at all sure the feedback loop works this way. If for some reason prices start to rise, I’m not sure people automatically pay off more loans to adjust prices downward. There are a whole lot of inter-related variables and I don’t know how important that relationship is.

  6. J Thomas
    March 4, 2014 at 11:22 pm

    But maybe I’m still looking at the wrong question. Why to people accept fiat money? That isn’t it. What control mechanisms maintain the value of fiat money? Not that either.

    Maybe it’s more like this: Does fiat money have any objective value, or is it only subjective?

    If you have a gold coin its value does not just depend on how much people trust the government. The gold can be warmed by your hot little hand, and people will trade for the gold no matter whose face is on the coin. The coin’s value as *money* depends on people’s trust in the government because they trust the mint to maintain purity standards. If it looks counterfeit they don’t want it. If they think the mint has started putting too much lead in the gold coins then they stop trusting them. But still, it’s your gold. There’s some kind of objective value there which fiat money doesn’t have.

    Well but some people say all value is subjective. Let’s ignore that for now. If the value of fiat money is only that people believe it’s valuable as a sort of shared illusion, then at any time they could wake up from the illusion and decide it’s worthless, and then where would we be? Gold is somehow less of a shared illusion than fiat money.

    You want to say that fiat money is created by loans, and it is backed by the things people borrowed money to get. That might have some philosophical importance. When you take out a loan and you put down collateral, the loan is backed by the collateral. So that’s something.

    I say, fiat money is backed by everything that’s for sale. If I go to Walmart and I have $4, I can buy a gallon of milk. I can buy 4 packages of Peeps. I can buy five 6-ounce cartons of strawberry yogurt. A pound and a half of hamburger with 27% fat added. A frisbee. A quart of motor oil. A pound of fake honey. Fifteen ounces of Frosted Flakes. A five-ounce container of roll-on deodorant. Two pairs of socks. One plair of flip-flops. An orange green and blue plaid scarf. A set of nail clippers. Ten pounds of charcoal.

    All that consumer trash backs the fiat money. The money is backed by everything I can buy with it. If I want something from Walmart and I don’t have money, I must shoplift or do without. And sometimes people get caught shoplifting and pay a whole lot.

    That’s what backs the money. And if China devalues the dollar so Walmart costs more? The Fed can do some things to try to keep prices stable. There are things the Fed can do, but each control mechanism works within limits and once parameters get outside those limits then the control doesn’t work well.

  7. Free Radical
    March 5, 2014 at 9:40 pm


    I think of the question sort of like “is the real value of the money supported by anything other than self-reinforcing confidence?” Another way of coming at it would be to ask “is there any real connection between money and “real goods” that would prevent the value of a dollar from falling to nothing (or at least dramatically less than it is now) if people suddenly began to question whether the next guy would accept it (holding all other things constant)?” My answer, put simply, is yes, the value is supported by the debt which it is capable of extinguishing. The important points to notice are that the debt is nominally denominated (doesn’t change with market conditions) and backed by real goods (collateral).

    For the record I think sometimes things manage to have value without being supported by any such thing. For instance, I have said (and still say) that bitcoin won’t work out because it is an attempt to create exactly the kind of “bubble currency” that many people claim, erroneously, that all fiat money is. Yet they are still valuable (for now). Same thing with the classic Dutch tulip story. But these things don’t last a hundred years. And more importantly, if we want a theory to explain why they happen, it can’t be based on “irrationality.” I think I will do a post sometime in the near future about the role of rationality in economics and bubbles and the efficient market hypothesis.

    • J Thomas
      March 6, 2014 at 12:38 am

      I think of the question sort of like “is the real value of the money supported by anything other than self-reinforcing confidence?”


      And I say that people’s sunk costs in dollars does not support “real” value of money.

      If I have a mortgage denominated in dollars and then dollars start to be less valuable, my immediate response is “Great! Wonderful! Cheap dollars means my mortgage won’t cost me as much.”

      Unless of course I am an employee and I’m not in a good position to negotiate for raises. Then my immediate response is “Oh no! How am I going to eat?”

      “is there any real connection between money and “real goods” that would prevent the value of a dollar from falling to nothing (or at least dramatically less than it is now) if people suddenly began to question whether the next guy would accept it (holding all other things constant)?”

      Yes. As long as I can go to Walmart and buy whatever Walmart has for sale at about the price I could do it yesterday, then the money has value for me.

      “My answer, put simply, is yes, the value is supported by the debt which it is capable of extinguishing.”

      No, if I think other people won’t sell stuff to me for dollars, and if I think dollars will be easier to get because people don’t want them much, then that doesn’t support the value of dollars much at all. If somebody else throws his dollars on the street because he thinks they’re waste paper then sure, I’ll pick them up and pay my mortgage with them. But it doesn’t mean I value them much. I value dollars because they are a working medium of exchange. Meaning I can buy things with them.

      If the time comes that people won’t take my dollars then I won’t want them much. I’ll gladly slave away for $50/hour when my money will buy anything in Walmart. If my dollars won’t buy stuff then I’d rather work for something that will buy stuff. If I can get a currency that Walmart accepts that I can also convert into dollars at a good rate, then fine! I want that currency. If I work for dollars but Walmart and McDonalds won’t take dollars, and I get a bad rate exchanging dollars for the currency that they do take, I’m going to be disgruntled.

      “is there any real connection between money and “real goods” that would prevent the value of a dollar from falling to nothing (or at least dramatically less than it is now) if people suddenly began to question whether the next guy would accept it (holding all other things constant)?”

      Under normal circumstances people won’t start to question whether the next guy will accept dollars. They have every reason to think he will. If Bill Gates and Warren Buffet and T. Boone Pickens and Steven King all went on TV together and announced that the US dollar is about to be worthless and they’re all switching to Polish zlotys as fast as they can, a lot of people might panic. But next morning if McDonalds still sells a McGriddle for dollars, they’ll panic less. Trading in their dollars for zlotys will start looking less like something they need to research how to do right away.

      Within a few days they’ll be laughing about it. What does Bill Gates know?

      Maybe there’s a chance they really would panic and try to get rid of their dollars. But how can they? If Walmart won’t sell for dollars, what will they accept instead that people can give them? People have dollars to spend, and they don’t have anything else to spend. They had better hope that McDonalds will take dollars because if it won’t they have no other way to get a Big Mac. If dollars turn worthless they are screwed. So they must live on hope.

      Hyperinflation does not happen because people stop believing in the money. Most people stop believing in the money after they experience hyperinflation, and not before.

  8. March 6, 2014 at 12:14 am

    Am I able to sign up to the articles you write?

    • Free Radical
      March 6, 2014 at 9:32 pm

      Great question! I think so…. (I’m still figuring out this whole blogging thing haha). I have had some people subscribe in the past though because when I post things it says “a notification has been sent to X people who subscribe to your blog” so there must be a way. I’ll try to figure it out. You can also follow me on twitter @RealFreeRadical I try to always tweet new posts.

      • May 15, 2017 at 2:14 pm

        Have you given any conerdsiation at all with translating your web page in to Chinese? I know a few of translaters here that would certainly help you do it for free if you wanna get in touch with me personally.

    • Free Radical
      March 6, 2014 at 9:34 pm

      When I look at the main page there is a link in the upper left that says “follow.” Not sure exactly what it does… It might be a wordpress thing that you have to be signed in to use.

  9. J Thomas
    March 15, 2014 at 12:47 pm

    I might have finally gotten the point about debt.

    I was thinking, OK, you can buy stuff with dollars, you can pay debts with dollars, two reasons to value dollars. Kind of equivalent.

    BUT — let’s simplify. There’s one bank, and it lends a billion dollars at 6% simple interest. So there is 1 billion dollars circulating in the economy. After one year, debtors owe $1,060,000,000 but there is only $1,000,000,000 in existence. Is there any possible way for them to pay off their total debt? No. Every time a debtor pays a dollar he owes to the bank, that dollar vanishes. The extra cannot be repaid because there are not that many dollars in existence.

    Well, but the bank can pay to have its vault refurbished, and it can replace the black marble with pink granite etc. It can pay money to its owners who spend the money. But for simplicity let’s say it doesn’t do any of that. Its debtors owe it banknotes that there is no way for them to get.

    Unless the bank lends them the money. If the nice bank wants to get out of the banking business, it can lend them $60,000,000 and next year they will owe $360,000 that there is no way they can repay. It dwindles each year.

    More likely, though the bank instead lends more like $1,060,000,000 or even more. So next year the interest owed is $60,360,000 for a total debt of $1,120,360,000 and as before 6% of it cannot be repaid because there aren’t that many dollars in existence.

    Imagine that people start trading in some other currency they like better. The value of banknotes can’t go down too far, because debtors *need* banknotes. The bank doesn’t have to accept any other currency. The exchange rate *cannot* fall too far, because debtors need more banknotes than they can get. If they must all pay off their yearly loans before any new loans are issued, something like 6% of them will be stuck without enough banknotes and must fail, losing their collateral. Depending on how the bidding for banknotes goes, possibly all of them might fall 6% short and they all fail.They will be desperate for dollars. They have to bid up the price of dollars as high as they can, up to the point that it costs more than it does to lose the collateral and their credit rating etc.

    It’s like a short squeeze.

    It’s utterly different from merely having the opportunity to spend your dollars at Walmart. Debtors will be desperate for bank money. Because they will lose their collateral without it, and there is not enough to go around.

  10. March 24, 2014 at 12:18 am

    The debt that drives the value of a fiat currency are tax obligations. Without taxes to support it, the currency will become worthless. I assume that’s not what a libertarian wants to hear, but that’s the way the existing system works. For example, hyperinflations are typically associated with countries running fiscal deficits of around 50% of GDP.

    • Free Radical
      March 24, 2014 at 7:13 pm

      I can only assume that you haven’t read anything I’ve been writing here since you aren’t addressing any of my arguments you are just stating the basic principle behind MMT which you probably assume incorrectly that I am completely unaware of. I am tempted to try to explain how tax obligations are only a small portion of the debt which is denominated in fiat money and requires that money to repay but I’ve been doing that so if you are interested, it’s all there waiting for you.

      P.S. What I “want to hear” as a libertarian has nothing to do with any of the arguments I am making.

      • J Thomas
        March 24, 2014 at 8:50 pm

        “I am tempted to try to explain how tax obligations are only a small portion of the debt which is denominated in fiat money and requires that money to repay but I’ve been doing that so if you are interested, it’s all there waiting for you.”

        I think there are a collection of related questions here, and you have given a good answer to one of them.

        If we ask why do people accept money, I think most of them trust the money without a second thought because everybody else does. Like they trust people to drive on the right side of the road.

        If we ask why doesn’t the money inflate so fast that people stop trusting it, then Brian’s idea has some merit. If the government spent money at the rate it currently does but collected no taxes, something would have to give. They could sell a whole lot of T-bonds to pay for it all, but could the Fed really keep interest rates low and money supply reasonable both at the same time, in that case? Taxes are used to pay for some of the spending, and the effect is to withdraw money from the system.

        Your idea is important for people who want to stop using dollars. Not only do you have trouble buying things with your replacement money, but you need dollars to pay your debts. You can get by without buying, but you have to pay your debts.

        Suppose now that the banks wanted to switch to a new currency, call it Batcoins. Your banker calls you in and says “About that loan, you want to renegotiate it?” He talks with you about it some, and then at some point he says “This is the exchange rate. Here’s your equity and here’s what you owe. Here’s the rate we’ll give you. That’s the deal” and he bangs his fist on the table. You can take the deal and start paying in Batcoins or you can refuse and keep your existing contract in dollars.

        The reason the existing contracts in dollars locks people into dollars is that creditors want it that way. If creditors and debtors agreed, they could switch to something else pretty easy.

  11. Clay
    January 13, 2016 at 2:39 am


    If the bank is unwinding they would just issue people their assets (gold) in accordance to the percentage of the dollars the bank issued.

    When a person takes out a mortgage, the money supply does not change? The bank originally bought the house from someone, he has that money.

    • Free Radical
      April 2, 2016 at 2:59 am

      Yes it does but it depends what you mean by “the money supply.” The money base doesn’t change but the broader money supply increases.

  12. Free Radical
    April 2, 2016 at 3:03 am

    J Thomas: (Sorry it’s been a while.) The banks can’t switch to batcoins because the central bank requires them to have enough dollar denominated assets to back their liabilities (deposits). If they were independent of the dollar system and the central bank, they could theoretically issue debt in batcoins but they would have to create the deposits and the debt both in batcoins (or whatever). One might argue that there’s no reason to do that because dollars work fine but if you were trying to create a parallel system, I would argue that you need to have debt backing it which is why I think bitcoin will eventually fall apart. But in fairness, it has lasted longer than I thought originally….

  1. March 3, 2014 at 8:40 pm
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  3. April 9, 2014 at 4:13 am
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