Editor’s Note: With tax season well upon us, money manager Jon Shayne presents a timely way for understanding how and why American currency has value. Simply put, we need dollars. That’s not like saying we need money to obtain food and shelter to survive — that’s obvious. Americans have to pay their taxes in U.S. dollars – and nothing else. You cannot barter vegetables, and while Bitcoin can buy you plenty else, you cannot send crypto-currency to the government. (The IRS recently announced it will treat Bitcoin as property, not currency.)
Jon thinks a lot about the value of money and the nature of money printing. He also sings about it, dressed up as his alter ego, Merle Hazard. We featured his “Inflation or Deflation” song in our segment on interest rates. Our econ-crooner’s latest tune is about the Fed’s “Great Unwind.”
The Fed may not need more money, but in this adaptation of a topic first explored on his blog, Jon explains why Americans need dollars.
— Simone Pathe, Making Sen$e Editor
Have you ever wondered why the U.S. dollar has value?
It is not because of the gold in Fort Knox. There used to be gold behind the dollar, but not now. President Richard Nixon cut the last ties in 1971, effectively ending the foundation of the Bretton Woods international monetary system.
Rather, the ultimate reason that the U.S. dollar has value, at least in the opinion of some economists, and in my own, is that no one likes being in jail. And dollars are a get-out-of-jail-free card.
April 15, when Uncle Sam collects taxes on our incomes, is right around the corner. We must pay those taxes in dollars, and there are penalties for not paying them, which can include time in prison.
On the front of U.S. currency, next to each president’s head, are the words “This note is legal tender for all debts public and private.” Creditors must accept dollars in payment of what they are owed. Tax is just one of the obligations that cash satisfies, but it is, in a sense, the ultimate, because it is to the government itself.
Now, you may think that you can skirt having to use dollars by, say, growing your own vegetables and bartering for everything else. Not so. Tax is due even if you make your way in the world by trading goods without cash. If you want to stay legal, you will need to sell something, perhaps your labor, to get some of those all-paper dollars. (Or their electronic equivalent, bank deposits.)
Court opinions, like dollars, are words on paper, but they are not just words on paper. If a final court decision condemns you to years in prison, you will, in fact, have to do time. So, a court opinion, despite consisting only of words, means a lot more than a greeting card. And courts, interpreting the law, are what give the dollar its power to satisfy financial obligations.
Beyond the court system, there is a social component to the value of a paper currency. The purchasing power of the dollar will change in response to inflation, as more dollars get created, and in response to the value of other currencies. Those changes are generally going to be gradual, however. I am not claiming that the extra-legal influences on the value of the U.S. dollar are insignificant. It is just that the need to come up with some cash to pay taxes is, practically speaking, absolute. Only the amount might be subject to a court’s interpretation. You could be arguing with the IRS about, say, how much the nursing care you bartered for with your homegrown vegetables is worth, but there would be no successful dispute about your owing something.
To understand the value of the dollar, it is instructive to consider how U.S. dollars are different from bitcoins. We do not need bitcoins to stay out of prison, and U.S. law is unlikely to ever recognize them as legal tender. Granted, bitcoins are elegant and, in their wonky way, beautiful. But many things are beautiful. Bitcoin is not even the only crypto-currency.
Few people, in my experience, consider taxes to be the grounding for the dollar’s value. Most people just don’t think about it. However, Paul Solman, the master of the bits on this page, touched on the idea last year in an interview with Boston University finance professor Zvi Bodie.
Adam Smith, the father of economics, had the same idea in 1776. He wrote in “The Wealth of Nations”:
A prince, who should enact that a certain proportion of his taxes should be paid in a paper money of a certain kind, might thereby give a certain value to this paper money, even though the term of its final discharge and redemption should depend altogether upon the will of the prince.
These days, the easiest place to stumble upon the idea that taxation is the basis of money’s value is in a somewhat obscure school of economics called Modern Monetary Theory. MMT is, I think it is fair to say, just left of mainstream, and builds upon this idea as it makes a case for greater government spending. One prominent proponent is Jamie Galbraith, an economist at the University of Texas.
I am not sure why the idea of the dollar as a get-out-of-jail-card gets so little, um, circulation. But I have found it helpful, myself, as a money manager. It keeps me from freaking out at the necessity of, sometimes, holding cash in a portfolio while looking for other investments. There is still the possibility that the government – the “prince,” as Adam Smith put it in the passage above — will print too much, and that purchasing power will erode quickly. Still, dollars are better than bitcoins because like death, as Benjamin Franklin taught us, taxes are unavoidable. If the government were weak, we might worry, but ours is very strong.
Paying taxes this month will get us down. We can take comfort in the idea that the need to pay them is much, and, as I see it, most, of what gives our paper currency its value.