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Fiat Currency and Intrinsic Value

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‘Yes, but Bitcoin has no intrinsic value,’ is a comment I hear a lot from
people trying to understand why Bitcoin has a price. However, it is not a
very good argument against Bitcoin. Fiat currencies—USD, GBP, EUR,
etc—have no intrinsic value either. In fact, fiat currencies are defined by
not having intrinsic value.
That is worth repeating. Fiat currency has no intrinsic value.
But that is ok! On the European Central Bank’s (ECB) website44 you can
Euro banknotes and coins are money but so is the balance on a bank account. What actually is
money? How is it created and what is the ECB’s role?
The changing essence of money
The nature of money has evolved over time. Early money was usually commodity money—an
object made of something that had a market value, such as a gold coin. Later on,
representative money consisted of banknotes that could be swapped against a certain
amount of gold or silver. Modern economies, including the Euro area, are based on fiat
money. This is money that is declared legal tender and issued by a central bank but, unlike
representative money, cannot be converted into, for example, a fixed weight of gold. It has no
intrinsic value—the paper used for banknotes is in principle worthless—yet is still
accepted in exchange for goods and services because people trust the central bank to keep the
value of money stable over time. If central banks were to fail in this endeavour, fiat money
would lose its general acceptability as a medium of exchange and its attractiveness as a store
of value.
The St Louis Fed, in episode nine of a podcast series called Functions of
Money—The Economic Lowdown Podcast Series, says:
Fiat money is money that does not have intrinsic value and does not represent an asset in a
vault somewhere. Its value comes from being declared ‘legal tender’—an acceptable form of
payment—by the government of the issuing country.
So next time someone brings up intrinsic value, try to be patient and
explain that intrinsic value doesn’t really matter. What matters is if there
is utility in the asset. How useful is it? Well, fiat currency is useful, at the
very least because it is the settlement instrument with which you pay your
taxes to the state, and more broadly because it is legal tender and must be
accepted by merchants.
If you don’t pay your taxes you go to prison, or worse. So some people
argue that fiat currency is backed by the threat of state violence. Other
people say that fiat currency is backed by the trust and confidence in state
institutions—which is a little bit vague, don’t you think? But at least it
sort of makes sense, unlike the cryptocurrency favourite: ‘Bitcoin is
backed by math’—which is entirely nonsensical. Although at first it
sounds kind of profound, don’t stop to think about what that means.
Mathematics is used to determine which transactions are valid or not,
and is used to control the speed at which bitcoins are created, but this is
not a ‘backing’ in the sense that a bond is backed by the issuing company,
or a US dollar is backed by the assets on the Federal Reserve’s balance
sheet, or a startup is backed by a venture capitalist.
Legal Tender
When a currency is declared legal tender, it means that by statute (law),
people must accept it as a settlement mechanism to meet a financial
obligation, and that you can pay your tax bills with it45.
Not all notes and coins are legal tender in all circumstances. Currencies
are, in general, not legal tender outside of their home jurisdiction. For
example, someone in the UK can refuse to accept Russian roubles as
repayment of a debt. This doesn’t stop a recipient accepting roubles if
they want; it just stops someone being able to force a recipient to accept
Also, in many countries you can’t force a recipient to accept payment in
an antisocial amount of loose change: there are specific rules as to what
counts as legal tender. In Singapore, according to the 2002 Currency
Act46, you can’t force someone to accept more than $2 in any combination
of 5c, 10c, 20c coins, and you can’t force someone to accept more than
$10 in 50c coins. Currently there are no limits for payment in one dollar
coins, but after a series of high profile incidents in 2014 where people and
merchants made payments in large amounts of loose change47, the
Currency Act is being reconsidered to a more memorable uniform legal
tender limit of ten coins per denomination, across all denominations, per
transaction. This means that a payer would legally be able to use up to ten
pieces each of 5-cent, 10c, 20c, 50c, and one dollar coins, but no more,
per transaction.
Also in Singapore, under the 1967 Currency Interchangeability
Agreement, the Brunei dollar is acceptable as ‘customary tender’ on a 1:1
basis. You can pay for a coffee in Singapore by handing over the same
amount in Brunei dollars. Banks in each country will accept the other
currency at par48.
Zimbabwe uses USD as the main currency for pricing goods and for
government transactions, but lists the following currencies as legal
tender: Euro, United States dollar, Pound sterling, South African rand,
Botswana pula, Australian dollar, Chinese yuan, and Japanese yen. Its
own currency, the Zimbabwe dollar, is not on that list. There are also
multiple versions of the Zimbabwe dollar (with different pricing) and the
country is a fascinating case study for how not to do currency. It is a mess
for shopkeepers, but a delight for monetary economists!

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