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What´s the source of value of the dollar?

Recently, I´ve had a discussion with Keith Weiner at facebook regarding the source of value of the dollar. While we both fully agree on the credit nature of the dollar, Keith´s main argument is that the source of value of the dollar comes from the debtors (an indebted farmer, for example) trying to get dollars to cancel their debts. My main argument is that the source of value of the dollar is the issuers obliging themselves to accept dollars, although I conceded this was a necessary condition but not sufficient.

I believe I failed to explain myself correctly on my argument of the issuer obliging itself. Keith qualified my argument as a tautology, but it is not. The government did not oblige itself to accept the greenbacks issued during the civil war, and that was the reason why that currency failed so miserably. So the issuer accepting its own currency and how it does it is nothing to give for granted, instead, it is a key condition that issuers have learned they need to do for their currency to survive (at least for the medium term). Moreover this condition will have a very important impact in the quantity of currency in circulation, as I will explain later.

The issuer obliging itself has very important implications, the first one is fully acknowledging their currency as a liability, which automatically triggers the market to scrutinise its balance sheet, which has the consequence of putting the issuer in the need to be diligent on its accounting and which has the consequence for the issuer to be careful on what he places on the asset column of its balance sheet.

“Irredeemable currency” is not the same than “unbacked currency”. Today´s dollars are backed mainly with debt assets and, sadly, very little gold, while for example greenbacks were not backed at all. Where is the difference? The Fed and the banking system oblige themselves to a much higher degree than Lincoln´s government did.

“Irredeemable currency” is an unfortunate term as it leads the reader to think that the currency issued remains forever within the monetary system, as it could never be redeemed. This is not the reality. Acknowledging the currency issued as liability means that currency is issued when it is loaned out, and destroyed when that loan is repaid. The latter is absolutely a key consequence of my argument “the issuer obliging itself to accept its own currency”, which I concede I failed to specifically introduce into the discussion.

Keith and I were also discussing if the government demanding dollars to pay taxes was a source of value for the dollar, I said it was and Keith it wasn´t. Keith stated that when the government collects dollars immediately spends it and that if the recipients repudiated the dollar, that would be corresponding selling pressure to match the tax payer pressure. And the dollar’s value would be set in the market. A market which, under this supposition, repudiates it. Its value would be zero or near zero.

I don´t agree that the government will inmediately spend it. In the current system, an important part of those dollars will go to repay bond principals, and therefore those dollars are destroyed. If the government wants to spend more, it would have to go to the market and sell bonds, even in the event the Fed is the only buyer of those bonds, the Fed balance sheet will still be under scrutiny of the market.

I am not a quantitativist, but that doesn´t mean I totally disregard the property of relative scarcity that a currency must have to succeed. Relative scarcity can be achieved when an issuer demonstrates that duly Creates / Destroyes currency through Loaning / Repaying, adhering to strict double entry accounting principles. The quality of that debt relies on the assets´s quality placed into its asset column and its proper matching with its liabilities (duration, etc).

As a side note, I would like to end this post adding that the term “counterfeiting” might apply for money, but does not apply for credit currency. Issuing a lot liabilities and demonstrating a poor compromise with the management of those liabilities such as issuing more than initially promised or backing them poorly, is not counterfeiting, the same way General Electric issuing any amount of bonds is not counterfeiting.

Conceding the term counterfeiting to credit currency is akin to granting the category of Money to credit currency, and it is not. No line can be drawn to distinguish “authentic credit currency” from “counterfeited credit currency” from the same issuer, it is all fungible so there can only be more or less quantity of currency or better or worse quality of currency, and the market will adjust its exchange value according to that quality and quantity, just like any other debt asset.

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