Stanley Dundee

Back: Money is Complicated? Not Really Top: Getting Money Right

Money is Finite? Nope

In historic times, money has sometimes been associated with a physical commodity, typically gold or silver. Governments or private parties have agreed to exchange money for the commodity at some fixed rate. Under this condition of convertability, the amount of money that could be safely issued in a society was capped by the amount of exchangable commodity available. But nowadays, no society offers convertability of its money to a physical commodity. What we have today is fiat money, which means it's backed only by the say-so (fiat) of its issuer. Fiat money itself is neither a good nor a service, but it does represent claims on the goods and services available for sale in the society that issues the fiat money.

Although no convertability has been offered for the US dollar since at least 1972, political discourse and economic policy are typically presented as if there was still a physical backing of the money. This matters because a physically-backed money is fundamentally finite, hence subject to genuine scarcity. Fiat money has no physical limit hence its scarcity is a matter of policy not physical necessity. Consider the US dollar, issued by the US Federal Government (USG) operating through the US Treasury and the Federal Reserve. There's no physical limit on money issuance by the USG. A useful corrollary to the unlimited nature of fiat money is that the USG can buy anything that's for sale in US dollars. Not that this would be a good idea! But there's no physical limitation preventing this, only policy. Fiat money is unbounded.

You might be wondering how it is that a money with no physical backing and no physical limit on its issuance could have value such that people would be willing to exchange it for goods and services. The answer is also simple: in all modern societies, money gets value because the sovereign requires that taxes and fees be paid in the fiat money. This creates a baseline of demand for the money. If you have to pay taxes, you must obtain sufficient money to make the payments. To obtain that money, you must sell goods or services (or issue debt, if you can). As long as a society has the power to compel tax payments, the money in which those taxes must be paid will have value. Taxation ensures demand for fiat money.