The Confidence Trick of Fiat Currency

Earlier today, I re-posted on Naked Capitalism, the article “If the U.S. stopped issuing treasuries, would it go broke?”, which I wrote in November 2009. I said that at the time wrote the original piece, I was getting to grip with how the government designed constraints in order to prevent deficit spending. What was and still is clear to me is that while different types of federal government obligation served different operational purposes, they all are identical in that they are a promise to pay the holder of that obligation a specific sum of the money unit of account.

In a world in which government is the creator of that currency and in which the currency has no tether to a physical product like gold, this promise has no tangible financial support other than the full faith and credit of the issuing government supported by its monopoly power to tax in its jurisdiction of control. Put more simply, there is nothing supporting fiat currency besides the coercive power of the state to impose tax and to entrench its obligations’ circulation as legal tender.

When thinking about the debt ceiling debate, the reality then is that the debt ceiling is a purely artificial constraint; Treasury notes or bonds are substantively the same as every other US government obligation. It is interesting that no other major developed economy has such a constraint. [Correction: at least Denmark and Australia have this constraint as well. There may be others.] I would be interested in readers’ with knowledge of the debt ceiling history explaining why this is so.

In any event, some economists recognize that the US government obligations are all substantively identical promises to repay a specific amount of the currency unit of account backed by nothing but taxing authority. As a result, there has been a lot of chatter about ways of circumventing the debt ceiling by issuing other forms of US government obligations and swapping those with outstanding Treasuries to diminish the number of Treasuries outstanding. Some of these proposals are fairly inventive. See Scott Fullwiler’s here for instance.

I doubt Secretary Geithner would implement any of these schemes, of course. But the larger question I have goes to the reason the debt ceiling exists at all: all deficit spending must be accompanied by the issuance of an equivalent unit of currency amount of Treasuries. Mentally, this ties the deficit spending and the treasuries together so that the layman thinks the Treasuries ‘fund’ the deficit spending. But, I just told you that all government obligations are promises to repay the currency unit of account backed by nothing but taxing authority. It’s as if you go to the government with your paper IOU with $100 printed on it to claim your money and the government hands you another paper IOU with the exact same amount printed on it. That’s pretty much how fiat money works. So, Treasuries don’t ‘fund’ anything. The US government issues Treasuries only because it is forced to do so to create the artificial tie between Treasuries and deficits and the mental connection we make as a result.

Now, with a default looming, we are seeing that as artificial as this constraint is, it has real world implications.

That’s all I said in the NC version of this before adding the original column. But let me add a few more words here.

In my view, fiat currency is a confidence trick. The key to confidence in a fiat currency is the belief of citizens that the government issuing the currency will manage its finances in a way that promotes general “life, liberty and prosperity”. If confidence erodes, tax evasion will rise, citizens will begin surreptitiously using other media of exchange to transact and inflation and currency depreciation will spiral out of control.

The question we are asking right now about the debt ceiling in the US goes to the existence of and need for artificial constraints in maintaining this confidence trick. As I demonstrated above, the need to issue treasury bonds to match any government deficit spending and the debt ceiling that emanates from that tie are artificial constraints meant to tie government’s hand in diverting real resources to the few who can line their pockets at the expense of the life, liberty and prosperity of the greater many.

This is a debate I often have with some of my blogging colleagues. Your answer depends crucially on your view of what the public purpose of government is. If you believe government’s core public purpose is to maintain the value of currency and permit the private sector freedom to deal with distributional issues of equity and general prosperity issues of efficiency then you will answer one way. On the other hand, if you believe the government’s public purpose is to maintain full employment in pursuit of life, liberty and prosperity, you will answer another way.

Personally, I like having some artificial constraints and am not enamoured with fiat money for that reason. When I made a vague reference to counterfeiting, that was my subtle way of indicating this. I like gold but I don’t think a return to the gold standard is practical or desirable since the gold standard has its own problems with limiting fiscal space and precipitating a deflationary spiral as we saw during the Great Depression. But I am trying to look at this neutrally.

Supporters of fiat money like it because it gives government fiscal space to deal with the consequences of crises. And we see what that means with the lack of fiscal space affecting the euro zone sovereign debt crisis. On the other hand, fiscal space also allows the few well-connected to be favoured at the expense of the many, which is neither fair nor efficient.

Ultimately, this is a political philosophy question. This debate, then, is not an objective one. And that makes it emotional, intractable, and potentially violent in the same ways political philosophy did during the American Revolution, the Civil War and the Great Depression.

  1. Reality says

    The United States and most of the world has reached ‘Peak Debt’.
    The nation’s motto “E Pluribus Unum” has been replaced with “I will gladly pay you Tuesday for a hamburger today”.
    If the nation is to survive we must have a “peoples” currency backed by tangible assets.

    H.R. 2755: Federal Reserve Board Abolition Act

    1. roger erickson says

      ” a “peoples” currency backed by tangible assets”

      ?? That’s exactly what we have. The ultimate “tangible asset” of any social species is the return-on-coordination. Ask the Marine Corp.

      It’s more valuable, by far, to have a currency supply that is as agile as our public intent, initiative & will to respond to any & all challenges, regardless of the pace. We couldn’t have prosecuted WWII as proficiently as we did, if we’d tried to stay on a gol-std.

      That’s the reason why the gold std had to go.

  2. Aaron R says

    I would add another disadvantage of fiscal space:

    If used improperly (even if well-intentioned), it can actually CAUSE a crisis. I believe the falling interest rates of the past 25 years, held artificially low by the Fed, had a lot to do with the 2008 crisis.

    1. roger erickson says

      Believe what you want, but do try to keep up with operational feedback.

      No nation can scale a productive currency supply without an effective, distributed credit rating system. Next, we can’t scale distributed credit rating without successfully scaling regulations & fraud control.

      Currency, credit-rating & fraud-control are 3 legs of the same stool.

      Instead, we have gold bugs, clueless patsies, and regulatory capture by frauds.

      Cue your own puns. It ain’t funny no more.

  3. Bob Salsa says

    Even if only implied, you too easily diminish the nature of the monopoly power to tax (perhaps, in part, by not fully considering the monopoly on legal violence). Your choice: use the dollar and pay your taxes or leave – either overseas (where dollar disengagement remains a questionable tactic) or by joining the prison population.

    Do you really believe anything that Congress says or does provides more ‘confidence’ in the use of the dollar?

    1. Edward Harrison says

      Coercion and monopoly powers by the state are at odds with a system of governance based on liberty. I don’t like the government having a monopoly on anything and we should only tolerate it if there are constraints and remedies for the citizenry to defend itself from their own government if circumstances so dictate.

      How do you deal with that? I would argue you need to modify the monetary system to have constraints. And no I don’t believe what Congress says or does provides any more ‘confidence’ in the use of the dollar.

      On gold, read here:

  4. Bob Salsa says

    Oh, just to add, when one does go to jail for not paying their taxes, the money issuer will also confiscate your gold.

  5. Chaos says

    History has proven repeatedly that if states abuse their currency people will revolve against it in one way or an other. This happened usually under states of authoritarian nature (empires, feuds, modern authoritarians states, etc.).

    All this artificial limits are non sensical, the best limit is not issuing of bonds and debt ceilings, all them misguided and product of the age of bullion and coinage that has lasted around 500 years. The best limit in a pure credit and debt system like we have since stupid gold standard was blown up are the natural limits, and monetary freedom (private currencies should be an option, even if not backed by governments), but government should issue its own currency and being able to tax it.

    Pure virtual credit (or debt) systems have been operative for longer periods of humanity than bullion, and in general (with good check & balances) have been certainly not worse than bullion ages. This hard-on on ‘hard currencies’ is just product of a misunderstanding (and short-termism) of the history of money and debt.

  6. Wingnut says


    We ALL see the pyramid scheme symbol on the back of the USA one dollar bill. We ALL see the servitude infestation in capitalism. We ALL see the “pay up or lose your wellbeing” Chicago mob-like felony extortion widespread within capitalism. We ALL see the “join or starve” felony extortion done to the 18 year olds… by this ugly competer’s church called capitalism. We ALL see how forcing competer’s religions onto 18 year olds, and/or LURING them into it with bling-dangling and promises of empowerments… kills membership in the cooperator’s church (Christianity/socialism). We ALL understand that AmWay (American Way) (New World Order) got “the exclusive” (legal tender) on the TYPE of survival coupons (money) accepted in supply depots (stores) and leverages 18 year olds into the organization via that felony activity. (It puts AmWay-coupon slaving requirements called price tags… on all the survival goods). We ALL understand how sure-to-collapse farmyard pyramids work… from our childhoods. Upper 1/3 are “heads in the clouds” while the kids on the bottom ALWAYS GET HURT from the weight of the world’s knees in their backs. And, we ALL see how such systems are illegal, immoral, and just plain sick.

    We American Christian socialists are patiently awaiting the natural fall of the pyramid-o-servitude, or the busting of the free marketeers felony… by the USA Dept of Justice. We Christians are VERY CLOSE to issuing a cease and desist order until the servitude and inequality goes away… which means it turns into a commune. Commune is a word we LOVE when used in the word “community”… but its one the caps HATE when used in the word “commune-ism”. Go fig. PROGRAMMED!!

    Do a Google IMAGE SEARCH for ‘pyramid of capitalist’ to see a full color picture made way back in 1911, when capitalism was first discovered to be a con/sham instigated by the Free Masons/Illuminati. Folks sure bought into the thing… hook, line, and sinker just the same. The caps didn’t even check if a string was attached! Now THAT’S easy fishing, eh?

    Time to level the felony pyramid scheme called capitalism. Abolish economies and ownershipism worldwide, and hurry. Economies just cause rat-racing, and rat-racing causes felony pyramiding. BUST IT, America! Look to the USA military supply/survival system… (and the USA public library system) for socialism and morals done right. Equal, owner-less, money-less, bill-less, timecard-less, and concerned with growth of value-criteria OTHER THAN money-value. Quit doing monetary discrimination immediately, and make it illegal. There are MANY measurement criteria of “value”… not just dollars. Try morals, efficiency, discrimination-levels, repairability, etc etc. Economies are cancerous tumors, and to cheer for their growth… is just insane. Profiting causes inflation, so if caps LIKE inflation, and if they LIKE a terrible time in afterlife when they meet the planet’s ORIGINAL OWNER before caps tried to squat it all with ownershipism, then keep it up with the felony pyramiding. I dare you. While us Christians are finally bulldozing that pyramid scheme back to level, lets make servitude and “join or starve” (get a job or die) illegal in the USA, and lets level the architecture seen in USA courtrooms, too. Right now, USA courtrooms are church simulators or “fear chambers”, by special design. Sick.

    Isn’t that back-of-the-dollar pyramid… a Columbian freemason symbol? And WHERE is the USA gov located? District of Columbia? (Not even part of the USA!) How much more blatant can ya get? The “Fed” runs a pyramid scheme called the free marketeers. If you’re using the “federal reserve note” certificates, or using no-other-living-thing-on-the-planet entitles of ownership, you’re bought into a servitude/slavery con/sham… called capitalism. Pyramiding 101.

    Larry “Wingnut” Wendlandt
    MaStars – Mothers Against Stuff That Ain’t Right
    Bessemer MI USA

  7. Jason Frey says


    Great post. A blend of MMT with a whiff of Austrian restraint is a welcome change from the “spend whatever it takes MMTers on one end and the balanced budget/gold standard preachers on the other.

  8. Ray Phenicie says

    I was waiting for a full statement to come out: something like “Fiat money is just a residue of the smoke and mirrors orchestrated by the government so we need to get with something real like ______.”

    Please fill in the blank for me.

    Money is a medium of exchange so goods and services may flow between businesses, households banks and governments. Intrinsically the paper has no value-that’s a given. So why is that BAD?

    Not sure what the point is I guess.

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