I generally liked this post by Joe Weisenthal on Bitcoin and the value of fiat money. In particular, I like these points:
“But fiat currencies have tremendous intrinsic value because governments say they do. That’s why they’re called fiat currencies. They have value by government fiat.
This truth might be annoying, but the fact of the matter is that we live in a world of laws, where governments have armies, and can imprison you if you don’t pay taxes. And every transaction that you do is taxed in some way, meaning that to operate in any practical matter in this world means transacting in US dollars.
So the US dollar isn’t just important because other people think it is. The US dollar is important, because the world’s strongest entity, with the full force of the US army, the FBI, the CIA, the NSA, and various local authorities with guns demands that you pay them in US dollars. That’s not faith. That’s the law. Sorry.
Even outside of the requirement to pay taxes in US dollars, the Federal Reserve system has established the dollar as the unit of currency for banking in the United States. So if you want to be plugged into the banking system at all — which is a requirement for virtually all individuals — you have to use US dollars.
So instantly, anyone who says the US dollar is backed by “faith” or an “illusion” has no concept of the sheer force behind the currency.
This isn’t true of Bitcoins at all.”
I think that’s pretty good. But I think Joe’s description misses an important point. Money doesn’t just have value because a government says it has value. After all, that money just serves as a means to an end. Saying that a US Dollar has intrinsic value just because the government says it has value is like saying that a theater ticket has value because a theater company declares it as the thing that gains you entry into a show. But this misses the point. The ticket to enter the show is just a means to an end. The real value is not in the ticket, but in the show itself. If the show is terrible no one will want your tickets even if you have an army that can attempt to force people to use your tickets.
The same can be said of the US economy. If the output of the US economy is not worthy of demand then the Dollar will have no value. Bitcoin has value in that it achieves the same thing the US dollar does – it gives someone access to goods and services. And its users attribute some value to it because it skirts the costs of transacting with bank deposits (like taxes and other associated costs). But the problem with Bitcoin (as I described here) is that it has an intrinsically low level of trust (because it is unregulated – yes, that court system and regulated monetary system most certainly does embed a certain level of trust in the money system) and does not give you access to the majority of the show that is the US economy. In other words, unlike bank deposits, Bitcoin isn’t a very good medium of exchange in that it doesn’t serve money’s primary purpose all that well. Not having access to all that output is a big problem for any kind of money. But there must be valuable and high quality output in the first place.¹
I think it’s important not to put the cart before the horse when discussing these matters. Output necessarily precedes taxation and government power. That’s why I put output at the top of my hiearchy of fiat money viability (see here). Miss the emphasis there and you’ll completely misunderstand the purpose of money in the first place.
¹ – The other interesting aspect of Bitcoin is that it is directly tied to the trust of the system through its mining. This means that it could serve as a central sort of payment system for creating trust across a broad set of decentralized applications. This adds a whole other layer of value to its creation that is not yet well understood.