The Real Reason the US Dollar Has Value


I was at a conference when I took out a dollar bill and waved it in front of the audience. I asked, ‘Why does this piece of paper have value?’ It’s interesting the range of answers I got.

One person said ‘gold,’ which has nothing to do with it. There was a time when you could demand a fixed weight in gold in exchange for a dollar, but those days are gone. Another said, ‘You can buy things with it’ — an answer that only begs the question why that it so. ‘Faith,’ said yet a third. Not quite.

The answer is one that (some) economists have known about for a long time. I’ll tell you about it below along with three other counterintuitive and seemingly bizarre conclusions about the twisted world of modern money. I don’t think you would draw it up this way if you had the chance — but it’s the way the system works.

Tax liabilities give otherwise worthless paper value. The US dollar has value because the government levies $3 trillion in tax liabilities annually and accepts only U.S. dollars in payment — which only it issues.

And there is the credible threat of penalties if you don’t settle up with dollars. In so doing, the government turns all of us into dollar chasers. It’s how a state, any state, can turn worthless pieces of paper into valued currency.

‘The modern state can make anything it chooses generally acceptable as money,’ economist Abba Lerner wrote in 1947. ‘If the state is willing to accept the proposed money in the payment of taxes and other obligations to itself, the trick is done.’ Brilliantly devious, isn’t it?

A US dollar is, essentially, a tax credit. Economists call this the tax-driven view of money, and it is at least as old as Adam Smith. It is also one of the core principles of Modern Monetary Theory, or MMT.

(This is a macroeconomic school of thought that has taken the deep dive into the plumbing of how modern money works.)

The principles of MMT have a certain forceful logic. And they can lead to some shocking and uncomfortable conclusions…

One example is that government deficits increase financial savings. It sounds outrageous. How can government deficits increase savings? Well, how else is the nongovernment sector supposed to get dollars? The only way is for the government to spend more than it collects — thereby leaving money in the economy.

Or think of it this way, as economist Warren Mosler puts it: ‘When the government spends, only two things can happen to that money… the money can be used to pay taxes, or it isn’t used to pay taxes. In which case, somebody out there still has it.’ So deficit spending equals financial savings at the macro level.

Government debt, then, is a form of savings for the private sector. Everywhere there is a Treasury security there is someone who owns it. For that holder, it is a part of his financial wealth, or savings.

But aren’t government deficits and debt too large? They can be too large, which then causes the dollar to lose value. However, in a fiat currency system, it is natural for the government to be in deficit, because the private sector usually wants to save something.

In fact, there is a good argument that any attempt to balance the budget is futile. It will simply lead people to cut spending in an effort to get back to a desired savings level. This also has the effect of contracting the economy and driving tax receipts lower, thereby putting the government back into deficit.

The trouble with budget surpluses is they take money out of the economy. That puts pressure on private-sector balance sheets. It may not be so surprising to learn, then, that economic depressions have followed every major surplus in U.S. history.

Another conclusion is that Government doesn’t need taxes and bond sales to finance spending. Most people think that the government collects taxes and sells bonds to finance its spending. But remember, the government issues dollars. It can’t run out. This sounds scary, but it’s the naked truth of a fiat currency system. The U.S. government faces zero solvency risk. It can always meet all of its bills.

Of course, there are consequences when government spends. If it spends ‘too much’ relative to what dollars can buy and the desire to save, then the dollar can lose value. (Which is what’s happened over the last century. I see no reason why this trend will end.) But the government clearly doesn’t need to borrow or collect something it issues in order to spend. That’s the point.

Further, think about it from the beginning: What must a government do before it collects its own money in taxes? It has to spend the money first. That’s how people get the dollars to meet the tax. So logically, spending precedes tax collection.

There is a classic paper by Stephanie Bell (now Kelton) that demonstrates that ‘proceeds from taxation and bond sales are technically incapable of financing government spending’ and that governments actually finance their spending by creating money directly. (See ‘Can Taxes and Bonds Finance Government Spending?’). It’s a bit technical, but I believe it is correct and I mention it here in case you want to hunt it down. It’s free online.

There is another key insight that follows from this.

The U.S. government is not at the mercy of foreign creditors. You’ve surely heard that the U.S. is in debt to China, because China holds some large amount of U.S. Treasury debt. Politicians even used this rhetoric around election time, saying how we are borrowing from the thrifty Chinese to pay for our lavish lifestyle.

It’s not true. And in fact, it can’t be true. Let me cite economist L. Randall Wray, who put it in no uncertain terms:

Those who claim that the U.S. government must borrow dollars from thrifty Chinese don’t understand basic accounting. The Chinese do not issue dollars — the United States does. Every dollar the Chinese “lend” to the United States came from the United States…. The U.S. government never borrows from the Chinese to ‘finance’ its budget deficit.

Again, think through how the Chinese got the dollars. They sold stuff to Americans. Presumably, they did this because they wanted to acquire dollars. That can change, and the foreign exchange value of the dollar will change, too, to reflect the desire of foreigners to hold dollars.

But the point I want to make is simply that the U.S. issues dollars; China and other foreign governments do not. Therefore, the U.S. doesn’t rely on foreign creditors to finance its spending.

As I told you, the world of modern money is a seemingly bizarre world, but it does have its own logic and principles. I’ve only touched on a few of the most surprising conclusions here. (I would humbly suggest that the best introductory guide to this monetary maze is Wray’s Modern Money Theory: A Primer on Macroeconomics for Sovereign Money Systems.)

At least you have a good answer why the U.S. dollar has value — albeit, a value that bleeds out over time. It’s a currency, not an investment vehicle.


Chris Mayer
for The Daily Reckoning Australia

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Chris Mayer
Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer's essays have appeared in a wide variety of publications, from the Daily Article series to here in The Daily Reckoning. He is the editor of Mayer's Special Situations and Capital and Crisis - formerly the Fleet Street Letter.

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5 Comments on "The Real Reason the US Dollar Has Value"

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2 years 6 months ago

So what happens when China and/or other countries no longer accept USD as payment?

2 years 6 months ago

They purchase all the western gold, silver and raw commodities they can before they do that… of course.
Then no longer accept USD. What happens?
In the words of Gerald Celente: Trade Wars => Currency Wars => World Wars.

2 years 5 months ago
Ever heard of the opium wars? They occurred because the west wanted Chinese commodities (tea, silk etc…) but all China wanted from the west was silver. When the west ran out of silver they had to find something else to sell to the Chinese – they came up with opium. Although many Chinese people wanted opium the Chinese authorities did not want their country to turn into a nation of addicts so they banned the sale of opium. The result was the opium wars where the west successfully forced the Chinese to accept imports of opium through the force of… Read more »
2 years 6 months ago
@Shoes, in advance of that, Chinese interests and timing still matter. Trade finance would already be another matter entirely except that major exporters-surplus countries have derived so much benefit from the printing. Why roll the US hegemon when their racket still engender world economic demand and keep shooting themselves in the foot at the same time? Kissinger-Nixon might have though they were clever kicking the can down the road. Being prototype western liberal short termists and opportunists, they could see no choice but to go for one of the biggest 3 card tricks in history to prolong the US empire’s… Read more »
2 years 5 months ago

Everyone needs the US dollar to buy oil.

Of course there will be an ‘inconvenience’ when world oil production begins to decline.

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