The Dollar Is Not a Ponzi Scheme

I was just reading someone saying that the dollar, being fiat currency, was a Ponzi scheme, just like cryptocurrency. Not so. There is a crucial difference.

First, though: cryptocurrency is much like a Ponzi scheme (using the term loosely, as a way to sell something worthless to people because they hope to resell it some other sucker later) . When you own a bitcoin, that doesn’t obligate anyone to accept it as payment. You can sell it if someone wants to buy it, but nobody has to buy it, or to pay any particular price. There is not even a moral obligation or an implicit promise: it is entirely Buyer Beware. If we knew the world would end 5 years from today, everybody would know that bitcoin would be worthless 4 years from today, so its price would have to be zero then, which means nobody would want to hold it 3 years from today, which means, following the chain, nobody would want to hold it today. You only hold it to sell it somebody else.

Well, how is a dollar different? It is different because it is “legal tender for all debts, public or private”. Unless a contract specifies otherwise, you can pay what you owe using U.S. dollar bills. If you do, the other side can’t take you to court and say you haven’t paid what you owed.

To be sure, you could write your contracts as barter instead. You could say, “Rasmusen owes Smith 1 pound of gold to be paid on December 1, 2030.” (History experts will want to talk about the Gold Clause cases in which the U.S. government banned this in 1933, but let’s continue on.) But the US government and the state governments have written the tax laws to require payment in dollar amounts, so you can always use your dollar bills to pay your taxes. The governments could rewrite the tax laws to say that you must pay in gold, and that dollars are no longer legal tender, but this would be of dubious legality for states because of the U.S. Constitution’s Contract Clause, and for all governments it would be a clear breach of an implicit promise— or if you like, an implicit breach of a clear promise.

So the question becomes whether tax payment is enough of a use to make dollars bills valuable. And it is. US state and federal taxes are 6 trillion dollars per year. The amount of U.S. currency and banks’ deposits at the Fed— the “monetary base”— is 5 trillion dollars. Thus, the amount of fiat money out there isn’t even enough to pay a single year’s taxes, much less the value of all future taxes.

You might wonder how people pay their taxes if there isn’t enough money to do it— what about that extra trillion dollars of taxes over money? The answer to that paradox has two parts. First, there is a flow of tax payments, and a stock of dollar bills. Suppose some people use their dollars bills to pay taxes in January. In February, the government uses those dollar bills to buy things like jet planes, so they are back in the private sector and someone else (the jet plane company) can use them to pay taxes in February.

Second, and related to this, there is a vast amount of non-physical money backed up by the dollars bills— bank accounts, for example. If you have $10,000 in your checking account, you can make $10,000 in payments by check, and those checks are almost like currency. In fact, “the money supply”, also called “M1” consists of the monetary base plus checking accounts. But when you deposit $10,000 in dollars bills in the bank, the bank doesn’t keep all those bills in the vault. It only keeps enough to cover the checks you’re likely to write in the next month, and it loans out the rest. This allows the amount of checking deposits to vastly exceed the amount of dollar bills, so when people pay their taxes by check, they have plenty of assets available to do it.

Thus, the dollar is not like crypto. It is backed up by a promise from the government to accept the pieces of paper as payment for your taxes, and that makes those pieces of paper valuable. If Judgement Day was going to come in in 5 years, and we had to pay taxes all the way to the end, the dollar would still be valuable up until that last Tax Freedom Day before the Day of Doom. On which, see the excellent and underrated 1662 poem by Michael Wigglesworth, which contains some useful musings on eternity. It starts,

Still was the night, serene and bright,
  when all Men sleeping lay;
Calm was the season, and carnal reason
  thought so ’twould last for aye.
“Soul, take thine ease, let sorrow cease;
  much good thou hast in store:“
This was their Song, their Cups among,
  the evening before.

Towards the end comes the warning to the cryptos—

Naught join’d to naught can ne’er make aught,
  nor Cyphers make a Sum;
Nor things finite, to infinite
  by multiplying come:
A Cockle-shell may serve as well
  to lade the Ocean dry
As finite things and reckonings
  to bound Eternity.