How is US currency worth anything?

Not long ago, my 8-year-old daughter asked me why we need money. Here's the basic conversation that followed, abbreviated. Please feel free to critique me if I got anything wrong.

Me: Well, if we didn't use money, what would we use?
Nobbette: We could trade stuff.
Me: Ok, so if I'm good at cleaning houses and you're good at making chairs, and I need a chair, you could make me one and I'll clean your house.
Nobbette: Right.
Me: But what if I don't need a chair? What if I need a TV?
Nobbette: Go to the TV guy.
Me: Maybe he doesn't need his house cleaned. Maybe he needs a chair.
Nobbette: Well, I'll give him a chair, and he gives you a TV, and you clean my house.
Me: Excellent. Now, what if you don't need your house cleaned right away? How will you remember that I owe you a house cleaning?
Nobbette: You can write me a note.
Me: Oh, ok. Suppose you decide that instead of getting your house cleaned, you'd rather have a Barbie doll. Do you think it's ok to trade that note for the doll?
Nobbette: Sure.
Me: So, anyone can trade notes that they get right?
Nobbette: Yep.
Me: So let's make the notes all look the same (so that way we don't have to read everyone's handwriting). And to make sure they're official notes, we'll make them out of special paper and ink, and put special drawings on them.
Nobbette: Ok.
Me: And we'll call those notes "money".
Nobbette: Oh!!!
 
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NobbyNobbs said:
Not long ago, my 8-year-old daughter asked me why we need money. Here's the basic conversation that followed, abbreviated. Please feel free to critique me if I got anything wrong.

Me: Well, if we didn't use money, what would we use?
Nobbette: We could trade stuff.
Me: Ok, so if I'm good at cleaning houses and you're good at making chairs, and I need a chair, you could make me one and I'll clean your house.
Nobbette: Right.
Me: But what if I don't need a chair? What if I need a TV?
Nobbette: Go to the TV guy.
Me: Maybe he doesn't need his house cleaned. Maybe he needs a chair.
Nobbette: Well, I'll give him a chair, and he gives you a TV, and you clean my house.
Me: Excellent. Now, what if you don't need your house cleaned right away? How will you remember that I owe you a house cleaning?
Nobbette: You can write me a note.
Me: Oh, ok. Suppose you decide that instead of getting your house cleaned, you'd rather have a Barbie doll. Do you think it's ok to trade that note for the doll?
Nobbette: Sure.
Me: So, anyone can trade notes that they get right?
Nobbette: Yep.
Me: So let's make the notes all look the same (so that way we don't have to read everyone's handwriting). And to make sure they're official notes, we'll make them out of special paper and ink, and put special drawings on them.
Nobbette: Ok.
Me: And we'll call those notes "money".
Nobbette: Oh!!!
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Beautiful!

So can your 8-year-old daughter explain this to Oliver? :D
 
Oliver said:
Well, she could explain me this graph:

http://en.wikipedia.org/wiki/Image:Dollar_value_chart.gif

Because I have no idea how the value of the
Dollar can be just some cents without any
major recognizable consequences.
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That shows that cash is not a good investment. Its advantage is in liquidity, not as a long-term investment. However, if you keep your money in a bank or bonds where it earns interest, you should approximately keep pace with inflation. In your mattress it will not perform so well.
 
UserGoogol said:
Also, to call the Federal Reserve completely independent from the government is not really right. It is somewhat purposefully independent, and private bankers play a significant role, but government appointees play important roles too. Bernanke isn't exactly a figurehead.
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To say it is completely wrong. "The Federal reserve is no more a part of the government than Federal Express" is a first step down the path to Libertarian/Militia/Patriot conspiracy theory nonsense.

It is set up by the government with government oversight to perform a governmental function. By any sane definition it is part of the government.

A few other tips: The bankers do not own you as a "corporate person" no matter how many times you acknowledge your name in all capital letters. The fringe on the flag in a courtroom is meaningless. Possessing the manufacturer's certificate of origin for your automobile holds no legal significance whatsoever.

Etc.
 
Another way to look at the "value" of your currency

JSG Boggs is a performance artist who draws currency inspired art and spends it.

So, for example, if he drew a $5.00 bill he would give it an initial value of $5.00. He might then attempt to "exchange" if for a $1.00 cup of coffee (and $4.00 in change).

His art consists of "selling" the record of the transaction... namely the receipt and the would be collector then needs to then track down the person who accepted his "art" at the value he placed on it and attempt to buy the art (generally for far more than the "face value")

Raises all kinds of questions about the "value" of both art and money.

He beat a currency forging charge with the Bank of England. And continues to have issues with the US Treasury. Governments being very unhappy with drawing anything that even vaguely resembles money and "spending" it.

There is a lot out there about him.

http://en.wikipedia.org/wiki/J._S._G._Boggs
 
Ziggurat said:
There is indeed a method to produce gold. It's called mining. And gold standards create an artificial incentive to do lots of it, which is really quite silly.

But I'm perpetually amused by the idea that we're in a cricis because we don't have a gold-backed currency. Welcome to the modern world. Inflation sucks a hell of a lot less than deflation, especially for the poor. The dollar has a damn good track record as a fiat currency, better than it did as a gold-backed one.
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I think of all the time and effort wasted on things like the Klondike "gold rush", which largely served to enrich outfitters in Seattle, and think of all the much better employment of labour and capital. The internet is packed chock full of wags who want to return to this kind of silliness.

Inflation is also a detriment to creditors rather than to debtors, a "virtue" seldom mentioned by the gold bugs. Needless to say, the US Fed (and almost all other central banks) have conspired against both inflation and deflation in trying to create stability instead. This is anathema to the gold bugs but none of them can really explain why they want a risky currency instead of a stable one. Something about Cornelius Vanderbilt, usually.
 
NobbyNobbs said:
Not long ago, my 8-year-old daughter asked me why we need money. Here's the basic conversation that followed, abbreviated. Please feel free to critique me if I got anything wrong.

Me: Well, if we didn't use money, what would we use?
Nobbette: We could trade stuff.
Me: Ok, so if I'm good at cleaning houses and you're good at making chairs, and I need a chair, you could make me one and I'll clean your house.
Nobbette: Right.
Me: But what if I don't need a chair? What if I need a TV?
Nobbette: Go to the TV guy.
Me: Maybe he doesn't need his house cleaned. Maybe he needs a chair.
Nobbette: Well, I'll give him a chair, and he gives you a TV, and you clean my house.
Me: Excellent. Now, what if you don't need your house cleaned right away? How will you remember that I owe you a house cleaning?
Nobbette: You can write me a note.
Me: Oh, ok. Suppose you decide that instead of getting your house cleaned, you'd rather have a Barbie doll. Do you think it's ok to trade that note for the doll?
Nobbette: Sure.
Me: So, anyone can trade notes that they get right?
Nobbette: Yep.
Me: So let's make the notes all look the same (so that way we don't have to read everyone's handwriting). And to make sure they're official notes, we'll make them out of special paper and ink, and put special drawings on them.
Nobbette: Ok.
Me: And we'll call those notes "money".
Nobbette: Oh!!!
Click to expand...

Yes, but that explination only works because 6 year olds don't ask tough questions, like explaining a light bulb by saying it works by magic. You make a jump in that explination that doesn't make sense. The "money" you end up with isn't anything like the "notes" that are clearly useful for trade, because they don't ultimately correlate to anything like TVs or Barbies or Chairs. If I write a note that says it's worth 3 chairs, it's worth 3 chairs. If I write a note that says it's worth 10 dollars, that's meaningless. It could be worth a billion chair or half a chair, and in reality it's worth zero chairs. If I hand out a bunch of notes that can be traded for chairs and then I die and my chairs are gone, the notes are worth nothing, even if people still use them for trade for awhile, the meaninglessness of it will catch up after awhile.

As in my cards example you have no reason to use chips. People might use them for awhile just out of ignorence, and then might sort of work for awhile, but inevitably people will except less and less for the chips until everyone realizes they're completely worthless. This make take 100 years when there are 100 million people in the card game, but it'll still happen, and we can see that happening.
 
Dabljuh said:
I'm an economist. The value of money is basically decided by offer and demand.

Actually there's a number of different theories on why money has (or should have) 'value'. I'll just give you the simplest and probably best here.

Money is 'valuable' because we (the people using the money) give that value to it. Because we need money to achieve any sensible amount fo division of labour.

If the entire society of the US agrees that tomorrow, every coconut will be worth 5 dollars, then you could go buy groceries with coconuts. Since you agree the coconuts are valuable, you do not easily part with them. And the grocery store clerk also thinks the coconuts are valuable.

Basically, the question of why money has value is easy to answer if you realize that we really, really, really need money. A society without money wouldn't be remotely as productive since everyone had to resort to bartering, and bartering is an infinitely more inefficient process. Try being a barley farmer and buying a car with 500 tons of barley. What car dealer has use for 500 tons of barley? The entire economy would break down to people who are self-reliant just to survive, we'd fall back 5000 years of technological achievements. So we really need money.
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Okay, but I understand how a backed currency has value and I certainly understand how such a currency would be useful in trade, but I don't understand why an unbacked currency is worth anything.



How much money is worth is a much more interesting question. The quantity theory gives you the answer. I'll break it down for you.

Basically, say an economy produces and sells 100 apples a year. To sell those 100 apples, you need at least 100 units of currency. So either 100 one-dollar bills or 100 one-cent pieces. Or 100 coconuts. So to sell 100 apples a year 100 units of <currency> have to travel around.

ware production = money supply
100 apples = 100 coins
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This is where you lose me and it starts to sound like circular reasoning to me. You're trying to explain where it gets it's value from. You can't start from the assumption that 100 apples is worth 100 coins. Why is 100 apples worth 100 coins, and not 1 coin or 10,000 coins.

Basically the problem of the economy in the world (the problem of "capitalism", whatever that may be) is that with reducing interest rates (reducing scarcity for goods, increased wealth) the turnover rate for money constantly decreases. This leads to the constant threat of deflation, which means mass unemployment, crisis and nazis or commies that take over the country.
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This seems like a contridiction in terms to me. If there is more wealth then by definition the economy is doing better. I don't understand why more things that people want would result in less things that people want, though I could certainly understand that increased wealth would lead to increased realization that the dollar is worthless which would further to tank our economy.
 
CaptainManacles said:
Yes, but that explination only works because 6 year olds don't ask tough questions, like explaining a light bulb by saying it works by magic. You make a jump in that explination that doesn't make sense. The "money" you end up with isn't anything like the "notes" that are clearly useful for trade, because they don't ultimately correlate to anything like TVs or Barbies or Chairs. If I write a note that says it's worth 3 chairs, it's worth 3 chairs. If I write a note that says it's worth 10 dollars, that's meaningless. It could be worth a billion chair or half a chair, and in reality it's worth zero chairs.
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Please send me all you worthless dollars. I'll give you a pretty picture or a kind word in exchange.

CaptainManacles said:
If I hand out a bunch of notes that can be traded for chairs and then I die and my chairs are gone, the notes are worth nothing, even if people still use them for trade for awhile, the meaninglessness of it will catch up after awhile.

As in my cards example you have no reason to use chips. People might use them for awhile just out of ignorence, and then might sort of work for awhile, but inevitably people will except less and less for the chips until everyone realizes they're completely worthless. This make take 100 years when there are 100 million people in the card game, but it'll still happen, and we can see that happening.
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No, It won't happen and we're most definetly not seeing it happen. We're seeing the alledgedly worthless US dollars loosing value against what you incorrectly percieve as equally worthless pieces of paper from other countries. If you were correct we would not see changes in exchange rates, we would see hyperinflation across the world. Yet in reality we only see hyperinflation when the central bank of a country pursues unsound monetary policies.
 
Kerberos said:
Please send me all you worthless dollars. I'll give you a pretty picture or a kind word in exchange.


No, It won't happen and we're most definetly not seeing it happen. We're seeing the alledgedly worthless US dollars loosing value against what you incorrectly percieve as equally worthless pieces of paper from other countries. If you were correct we would not see changes in exchange rates, we would see hyperinflation across the world. Yet in reality we only see hyperinflation when the central bank of a country pursues unsound monetary policies.
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No, we see alledgedly worthless US dollars loosing value against goods and services. The constant inflation we see is not simply in terms of exchange with other currencies.

Neither of your statements is an explination as to why US currency has any value.
 
CaptainManacles said:
No, we see alledgedly worthless US dollars loosing value against goods and services. The constant inflation we see is not simply in terms of exchange with other currencies..
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A small steady inflation is not hyperinflation, and is not a problem.

CaptainManacles said:
Neither of your statements is an explination as to why US currency has any value.
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No, but me previous post did and Dabljuh provided a longer and more thorough explanation. If you didn't understand it the first time then I don't see what good it would do to repeat it.

In any case I'd still like to have any worthless federal reserve notes you have lying around, yet you seem unwilling to give them to me. Could it be that you do know that dollars are not in fact worthless? I'l even go a step further and predict that you accept dollars in exchange for your work, if you're employed. Why do you do that if they're worthless?
 
The liquidity of cash money is itself valuable. Liquidity is not tangible, but is nonetheless valuable. It can be rapidly exchanged for anything, whereas less liquid assets are more troublesome.
 
Ziggurat said:
There is indeed a method to produce gold. It's called mining. And gold standards create an artificial incentive to do lots of it, which is really quite silly.

But I'm perpetually amused by the idea that we're in a cricis because we don't have a gold-backed currency. Welcome to the modern world. Inflation sucks a hell of a lot less than deflation, especially for the poor. The dollar has a damn good track record as a fiat currency, better than it did as a gold-backed one.
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But tyeing your entire economy to a single commodities price fluctuations seems like such a good idea.
 
CaptainManacles said:
Yes, but that explination only works because 6 year olds don't ask tough questions, like explaining a light bulb by saying it works by magic. You make a jump in that explination that doesn't make sense. The "money" you end up with isn't anything like the "notes" that are clearly useful for trade, because they don't ultimately correlate to anything like TVs or Barbies or Chairs. If I write a note that says it's worth 3 chairs, it's worth 3 chairs. If I write a note that says it's worth 10 dollars, that's meaningless. It could be worth a billion chair or half a chair, and in reality it's worth zero chairs. If I hand out a bunch of notes that can be traded for chairs and then I die and my chairs are gone, the notes are worth nothing, even if people still use them for trade for awhile, the meaninglessness of it will catch up after awhile.

As in my cards example you have no reason to use chips. People might use them for awhile just out of ignorence, and then might sort of work for awhile, but inevitably people will except less and less for the chips until everyone realizes they're completely worthless. This make take 100 years when there are 100 million people in the card game, but it'll still happen, and we can see that happening.
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The thing is that currency lubricates the ecconomy, its advantages to everyone is why it is valuable. Tieing a currency to a single comodity is foolish as comodity prices are very volitile.
 
ponderingturtle said:
The thing is that currency lubricates the ecconomy, its advantages to everyone is why it is valuable. Tieing a currency to a single comodity is foolish as comodity prices are very volitile.
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And besides, as Ziggurat implied a gold standard artifically inflates the price of gold, so the system is still essentially based on trust, not on the real value of gold.
 
We should go on the gold chocolate coin and silver condom coin standard, that way if the economy collapses all the currency doubles as something with real intrinsic value.
 
egslim said:
If the dollar continues to decline, and it will if current US policy does, then all those who own dollars will see their dollars vaporize anyway.
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Dollars still are holding their value inside the US, which is what it's all about anyway. To pull dollars out means you have some place better than the US to put them. That's not the case.

Second, you assume all parties' goal is to maximise the value of their financial holdings. But in reality countries often have other priorities. For example, if the US ever tries to put political pressure on China over Taiwan, expect China to counter by threatening to sink the dollar.
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China's government is, like any other dictatorship*, about enriching their political class. They've found out they can get much more flabulously wealthy with their own bizarre brand of capitalism than the usual keep-everyone-a-quasi-slave communism.

Hence this is about them enriching themselves, which also requires remaining in power. Taiwan provides a nice "hate the Jews" issue they can drum up in their own population, absent any real native Jewish community.

Hence Taiwan is a show issue rather than a real thing. They have no incentive to "bring it to a head" with a showdown. China "cutting off" the US will hurt their political class's self-enrichment program, and is unneeded to maintain power.

Therefore it will not happen, absent political instability that would force the political class to take desperate measures to remain in power, such as someone domestically forcing the Taiwan issue to get their own hoi polloi useful idiots behind them.


* Or non-dictatorship
 
Puppycow said:
I still don't see why not. Now the US has sanctions on Iran, so it would seem to be harder for them to spend dollars than euros, yen or renminbi. If Giselle Bundchen wants to be paid in euros, why wouldn't Iran? Why would Iran not take an opportunity to stick its finger in the eye of the Great Satan?
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With sanctions, Iran does have a problem getting money in and out of the US, so it may be in their interest to abandon the dollar, both as a practical matter and a stab in the eye of the Great Satan. (Should the "the" in "the Great Satan" be capitalized?)

My point is that the US is still a good place to invest, and pulling out tens to hundreds of billions of dollars, just for a public relations 1-day paper headline, isn't gonna sit too well with those selfsame dictators who own those billions.
 
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