First, I am not an economist, so seeking general "good enough" answers. Since Nixon went off the gold standard the U.S. dollar has been a fiat currency backed by federal debt.

While I understand there will be many complexities, I assume that what "backs" the value of the fiat dollar is faith in the stability of U.S. bonds and the government that issues and repays those debts.

So, this implies to me that the value of the dollar is ultimately based on the stable collection of federal revenues, which is largely based on future taxation, with an increasing percent falling on labor in the form of income taxes.

So, each dollar is a present credit issued on a future debt secured through tax collections. I am trying to sort out some of the socio-economic implications of this. But is there anything in this admittedly very crude description that is fundamentally wrong?

The national currency may be a kind of faith-based consensus and abstract medium of exchange, but it is ultimately based on a faith in the power of government to repay its rotating debt through its main sources of revenue, tax collection, correct? Just trying to make sure I'm not way off the trail here.


2 Answers 2


First correction of various misconceptions:

Since Nixon went off the gold standard the U.S. dollar has been a fiat currency backed by federal debt.

U.S. dollar is not backed by federal debt, and in general fiat currencies by definition of the word are not backed by anything (see Wallace 2017).

Also, generally if money is backed by something it has to be convertible/redeemable at some fixed rate for that thing. U.S. government does not give you promise to exchange your \$100 note for its bonds upon request. Moreover, if U.S. government would feel like running surplus budget they do not need to sell you any debt instruments either.

I assume that what "backs" the value of the fiat dollar is faith in the stability of U.S. bonds and the government that issues and repays those debts.

Again not generally correct, value of fiat money depends on demand and supply for that money. Depending on what sort of situation regarding government debt we talk about it might affect value of currency or not (see overview of literature on various aspects of sovereign debt in Reinhart and Rogoff (2009), some passages of the source on debt thresholds are outdated and no longer accepted but the overview of literature on sovereign debt crises and defaults is still valid and comprehensive and discusses cases when debt crises led to loss of value of currency and cases when it did not).

Regarding the main question

Is Fiat Money Ultimately Tax Based?

No and yes.

Fiat money by definition is not based on anything else than government decree. However, value of that government issued money will depend on demand for that money and supply of that money.

One important way how governments can artificially create demand for their money is by requiring taxes to be paid in money they issue. Taxes do not necessarily need to be paid in money, in principle they could be settled with in kind payments. However, if state requires you to pay taxes in dollars you always have to make sure you will have some dollars at hand when you need to pay them. Thus you will demand dollars even if you personally may not like them, and everyone else does the same. This creates non-trivial portion of demand for money and that is what gives money its value.

In addition, if government runs surplus and does not spend the money it collects through taxation it also reduces velocity of money in circulation which is tantamount to economy having lower quantity of money, so this would increase money’s value as well.

Sustainability of government finances affects value of money only to the degree it affects supply and demand for money. Moreover, as you can read in Reinhart and Rogoff (2009) empirically more often than not sovereign debt crises are resolved through debt monetization (which increases supply of money), and they are often accompanied by capital flight from a country (which both decreases demand for country's money and to increase in supply of money). This is why countries with debt problems typically end up with money that has low value, not because fiat money is in any meaningful sense backed by government debt.

  • $\begingroup$ Thank you, I will have to chew on this. So far, I'm still seeing money as monetized debt and that debt can only be "rolled over" by future taxation, mainly. Though there is no promissory "bond" replacement for gold, it is true that you can always and necessarily trade your dollars for government bonds/debt. And I'm not sure what sort of supply/demand drives the "price" of money, doesn't seem like other markets. Anyway, I believe what you say, but will have to think it through. Your answer gives me a good start. $\endgroup$ Oct 3, 2021 at 0:02
  • $\begingroup$ @NelsonAlexander you are welcome, also 1. You can trade your money for oranges, but that does not mean money are somehow backed by them. 2. You actually can’t always trade your money for debt - there are examples of countries with fiat currencies that have almost no debt (eg Norway), US could also decide to stop issuing debt if it wanted. 3. It is actually like other markets except the demand for money is not driven by wanting to have money itself but by other reasons, like being forced to use it to pay taxes, or just use it in trade as it is more efficient then barter. This is why for example $\endgroup$
    – 1muflon1
    Oct 3, 2021 at 8:53
  • $\begingroup$ demand for money increases when people’s demand for other goods increase as well. But aside from the motives for demand, and aside from the fact that this is market where supply is ultimately controlled by government, if you would have a look at any economic textbook you would not be able to distinguish supply and demand in money market from other markets if you would remove labels from axes $\endgroup$
    – 1muflon1
    Oct 3, 2021 at 8:56
  • $\begingroup$ @1muflon1 I'm reaching out to here because I couldn't find another way to reach to you as the chat we had is frozen. But this might be also an interesting resource for OP: drive.google.com/file/d/13a2To14MLbCyUMPexNwciwk7Valv5MTY/… $\endgroup$
    – trixn
    Oct 23, 2021 at 0:24

The answer is definitely not. All fiat money started off as non-fiat money. The non-fiat money was some kind of commodity money that transferred the trust in the commodity to the paper notes. When the link between the commodity and the notes was severed, people retained most of the trust in the notes. This is the ultimate origin of the market value of fiat money.

As long as people continue to accept the currency, the currency will retain its value. While requiring taxes to be paid in a fiat currency can increase demand for it slightly, the increased demand is minor in comparison to the total value of the currency, and so is most certainly not the primary driver of its value. The primary driver is the supply of money and the demand for loans (the primary way money is created).

There are many countries where foreign currency (usually dollars) are relatively widely accepted. However, many countries have currencies that have been stable enough to not be supplanted by a foreign currency. And some countries have explicit legal controls that disadvantage the use of foreign currencies in a way that bolsters the official national currency.

Currencies are fundamentally a network of those who have the currency and those who accept the currency. As such, they have network effects that turn currencies into strong monopolies. The difficulties of working with foreign currencies put significant barriers in place to using another currency, even in the face of high inflation.


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