Whenever I hear people talk about the "collapse of the dollar", I have to laugh. Why? Because the dollar cannot collapse, as it is nothing already. It once was, it was defined as a specific amount of gold or silver, but no longer. Today the dollar is defined as absolutely nothing. And so, despite what some may believe, it really cannot collapse, since there is nothing there already. The crisis will come, not because the dollar's "value" is eroded, but because citizens finally recognize that the dollar is worthless and refuse to hold it. That will be the supposed "collapse", but it will not come from eroded value, but from the eventual realization that the dollar has lacked value all along.

I know with my opening paragraph many will have dismissed me as a "monetary crank", as some sort of gold standard lunatic, but please bear with me. You see, we have become used to seeing money as nothing more than funny paper the government declares to have value, and so we think it foolish to ask what money is and why it has value, we tend to think in terms of "erosion of value" and "devaluation" when talking of those scraps of paper. But what we fail to do is to ask ourselves why we accept those scraps of paper at all. We never ask why money is accepted as having value, how that value is determined, and, most importantly, what could cause that value to vanish.

Traditional commodity money is easy to understand. Gold, silver, even the oddities like tobacco warehouse receipts once used in some colonial economies, all were simply goods that had value and were traded for other goods. Now, some will argue that gold and silver had value only "because they were money", pretending the gold standard was a fiat standard akin to the modern paper currency, but that is not true. You need only look at economies where there was no gold currency, say in Meso-America, and you will see that gold was still valuable. Gold is easily shaped, decorative, does not corrode, and is rare, and that makes it valuable.

In fact, gold was money because it was valuable, it was not valuable because it was money, though once accepted as currency, that did raise its value somewhat. The gold standard was not adopted, initially, by government fiat, but as an outgrowth of barter. Yes, later economies might have established gold as the "official" currency by decree, but long ago, in the earliest of economies, gold and silver were chosen by traders as the best currency, not imposed by lords.

And you can see why. Barter is a difficult system. If you have a heap of hides and want an assortment of goods, you have to hope all those merchants want hides. Otherwise, you might have to trade your hides for something else the merchant wants, like knives or flint, and then trade that. And, if the flint or knife dealer doesn't want hides, you may end up going through four or five trades just to get one item you need.

And so, for convenience, traders hit upon the idea of a general unit of trade, something almost universally desired, which could be traded to anyone. In some regions it was something practical, such as cattle or iron ingots. In others it was something decorative, such as gold or shells. Or a luxury, such as tobacco or opium. The idea was that the item was portable, was universally desired, and could be used in all exchanges. Rather than trying to trade my hides for everything, and ending up involved in an elaborate series of exchanges to get one thing I needed, I would just sell my goods for this unit, say for a set number of shells, and then trade those shells for what I wanted. Because everyone agreed the shells were a unit of exchange, the trade was simplified. Yes, some would end up actually using the shells as decoration, but for most the shells would end up being used exclusively as currency.

And given that origin, it is easy to see why precious metals, especially gold, won out. They are valuable, having a high value per unit of weight. They don't spoil or die like livestock or organic commodities. Gold, specifically, does not corrode or tarnish, and so lasts forever. And they can be subdivided infinitely. (For example, cutting a diamond in half does not give two diamonds worth half as much as the original, but cutting a gold ingot in half does.)And they are desired for uses other than monetary, and so have an innate value for those trading them, meaning their value does not rest entirely on being the unit of trade, and thus, even those unaware of the convention will trade for them, since the good is inherently valuable.

And that was true of our currency until Nixon closed the gold window between 1971 and 1973, though effectively our money was worthless for citizens from 1934 when FDR banned the holding of monetary gold. Yes, prior to that time our money was still just "slips of paper" for the most part, with a few gold or silver coins, but those "slips of paper" could be redeemed for gold. People, though they might not know it, were not trading goods and services for "dollars", but were simply bartering them away for a fixed amount of the commodity gold. In essence, though we had a monetary system, we were still engaged in simple barter. (This is why Say's Law is so redundant. Once you realize money is a commodity, all trade is nothing but barter.)

But then everything changed. Suddenly, our money was convertible into nothing. A dollar is... Well, it is not anything. It is a piece of paper issued by the federal reserve, which the government says is money. But it has no real backing, nothing behind it.

So, why do we continue to accept this currency? Two reasons. First, inertia. We have an elaborate economy which was running prior to the change, and it just kept going once things changed. People were used to using dollars and continued to do so. The system was already used to dollar being non-convertible for everyone but foreign banks and governments, so the change made little practical difference.

Second, and more importantly, there was always the belief that dollars, though not explicitly backed by gold, would one day become convertible again. That is why the dollar price of gold is so avidly watched, why writers talk of our gold reserves dwindling and the "value" of our dollars eroding. In their minds, the dollars are still implicitly backed.

But that is also what will eventually destroy the whole system. As we have seen since the 1970's, as time passed, faith in convertibility disappears. And as the number of dollars in circulation increases, even the possibility of restoring a gold conversion standard becomes ever more remote. Instead, it becomes obvious we have dollars which are nothing more than a government promise to pay the holder in... more worthless dollars. The entire system is backed by nothing.

And eventually that will lead to collapse. As we have seen in several monetary crises in the past few decades, confidence in the dollar is almost nil. People might be willing to trade goods for dollars backed by gold, but it is harder and harder to justify trading goods for paper backed by nothing, especially one with an ever declining conversion rate. As inflation increases pace, and the remote belief in eventual conversion to gold disappears, it is very likely we will experience some form of economic crisis unlike any we have experienced.

POSTSCRIPT

I realize many think gold is "anachronistic" and "managed currency" is the only sane policy, but I have to ask them, would they trade their car for a pile of Monopoly money from me? If not, why would they do so just because the government hands them the play money? And, more significantly, as money is not backed by anything at all, what is the difference between the mint and a forger? In the past the mint was printing legal promises to disburse gold, while the forger was making false promises, but today, both are simply printing worthless slips of paper, so where is the difference?

POSTSCRIPT II

My basic thoughts on this topic can be found in "Monetary Issues Made Simple Part I", "Monetary Issues Made Simple Part II", "Why Gold?", "The Limits of "Scientific" Management", "The Limits of Econometrics", "The Limits of Technocracy", "Technocrats", "Greed Versus Evil", "Clarifying a Reality of Capitalism", "Inflation and Uncertainty", "Bad Economics Part 7 " and  "Bad Economics Part 8".