The Intrinsic Value of Paper Money
The definition of intrinsic value in financial terms refers to the underlying value of an asset such as a stock, product or currency. It is determined through fundamental analysis of that asset, and not with reference to its market value.
It is of course possible to argue over what ‘intrinsic value’ actually means, whether even gold has intrinsic value (whether intrinsic value is subjective value), how value should be defined, and whether value exists outside of consciousness etc. The Marxian labour theory of value is the idea that the value of a good derives from the value of labour and capital that went into creating that good. The more labour that is needed to produce a good, the more valuable it should be. Austrian economist Carl Menger introduced the idea of subjective value in 1871. Subjective value is the value assigned to goods based on a person’s needs and wants. The value is completely independent of the value of factors of production. A 200 carat diamond stumbled upon in the bush is worth no less than an identical one painstakingly mined from kilometres underground.
We accept gold to be money with intrinsic value because of certain qualities it has. It is rare. It can’t be arbitrarily created. It is nice to look at. It is stable. Gold is one of a handful of elements that has the necessary properties to be considered money. Gasses can’t be used for obvious reasons. Most metals are too abundant, and are corrosive (they can’t survive the elements for hundreds of years, as gold can). Radioactive materials would be difficult to store. This is why, fairly consistently for most of the last 5000 years, gold has been considered money. It is interesting to note that money in the bank is not technically money. It is a risk asset. Money as a store of value and a tool used to facilitate trade is not supposed to have a yield. You receive interest on your bank balance because you take a risk in lending the bank the money. If you were to go to the bank tomorrow and demand to withdraw all your money, you will get a dirty look from your bank manager and possibly be told to wait a few days before you can have all of it. If you and all your friends and all their friends go to the bank on the same day and demand to withdraw your cash, the banking system collapses.
Why do we put up with a paper money system which is unstable, unpredictable, inflationary and subject to the interference of busy body central bankers and politicians?
The answer is taxes. If you try and settle your tax liability towards the state in stocks, bonds, gold, bitcoin or seashells, you’ll likely be arrested. The law requires that all taxes be settled in the local currency, in our case: rand. Everything is taxed, and taxes have to be paid at regular intervals. This effectively forces businesses and individuals to conduct business in the required fiat currency issued by the relevant government. If you don’t pay your taxes on time, and in rand, you go to jail.
Not going to jail has intrinsic value in and of itself to most people. This is why we are all suckered into using an unstable, unpredictable, constantly depreciating currency as money.
This is also why the official currencies of many 3rd world countries and failed states are abandoned for US$ or barter: the currency’s value has usually been inflated away through money printing, and a failed state isn’t very good at collecting taxes.
Money can be effectively used as money only as long as it has real or perceived value. The market is clever, so perceived value would fade pretty fast. What gives money real value is what backs it. What backs fiat currency is the gun of the state. On a local level, this is through the threat of police action against those who don’t pay taxes in the mandated currency. On a global level (in the case of the US$ as the world’s reserve currency) this is the threat of the US military against other nations. Ask Saddam Hussein or Muamar Gaddafi what happened when they threatened to start trading oil in euros and gold respectively instead of US$.
It is thanks to the threat of violence and incarceration by the state that paper money has intrinsic value. The market by itself would never adopt a fiat currency in its current form as money.