Most of us at this point have heard about fiat currency vs an asset backed currency. We understand that fiat currency is backed only by the full faith and credit of the American government. While this is the popular understanding the reality is that the American government generates no money and so it has no ability to back or guarantee anything. What we mean by backed by the American government is that it is backed by the American economy. That is, by the production of the American worker and entrepreneur.
So when someone accepts a US dollar in exchange for some good or service, they are implicitly validating their confidence that the US economy would continue to generate enough output to maintain, at least an effective (if not technical) condition of solvency in America.That touches on an incredibly important aspect of fiat currency which is how we value it. Most of us are familiar with purchasing power, which tells you how much you can trade for a given amount of dollars today. We see this in every store as each product has a price in dollars.
We also see the more general relative purchasing power as measured against other currencies. We’ve all exchanged money for vacation where we trade dollars at some conversion rate for another currency. That conversion rate varies day to day but generally doesn’t move very much over short periods.
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