I received an email about my “Fairy Story” making the point that most currencies did start off as commodity currencies and later switched to being fiat currencies.
So here is another take on how that has come about:
Imagine a large prison camp with many prisoners. The authorities have issued tokens to be used as a currency. One token is equal to a packet of cigarettes. The authorities promise to redeem those tokens for a packet of cigarettes and so the prisoners are able to use those tokens as a currency. For every token they take in, and for every packet of cigarettes they pay out, they in turn pay out that token in the form of wages for jobs the prisoners may do in the kitchens or the prison gardens. That’s like the Gold Standard of course.
Then one day one of the people in the prison authority comes up with a bright idea to eliminate the need for them to pay out any cigarettes.
How is that done?
The answer is that they impose a poll tax of one token per week from each prisoner. Or just from some prisoners. They have to pay in one token. There are severe penalties for non-compliance. The authorities have to give the prisoners a way of earning those tokens so they offer them a job in the prison gardens or the kitchens, as previously, so they can earn them. Even the prisoners who aren’t liable to pay can still work and trade their tokens if they want to.
That’s the way it works – I think.
So, the government pays out the tokens in the form of wages to its employees and contractors first and then receives them back in the form of taxes later.
The “conventional wisdom” is that it’s the other way around. Governments can only spend, unless they borrow the difference, what they receive in taxation! I don’t think so!
Modern Monetary Theory: Real Economics 