Since I try not to assume everyone knows every idiom, there's an old expression to the effect that the only constants in life are death and taxes. The latter is generally a superset of the former, since after all we tax certain forms of death. (That particular pejorative for the very reasonable estate tax, by the way, comes to us care of a Republican propagandist.)
But there seems to be some confusion about why we all carry around these little pieces of paper, and why we're willing to devote large amounts of our time and energy to acquiring more of them. But first let's go through a few common answers that are, nonetheless, probably wrong.
In my estimation, the most common misconception is that money gains value from currency law. For example, the US Constitution only gives the Congress the power to issue money (which it's delegated to the Fed), and the FBI enforces that position. But while it's conceivable that this is a necessary condition, it clearly isn't sufficient: consider the Zimbabwean dollar, which, in spite of currency law, stopped being used when the inflation got too bad. Of course, Zimbabwe demonstrates how this isn't necessary either: the Zimbabwean black market transacted in US dollars, which certainly was not enforced by Zimbabwean currency law.
This moves us cleanly to the "greater fool hypothesis," that I'll accept dollars because I assume you'll accept dollars, and you'll accept dollars because you assume that the grocery store will accept dollars. Partly this is problematic because it's the mother of all bootstrapping problems: why then did the first person accept the first dollar? The other problem is that this would be essentially unique among assets: even gold has more to it than just the Chicago Mercantile Exchange. For all other financial assets, people require something to justify holding them, whether it be coupons, dividends, or the promise of dividends later. So we're either left believing that money is the only financial asset where there are always greater fools, or there's something else going on.
But then, I did telegraph my answer from the start: there is only one thing in the universe that must be paid with US dollars, and that is US taxes.
To see why this matters, let's consider a hypothetical American store that accepts British pounds for purchase of goods. So let's take some reasonable assumptions, that there is no sales tax, but there is income tax. When customers come into the store, they exchange pounds for widgets. (All stores in my examples sell widgets.) The store naturally has employees, who expect to be paid. Since the store has no source of dollars, let's assume they pay wages in pounds. However, when the company pays out wages, it also withholds a portion of the wages to pay income tax.
But now the store has a problem. They only have pounds, but the income tax is due in dollars. The store now has to go to foreign (currency) exchange markets to sell some of their pounds to get dollars to pay the income tax. (If instead the income taxes are paid directly by the employee, i.e., they opt not to have any of their paycheck withheld, then the employee will face the same problem when tax season comes around.) This now opens the company to foreign exchange risk (their tax liability is now dependent on the USD-GBP exchange rate), and they also have to pay forex transaction fees on their taxes.
Now of course there comes a point where it's worth considering the involved financial calculus, as in the case of Zimbabwe, but for country with a stable economy, all these transaction overheads would kill a company trying to transact in a foreign currency or with precious metal or whatever else. It's also worth noting that this doesn't mean that everyone has to be taxed, since for example if there were only a transaction tax that were only charged on stores, they would still demand that their suppliers accept dollars, and that their customers pay them.
Graeber's Debt mentions an interesting theory that the first state coinage was actually intended to generate a distributed supply system for military forces without paying attention to the complex logistical details. Pay your soldiers with valueless tokens, demand your subjects pay tribute to you (taxes) with those tokens, and the whole thing works itself out. It has the added benefit that the soldiers don't get stabbed when they try to "requisition" supplies because on the surface it appears to be a fair exchange.
unfortunately I don't. rereading Graeber, I also realize that he never explicitly said "the first state coinage", so now I am uncomfortable with claiming such. he was speaking generally about Chartalist theories of states' early efforts to create markets and presenting a hypothetical situation in which it would be beneficial to do so.
I was only able to find this, which is by Graeber also: I've been told about a theory which postulates that markets came about as a way for generals to get rid of their booty in exchange for items which were more useful than the spoils of war, but I can't remember whose theory that was.
This is a really interesting post, as it's a perspective that I'd never considered before. This does make one wonder how currencies develop without the backup of a large organization to collectively make it in everyone's best interest to use it. For example, how have Bitcoins not flattened out? Why is there such a huge market for virtual hats in Team Fortress 2? What about gold farming and WoW? I assume that it has to do with the rather free-wheeling nature of the unregulated micro-economies involved, but I'd love to know if I'm correct about that, as well as any additional details.
At the core, money serves as a unit of account (that is, it's a way of expressing relative values of goods) and a medium of transaction, so the question isn't necessarily "why would we use money?" so much as "why would we use this particular brand of money?" Though the question of why we would use money at all is interesting, and as minimum_wage said, I've heard that Graeber's book Debt: The First 5000 Years is an excellent treatment of that topic. Suffice it to say, the parables of the goldsmith and of Robinson Crusoe are almost certainly false, and (from an anthropological perspective) the origin of money is almost certainly rooted in the origin of the state. World of Warcraft fits perfectly with the taxes-drive-money view, in that there are still plenty of taxes that are denominated in gold: chiefly (at the high end), equipment repairs, though at the low end one could also consider taxi costs, mounts, certain vendor items, and auction overheads. If there were no demand for gold in WoW, then it's conceivable that auction houses wouldn't be used, and instead player-driven barter systems would emerge (as they did in Everquest and Diablo 2). Indeed, Diablo 2 poses a telling example. I never played the game online, but I was told that gold was so plentiful and so useless that the unit of account in player trading was some (otherwise worthless?) legendary item, and the only thing anyone ever did with gold was the little gambling minigame. I've never played Team Fortress 2 so I don't know anything about any hat market, though certainly it's been shown that players can be heavily driven by vanity, because what else is there to do in online games? For example, I bought a few motorcycles during The Wrath of the Lich King, which is sadly an accomplishment that's been diminished by gold inflation. Player vanity is largely independent of this argument, though. I don't know very much about bitcoin, but I'd wager that either it's a fad, or if there really is narcotics trading in bitcoins, then of course the answer is similar to the US dollar black market in Zimbabwe: it's a convenient currency, but somewhat spurious to real national monetary systems. That is, for a black market, it really does make sense to suggest that the most convenient currency wins (after all, black markets aren't taxed); in normal markets, there's a lot of resistance to choosing a currency by convenience, since for example the euro is still limping along.
Bitcoin immediately came to my mind too. Personally, I think 'the greater fool' scenario works. Once there is a critical mass of 'fools' it will be very difficult to completely dispell the value of the asset. Furthermore, the more time that goes by that a critical mass of 'fools' exchange and desire this asset, the more difficult it becomes to dispell. Although income taxes collected specifically in that currency definitely butresses the fools delusion, I see it as an arbitrary value judgement. That is, the fact that I can exchange BTC for $ to pay my taxes might give value to BTC, but the fact that I can exchange $ to BTC to buy heroin also gives value to my $.
Planet Money recently did an episode about the Birth of the Dollar Bill It is really interesting and goes over the history of how we went from a country with hundreds of different currencies (issued by hundreds of banks) to a country with a single currency.
MMT is Modern Monetary Theory, and bgritzut hit the nail on the head: of all the posts I've made about economics, this is the most that's just a plain recitation of MMT.
How does MMT differ from say Friedmans view of money. Maybe I'm not getting it but are you saying that the value of all money is dependent on it's role in paying taxes? What about when kids develop a currency that is widely accepted in the scope of their child society like garbage pail kids or jalapeno Cheetos? Where does that fit into the tax thing?
Wray describes money in a country as a pyramid. In "Modern Money Theory", Wray, pg 85. So from that alone, MMT does support the role of money issued by non-government entities. To see why, he continues on pg 86 with:Private financial liabilities are not only denominated in the government's money of account, but they also are, ultimately, convertible into the government's currency.
We can think of a pyramid of liabilities, with different layers according to the degree of separation from the central bank...The shape of the pyramid is instructive for two reasons. First, there is a hierarchical arrangement whereby liabilities issued by those higher in the pyramid are generally more acceptable...Second, the liabilities at each level typically leverage the liabilities at the higher levels.
Taxes explain why people want a certain kind of money---that is, why in the US we carry dollars, and in the UK people carry pounds, and so forth. I'm less familiar with monetarism (i.e., Friedman), but I think the big difference between monetarism and MMT is that the former operates on the idea that money is a store of value, while the latter says that money is a unit of account and transaction medium. To clarify this a bit, by a store of value, I mean that monetarists take money to represent, say, an amount of labor. It's a very "bars of gold sitting in a vault" way of thinking about money, and it very much leads to the conclusion that price stability (low inflation) is the ultimate good in a monetary system. However, it also leads to the belief that money becomes "diluted" by issuing more of it---that is, it's based on the likely false belief that issuing more money causes existing money to become worth less. MMT instead pulls from a tradition called "functional finance," which holds that the "right amount" of money is the amount that would be required to purchase all the goods that could be produced in an accounting period, given a frequency with which that money is expected to be spent. This gets away from the belief that money is a store of value, to a more functional view, that money is a thing that exists to facilitate transactions, and that there is both such a thing as too little and too much of it. That is, having too little money to buy all things that could be made instead means that the deficit---the things that can't be bought---instead just won't be made. Regarding kids trading cheetos, I'd reiterate my argument from another post: taxes are a constraint on what forms of money can be used. If such a constraint isn't in place, for example, when considering black markets, or when considering elementary school children, then it stands to reason that people will tend to agree on what's most convenient to use. Taxes serve to limit the options available---using anything but the sovereign currency for transactions that are taxed (directly or indirectly) usually carries too high a cost, but when considering a simpler economy that contains no taxes, then anything could fill that void.