20.6 The origin of money
Tax cannot explain the origin of fiat money
Wray argues that a State can introduce a currency by imposing taxes payable in that currency and then spending the currency into circulation. The tax undoubtedly gives taxpayers a reason to obtain the required units, but that is not an explanation of how initially valueless tokens acquire the purchasing power necessary to become money. A tax specifies how many units must be returned to the State; it does not specify what one unit is worth in food, labour, land, or any money already in use. Wray describes this as a two-step process in which the State first imposes a monetary tax and then puts a monetary price on the resources it wants (see L. Randall Wray, Taxes and the Public Purpose).
The proposal faces a dilemma. Government must spend more currency than it taxes if any is to remain in private circulation. If taxpayers can obtain ample tokens and reserve enough to meet their liabilities, the surplus has little marginal value and they can otherwise ignore it. Any subsequent rise in its exchange value would depend on the uneven distribution of the tokens and their gradual passage through markets—a second-order Cantillon effect, not a satisfactory account of the currency's initial value. Conversely, if the State issues fewer tokens than are required to pay the taxes, taxpayers must compete for an insufficient supply under threat of penalties. The tokens may become extremely valuable and be hoarded, while some taxpayers must default regardless of what they offer. Such an instrument is poorly suited to become a stable medium of exchange.
The State can escape this dilemma only by introducing an additional source of value. It might convert an existing currency into the new one at a stated rate, promise redemption for something valuable, accept it in settlement of pre-existing debts, or announce the quantities of goods and labour for which it will exchange the currency. In the last case the State's purchasing schedule, backed by its coercive power, establishes the initial exchange ratio; the tax does not. Historically, a new fiat currency can also inherit the price structure, contracts, banking system, and unit of account of the currency it replaces. It is then not being created from valueless tokens merely by imposing a tax.
VoTa therefore agrees that taxation can create demand for an established settlement asset, but rejects it as a theory of monetary genesis. Demand for money must arise from a value or service independent of the bare tax denomination: the monetary object may have a non-monetary use, it may be redeemable for something valuable, or it may already provide the market utility of a generally accepted medium of exchange. This is the Austrian insight behind the regression theorem: present monetary demand rests on an antecedent purchasing power rather than emerging from an arbitrary nominal unit. Tax can reinforce the use of a currency once that bridge to value exists, but it cannot itself supply the bridge.
The Virginia treasury-note example
Wray offers colonial Virginia's paper money as an example of this process. Beginning in 1755, Virginia issued pound-denominated treasury notes to obtain provisions and meet military expenses before the taxes enacted for those purposes could be collected. The notes were then accepted in payment of the associated redemption taxes and destroyed. Wray argues that this illustrates why a currency issuer must first spend its currency before it can receive that currency in tax, and why people would accept the paper from the colonial government (see The Real Story of Money with Randy Wray).
The example establishes the sequence of issue and retirement, but it does not show an arbitrary fiat currency acquiring value from tax alone. The first Virginia emissions paid interest. Later emissions had no explicit interest but retained specified maturity dates, dedicated taxes to fund their retirement, and redemption at face value in specie equivalents. The notes could also discharge the relevant taxes at face value before maturity. They were therefore transferable claims against identifiable future government receipts and redemption, not irredeemable tokens possessing only a tax-induced demand.
Farley Grubb's reconstruction finds that the first notes functioned as interest-bearing bonds and the later ones as zero-coupon bonds. Their market exchange value was explained predominantly by the discounted present value of their expected redemption, with only a relatively small additional premium attributable to their convenience in transactions. On this analysis they gradually acquired money-like characteristics, but were not initially fiat money (see Farley Grubb, Colonial Virginia's paper money, 1755–1774: value decomposition and performance).
Nor did the notes introduce a unit of account without an antecedent purchasing power. They were denominated in pounds, shillings, and pence within an economy already using sterling bills, foreign specie, tobacco, tobacco claims, and private credit. Their values could be assessed against those existing monies and commodities. The Virginia episode consequently shows that tax-receivable government debt can circulate as currency and acquire a transaction premium. It does not show that taxation can transform initially valueless paper, denominated in a new and unpriced unit, into fiat money. Its development instead followed the sequence of a valuable government claim becoming a circulating claim and then a money-like instrument.