Legal tender is fiat money, or currency (bank notes and coins). It has value because a government creates it and backs it, and people using it have faith in its value. Fiat money such as US dollars can be used as an exchange for goods and services.
The point is that other kinds of money have been used. Legal tender differs from commodity money and representative money. Commodity money is based on a "good", often a precious metal such as gold or silver, which is desired or has other uses. Representative money is a claim on the commodity rather than the actual good. In that case, the gold stays in a bank, and its ownership changes from time to time as the money is used. Why might a good be used at all? One reason is that governments cannot just make it. It is said that this stops inflation because, with fiat money, governments can just print more.
Some economists argue that an economy can only grow if it can produce more capital goods and not more money in the form of credit. This means that good economies must produce things rather than borrow money to buy things produced in other countries.
Alan Greenspan was an early critic of fiat money arguing that "Deficit spending is simply a scheme for the confiscation of wealth". He thought the value of money should be backed by gold. Richard Nixon ended gold backing for the United States dollar in 1971. Other countries also changed to Fiat currency.
- N. Gregory Mankiw 2014. Principles of economics, p. 220: fiat money: money without intrinsic value that is used as money because of government decree. ISBN 978-1-285-16592-9.
- Walsh, Carl E. 2003. Monetary theory and policy. MIT Press. ISBN 978-0-262-23231-9
- Greenspan, Alan (1966). "Gold and economic freedom". Archived from the original on 2010-09-25. Retrieved 2009-11-15.