Money Mischief_ Episodes in Monetary History - Milton Friedman [5]
The "legal tender" quality means that the government will accept the pieces of paper in discharge of debts and taxes due to itself and that the courts will regard them as discharging any debts stated in dollars. Why should they also be accepted by private persons in private transactions in exchange for goods and services?
The short answer—and the right answer—is that private persons accept these pieces of paper because they are confident that others will. The pieces of green paper have value because everybody thinks they have value. Everybody thinks they have value because in everybody's experience they have had value—as is equally true for the stone money of chapter 1. The United States could barely operate without a common and widely accepted medium of exchange (or at most a small number of such media); yet the existence of a common and widely accepted medium of exchange rests on a convention: our whole monetary system owes its existence to the mutual acceptance of what, from one point of view, is no more than a fiction.
That fiction is no fragile thing. On the contrary, the value of having a common money is so great that people will stick to the fiction even under extreme provocation. But neither is the fiction indestructible: the phrase "not worth a Continental" is a reminder of how the fiction was destroyed by the excessive amount of Continental currency the Continental Congress issued to finance the American Revolution.
The numerous inflations throughout history—whether the recent moderate inflations in the United States, Britain, and other advanced countries, or the very large recent inflations in South and Central American countries, or the hyperinflations after World Wars I and II, or the more ancient inflations going back to Roman times—have demonstrated the strength of the fiction and, indirectly, its usefulness. It takes very high rates of inflation—rates well up in double digits that persist for years—before people will stop using the money that is so obviously inflating. And when they do lose faith in the fiction, they do not revert to straight barter. No, they adopt substitute currencies. The substitute currencies in most inflations in history have been gold, silver, or copper specie, often, as during the American Revolution, in the form of coins of foreign countries. What's more, people may not abandon paper altogether: they may turn instead to paper money that has not been overissued.
Two particularly revealing examples are provided by the American Revolution, more than two centuries ago, and the Russian Revolution of 1918. The Continental currency was overissued. The result was that the promise of redemption in specie was not honored, and Continental currency came to be accepted only at the point of a gun. On the other hand, some of the original thirteen colonies issued their own paper money, which remained limited in amount, and this paper money continued to be used, along with coins of foreign countries. An even more striking example is that provided by the Russian Revolution of 1918, which was followed by a hyperinflation of far greater magnitude than the American revolutionary inflation. When, in 1924, the inflation was ended and a new currency established, one of the new chervonets rubles was exchanged for 50 billion old rubles! These old rubles were the ones that had been issued by the new Soviet government. There also still existed old czarist paper rubles. Since there was small prospect that a czar would return to redeem the promise printed on the czarist rubles, it is remarkable that they were