April 2, 2011

Positively Valued Fiat Money after the Sovereign Disappears: The Case of Somalia

  • Lawrence H. White

    Distinguished Senior Fellow, F. A. Hayek Program for Advanced Study in Philosophy, Politics and Economics
  • William J. Luther

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Economists commonly invoke sovereign powers to explain the acceptance of unbacked paper money at a positive value. The government accepts or compels taxes paid in the money (makes it publicly receivable) or compels creditors to accept it (grants and enforces legal tender status). Thus fiat money is thought to rely on enforcement of a literal fiat or decree. The case of Somalia defies this account: following the state’s collapse in 1991, unbacked paper Somali shillings continued to circulate at a positive value. We explain how historical acceptance, or “inertia,” can sustain the ongoing acceptance of unbacked money even in the absence of ongoing sovereign support. Although sovereign power might be necessary to launch a fiat standard, we conclude that it is not a necessary condition for its survival.