When we buy and sell things from each other here in the United States, we almost always use dollars. But we don't have to. We can trade goods directly for other goods (barter), we can use other currencies such as the Euro, and private entities can even make up their own currencies for trading with each other. There is no law in the United States that says that two private entities must use dollars when buying and selling.
But even if we all decided to barter or use other currencies, even if we all stopped using the dollar on a day-to-day basis, the dollar would still have inherent value. That's because we must pay our taxes with dollars. Thus, dollars are rather like a get out of jail free card (except for the "free" part), since if you don't pay your taxes (in dollars), those nice men associated with IRS will come and haul you off to jail. You must acquire enough dollars to pay the taxes you owe to the government. That makes dollars inherently valuable.
This is why every national government in the world, no matter how rinky dink, no matter how unstable, can have its own fiat currency. This is why its citizens, who must pay taxes to that government in that government's currency, use that currency. This is why currencies need not be gold backed and citizens of a country need not have a lot of confidence in the currency, yet the currency has value and finds widespread use within that country, whether or not there are laws requiring the use of that currency. People need the currency to pay their taxes.
Warren Mosler wrote in "Soft Currency Economics" (hat tip: Skeptical Optimist):
A government using fiat money has pricing power that it may not understand. Once the government levies a tax, the private sector needs the government's money so it can pay the tax. The conventional understanding that the government must tax so it can get money to spend does not apply to a fiat currency. Because the private sector needs the government's money to meet its tax obligations, the government can literally name its price for the money it spends. [...]
The concept of fiat money can be illuminated by a simple model: Assume a world of a parent and several children. One day the parent announces that the children may earn business cards by completing various household chores. At this point the children won't care a bit about accumulating their parent's business cards because the cards are virtually worthless. But when the parent also announces that any child who wants to eat and live in the house must pay the parent, say, 200 business cards each month, the cards are instantly given value and chores begin to get done. Value has been given to the business cards by requiring them to be used to fulfill a tax obligation. Taxes function to create the demand for federal expenditures of fiat money, not to raise revenue per se. In fact, a tax will create a demand for at LEAST that amount of federal spending. A balanced budget is, from inception, the MINIMUM that can be spent, without a continuous deflation.Again, it's taxes that form the basis of the value of a currency. To be sure, there are many other factors such as the size of the money supply, total GDP, etc., but taxation is the fundamental driver of a currency's inherent value.
With this understanding, we can now turn our attention back to the meaning of savings and investment in the next posts in this series.