Historically, and according to Natural Law or Austrian economics (take your pick), stuff's worth is assigned by the free market. A loaf of bread has a certain value "assigned" to it by the free market (the balance between supply and demand, at its simplest). Money is merely a means of quantifying that worth in a form that is convenient. It was convenient to choose precious metals as the means of storing and trading value. A loaf of bread might be worth a particular gold coin, for example. (The coin would likely be very small or have very little gold in it, in this example, since bread isn't worth much in the grand scheme of things.) It later became convenient to create pseudo-money, or a currency that had no inherent worth in itself but symbolized real value. Paper money fits this bill well. In the good ol' days, paper money could be traded at any time for an amount of gold, say (any agreeable commodity will do, really), that was imprinted on the money. For example, a hundred dollar note might be traded for an ounce of gold bullion (for all intents and purposes, pure gold). This relationship was fixed by definition. One ounce of gold was always "worth" a hundred dollars, because a hundred dollars was defined to be the same value as an ounce of gold. Such was the nature of the gold standard.

Over time, the U.S. dollar's value was arbitrarily altered by the government (immorally, mind you) to ever shrinking amounts of gold. This had the effect of devaluing the dollar, or making everybody poorer. (It's a sneaky kind of theft.) Later, the gold standard was wholly abandoned. This is what a fiat currency is. The value of the dollar is not fixed at anything. Its definition is no longer defined against some constant, valued commodity. Instead, its value is implicitly assigned by those who use it. On the surface, this would seem to be more free-market-ish than a gold standard. Note, though, that a market for fiat currency is not a real market but a meta-market. Fiat currency has no inherent worth except that it can be traded for other things that do have inherent worth.

The problem with our fiat currency lies in the particulars of its management. The biggest problem is in federal monetary policies. The government essentially prints its own money. (Technically it's the Fed, which is "private", but realistically, it's under fascist control.) As more money is printed, and while the value of the whole money supply is maintained relative to produced commodities, existing gold, etc., the value of each individual dollar drops. Imagine all of the world's goods being worth $1000 in 2007 dollars. If you print more money next year, let's say $1000 more, you'd then have $2000 worth of 2008 currency but only $1000 of goods (as measured by 2007 dollars). This means twice the money is spread over the same goods, resulting in each dollar being worth in 2008 half of what it was worth in 2007. This is inflation. (This is a simplified perspective. Really, the goods increase, too, with production. Were the goods to increase at the same rate as the money supply, inflation would be flat or zero.)

Couple the willy-nilly printing of money with the habit of our government of living beyond its means, and you've got a recipe for disaster. Our government lives on borrowed money, ironically money it also prints. It borrows money, for example, in the form of T-bills. Some of the largest investors in the dollar are, oddly enough, not Americans. Many nations--their governments, really--use the dollar in their trade. Foreign governments buy T-bills, essentially loaning the fedgov money. The U.S. promises to pay back the loan with interest in the future. Meanwhile, as more money is being printed, the value of the dollar continues to fall. Of course, to repay its debts, it must print more money, because it doesn't have enough stuff of real value (e.g., gold) to do so. If the value of the dollar falls faster than the promised return on investment for our creditors, our creditors will lose their faith in the dollar; specifically, they'll lose faith in the ability of the fedgov to pay its debts meaningfully (as opposed to paying them back in ever more worthless dollars). When that faith is lost, the value assigned to the dollar by investors/creditors will plummet. If all these nations divested themselves of the dollar, for example, our economy (being so dependent upon these foreign nations) could collapse into something even worse than the Great Depression. If our foreign policies piss off enough foreign governments, combined with our self-destructive monetary policies, they could choose to divest themselves of the dollar. Without a single shot fired, a small conspiracy of dollar-investing, America-hating governments could do serious damage to our economy.

I should note there are those detractors who say every dollar divested must then be bought by somebody else. To a degree, true. But this optimistic view hinges on the dollar settling into its true value in relatively short order--a kind of market correction, if you will. However, divestment could continue to the point of bankruptcy. Like the tech bubble bursting in the early part of this decade, we could see the fedgov--and therefore much of the American economy--go belly-up. In other words, the true value of the dollar may not be a mere 20 to 30 percent below its present, declining value, but could be 90+% below. If the fedgov goes belly-up, the dollar may not be able to be salvaged. This is what happened to post-WWI Germany's currency. (The exchange rate between the old Papiermark and the new Reichsmark was 1 RM = 10¹² Papiermark. How's that for inflation?) Such bankruptcy, by the way, would make the American economy ripe for foreign "buyout", too. We could become Chinese, or European (again), or worse, almost overnight.

If we accept government-printed currency--we really shouldn't--we could remedy the situation by backing the currency with gold. By returning to a definition relative to a commonly acceptable commodity, the value of the dollar remains fixed by definition. It would then prevent the government from printing more money than we have commodity to back it. (Of course, they won't do this, because if they don't print the money, they can't subsequently borrow it to fund all their illegal programs/power.)

On the other hand, if we were to allow a rapid collapse of the dollar (we won't), the market would adjust rather quickly. Rather than going to work to get paid in dollars--which would be useless to us--we would insist upon payment in some agreeable currency. It may be gold--doubtful--or it could be some other currency (e.g., the Euro) or a different commodity. Such market adjustment would be pretty quick because all markets depend upon agreeable currency. Of course, we'd be in "survival mode" this way, having so many markets collapsing while awaiting this adaptation.

However, what will actually happen when the fiat currency collapses will be several, failed, governmental attempts to prop it up to vainly avoid its imminent and necessary collapse. The fedgov will not be able to let it go, because the dollar is all that supports its massive power base. Without this fake commodity--or rather, without this commodity's market-assigned value--the fedgov has no equivalent means of paying its debts, programs, etc. In anticipation of this, some decades ago, it was made illegal for Americans to own gold. In essence, the fedgov stole the gold from the people and hoarded it. That law was since reversed, but it still retains a massive cache of essentially stolen gold. It's not nearly enough to pay for even a tiny fraction of its dollar-based debts, mind you, but it'll work well enough to purchase the tools of force to retain its power over the people.

Rest assured, fedgov policies of the last century or more have all but insured an eventual collapse of the dollar and the decimation of the American economy. I believe we might be able to dig ourselves out, but not without incredible pain--not just to the 85+ million employees of government (plus their 42+ million dependents) but also to the rest of us who always cry to Big Brother to save us from our own stupidity, or merely from the ripple effect. Digging ourselves out, though, would require replacement of all of the Executive Branch leaders and the bulk of Congress and the Court with those who understand Austrian economics (i.e., reality) and the humility to submit to Constitutional limitations on their power. Short of an armed revolution (which I think is no longer feasible) , I really don't see that happening. Besides, I'm not sure there are enough people in the country who understand even the basics of politics and economics to fill all those positions (not to mention, those who do understand generally wouldn't want the positions).