Last week, we saw President get his government into the banking business by shifting all of his government money into a newly created government-run bank that we are calling First Bank. President also implemented some safeguards to lower the risk of him losing this new revenue stream and his entire government savings in one fell swoop. These consisted of establishing a reserve-sharing central bank, establishing a minimum reserve ratio, and also giving himself the authority to suspend banking transactions temporarily in the event of a bank run or other financial emergency.
What happens next?
Something I have purposefully not yet acknowledged in this series is that, historically speaking, by this time there would have been a number of other exciting banking events in our fictitious society such as bank runs that actually did culminate in a collapse, fraudulent banking practices, banks ceasing giving specie for various lengths of time, and myriad unscrupulous business dealings.
Thus, realistically, the business practices and reputation of a bank is a big deal at this stage in the evolution of money. Consequently, Goldnotes from the different banks always end up being traded at different values according to the public’s image of the bank.
This would make for a very confusing monetary system! Can you imagine having a whole bunch of different currencies, all of which have different values, all being used at the same time?
I hope you can see where this is leading. It would make a lot of sense to simplify the monetary system by standardizing around a single bank’s bank notes. Importantly, this would make pricing and trade much more efficient. President knows this. And, for the first time ever, he has all the tools at his disposal to make it happen.
So how does he go about enacting it?
The obvious first choice is to standardize around First Bank’s Goldnotes. Not only would this be beneficial for First Bank (and, therefore, financially beneficial for the government) by strengthening First Bank’s presence in the financial community, but also First Bank’s Goldnotes are already, on account of them being backed by the full faith and credit of the government, seen as the most reliable Goldnote option. That is why First Bank’s Goldnotes have already started to become the preferred common medium of exchange. To expand their use, President decides to create a few new laws:
First, there will be a tax on the lending of non-First Bank Goldnotes. So, from that point on, any time another bank loans out their Goldnotes, they have to pay, say, 3% of the total loan value to the government in the form of taxes.
Second, banks are allowed to use First Bank Goldnotes as their reserves instead of specie.
Third, any bank that wants to trade out their Goldnotes for First Bank Goldnotes can do so.
This is how that third law would work. The bank has to pack up their entire store of specie and bring it to First Bank. When they give their specie to First Bank, in return they will receive that many First Bank Goldnotes PLUS enough Goldnotes to buy back all of their circulating Goldnotes (subject to a cap–if the bank is under their required minimum reserve of 0.2 at that point, they will only get as many as would allow them to buy back 5 times the number of gold coins they provided).
So First Bank would be giving the bank two lump sums of First Bank Goldnotes: (1) a lump sum of Goldnotes to replace their reserves–one First Bank Goldnote in exchange for one gold coin–and (2) a lump sum of Goldnotes to allow them to buy back their circulating Goldnotes.
The calculation of the second lump sum would be as follows: If the bank’s Goldnotes are trading at 80% of the value of a First Bank Goldnote, and they have 10,000 of them circulating, then 80% x 10,000 = 8,000 First Bank Notes.
The exchange rate used in that calculation will be locked in from that time forward, so all contracts that specify money in terms of that bank’s Goldnotes will be amended to specify 0.8 times the number of First Bank Goldnotes instead. And there will be a buyback period, where anyone who possesses that bank’s Goldnotes can bring them in to the bank to be traded out for 0.8 times the number of First Bank Goldnotes. After the buyback period, that bank’s Goldnotes will immediately and forever have no monetary value.
This is an offer the banks can’t refuse. Trading out their reserves of specie for First Bank Goldnotes does not hurt them in the least if they will no longer be required to redeem Goldnotes with gold coins, and receiving enough First Bank Goldnotes to buy back all their circulating Goldnotes also does not take any wealth away from them. But making this exchange does allow them to avoid the 3% tax.
Any bank that takes that deal will then forever after have First Bank Goldnotes as their reserve. Instead of giant piles of gold coins in their vault, they will have giant piles of government-stamped pieces of paper.
Other than the change in the physical form of banks’ reserves, the society’s fractional reserve banking system will continue to operate exactly the same, and probably nobody will notice anything except for the convenience of finally everyone getting to use the same money that was the preferred form of money already. But we will see soon enough that this change has major implications on the future of their monetary system.
And, voila. Over the next several months after passing those three new laws, Goldnotes from all the various banks start to disappear as they get traded in. And all the specie in the entire country has now been transferred, without forcing anyone to do so, to First Bank.
Once all of the other Goldnotes are completely gone, President creates a couple more laws to protect the ground he has won.
First, to forever prevent regression back to a multi-currency society, he declares that First Bank now has a monopoly on issuing bank notes.
Second, to reinforce First Bank Goldnotes as the only form of acceptable money in the country (in the unlikely event of a banking fiasco that harms their reputation and tempts citizens to start using something else, such as another country’s currency, as their common medium of exchange), he passes a legal tender law (explained in Part 24).
And to commemorate this change, all of First Bank’s subsequent Goldnotes will be printed with a new pithy name: First Bank Note.
*Moment of silence for Goldnotes*
And on these new First Bank Notes will be the legal tender inscription: “This note is legal tender for all debts, public and private.” Each First Bank Note will still be worth one gold coin, which can be redeemed at any First Bank branch, so the country’s new official receipt money will still have an anchor to gold to keep its value from drifting arbitrarily.
Oh, one more thing. For simplicity, I’ve ignored fractions of gold coins until now, and I’ll continue to do so; but surely this society can have half coins, quarter coins, etc., and it can have receipt money (whether it’s paper money or token coins) that reflects the value of those fractional coins as well. I just think talking about that doesn’t help explain anything and risks confusion.
Anyway, we have finally achieved a uniform currency! It’s starting to seem like modern money, isn’t it? Take a look at this . . .
Next week, we will process more of the implications of this change before we finish with the last few major money transitions.
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