The Theory of Money, Part 26

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Last week, we saw President get his government into the banking business by shifting all 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.

I’m going to now throw caution to the wind and move things quickly through the last several changes to this monetary evolution. But I don’t want it to seem rushed. I want each change to be shown as a logical and reasonable next step for the decision makers to make, given their circumstances. And once we get this money to the end of my planned state of evolution, then we can take some time to process the impacts of those changes after that.

We haven’t seen much bad banking behaviour in our fictitious society so far, but historically there probably would have been a number of exciting events by now, including some bank runs that led to bankruptcies, some banks that were on the verge of bankruptcy and stayed afloat by temporarily ceasing giving specie in exchange for their Goldnotes, and others that were forced to cease business or get bought out due to unscrupulous practices.

All these events commonly happen if a society is given enough time with fractional reserve banking. And an important result of it is that the bank notes from some banks end up being traded at a discount relative to their stated worth because of uncertainty about whether the bank will continue to be in business or continue to exchange its bank notes for specie.

For this reason, things have gotten confusing. There are a bunch of different banks issuing Goldnotes, and all of them have different values.

First Bank’s Goldnotes, on the other hand, are seen as more reliable. People believe that if the government is backing a bank, it’s more likely to come out all right in the event of a panic, so it’s quickly becoming the de facto currency for commerce.

President sees all this and decides it’s time for a change. He wants more uniformity in his country’s monetary system, which will decrease the frictions people are experiencing when they are transacting with different forms of receipt money. President hopes this change will “grease the wheels of commerce.” And, with a government-run bank at his disposal, he has all the tools necessary to finally do this.

So he declares that First Bank now has a monopoly on issuing bank notes, and he passes a legal tender law (explained in Part 24) backing that up. To symbolically demonstrate this change, all First Bank Goldnotes will be newly 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 be worth one gold coin, which means any bank will be required provide one gold coin when they are presented with one First Bank Note. This will establish a stable value (relative to gold coins) for the country’s new official receipt money.

The logistics of the Goldnote phase out would be relatively straightforward. Each bank’s Goldnotes will be assigned a value based on the current accepted value in the market. Then the issuing bank will be provided with the correct number of newly printed First Bank Notes to allow them to buy back all their circulating Goldnotes. People will be required to trade in all the Goldnotes in their possession within, say, 1 month, after which time no more buybacks will be allowed.

So if Indie Bank Goldnotes are trading at 0.9 their stated worth (a residual effect from the scare I described in Part 17), and they have 1,000 Goldnotes circulating, they would be given 900 First Bank Notes with which to buy back the Goldnotes with the Indie Bank stamp on them. I’ve ignored fractions of gold coins until now, and I’ll continue to do so; surely this society can have half coins, quarter coins, etc., and it can have receipt money that reflects 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! If my planning is correct, there are three other big monetary changes that need to take place, which I will describe starting next week.

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