The Theory of Money, Part 27

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In Part 26, our fictitious society finally transitioned to a uniform currency. To be clear, their money is still backed by gold, but their receipt money is now uniformly First Bank Notes.

Since that transition, transacting has become easier because now everyone is using the same notes, and they are each worth the same as a gold coin, which is much simpler than what they had to do before when they were trying to account for discounted Goldnotes from many different banks.

But a question arises about this system.

What happens if a bank has a ton of people come and request specie in exchange for First Bank Notes? Aren’t we risking banks running out of specie since there are many times more First Bank Notes than there are gold coins in any one bank?

The answer is that if a bank has to give up a ton of its specie, it is getting First Bank Notes in return, which it can then take and get specie from any other bank.

But this brings up another question.

What’s the point of a reserve-sharing central bank if any bank can get reserves from another bank simply by giving a bunch of First Bank Notes that it has on hand? It seems like all bank reserves have become shared since the receipt money now in use entitles a person to a gold coin at any bank.

This is true, and it means I haven’t perfectly thought through the exact steps that a banking system takes to get from there to here. Sure, these steps are just transitional steps, but I think it’s important to understand each one thoroughly nonetheless.

So this is what I’m going to do. I’ll stop here this week and do some more reading and thinking by next week. This is a great reminder of an important point: my knowledge is imperfect. I hope that’s not a surprise to anyone. I’ve written before about academic integrity, and I just re-read that post and still completely agree with everything I wrote. I recommend taking a look at it. It applies to my knowledge of money and banking just as much as any other topic.

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