The Theory of Money, Part 28

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Ok, for those following along, last week I pointed out some issues that didn’t make sense with some of these recent changes I said President made. It’s time to clarify them. I may go back and just do that in the original posts later on for the sake of avoiding confusion for future readers, but we’ll see.

As an aside, what a fun journey to be on, right? Figuring out money and banking, and also figuring out how to explain it in a comprehensible format! If you haven’t ever read anything on money and banking, you should. Try, for example, reading these speeches (PDF) made by some Ph.D. economists during a congressional hearing on fractional reserve banking in 2012. If you already understand what they’re talking about, their statements make sense. But if you don’t, man is it befuddling. I’m sure I fail sometimes at making it completely comprehensible as well, but I hope a deliberate stepwise approach to this information (plus some simplifications that don’t alter the underlying mechanics) helps.

Anyway, here’s a quick summary of the issue needing to be clarified: The confusion was about exactly how we transition from our current system with a bunch of different banks offering their own version of Goldnotes to this new system of exclusively using First Bank Notes.

I originally said that we could phase out all the other banks’ banknotes by having First Bank give each bank enough First Bank Notes to directly buy back all their circulating Goldnotes, and that you could take a First Bank Note to any bank and exchange it for specie. But I identified some problems with that method last week–the biggest problem was that, since anyone could get specie in exchange for a First Bank Note from any bank, it basically converted all banks into a single huge bank with a single shared reserve. And that means any bank could get away with lending out a lot more (draining the collective reserve) and earning more money than the rest, which would soon lead to all the others following suit, and then the reserves would be depleted and a banking collapse would occur.

My challenges with getting our fictitious society to make this transition arise from the difficulty I’ve had in finding more details on the specifics of how a government-run bank’s monopoly on the issue of banknotes actually gets enacted. So let’s do this in a different way that makes a little more sense to me.

We’ll start by clarifying that First Bank Notes are good for one gold coin, but you can only make that exchange at First Bank itself. It’s First Bank guaranteeing this receipt money can be converted back into commodity money at any time, so it makes sense for that to be the only place someone can make that exchange.

And if First Bank notes are the only ones that are going to be used in all of society, and anyone can go to First Bank to request a note be exchanged for a gold coin, then all the gold reserves also have to be in First Bank.

So, these are the steps I think President could take to make this transition:

First, he will have each bank send all their gold coins to First Bank, and those gold coins will be deposited into each bank’s account. Yes, this means every bank now has a bank account at First Bank.

In return, he will give them First Bank Notes. Since the established reserve ratio is 0.2 right now, that means the money multiplier is 5, so he will give them 5 times the number of First Bank Notes than they gave in gold coins, which they will then have to use to trade in all their circulating Goldnotes.

All contracts will also need to be converted into First Bank notes or gold coins. So, if a contract is currently denominated in Story Bank Goldnotes, which are trading at 0.9 of their stated value, the conversion would be simple. If a contract is worth 1,000 Story Bank Goldnotes, then it will immediately get switched to be worth 900 First Bank Notes to retain its current market value.

I think that’s it. Ultimately, the exact process of how this works is less important than the fact that people are only using First Bank Notes now. And when banks are lending out money, it’s First Bank Notes that they are giving out, which they are getting from First Bank in return for the specie that they’re storing in their account at First Bank.

From what I can tell, historically the phase-out of other bank notes was done by charging a higher and higher tax on any non-government bank notes, which made them worth so much less that they became no longer viable as a low-cost means of using as a common medium of exchange. But information on the exact details of how that went down is not readily available based on my searching and reading.

All right, next week we’ll resume our more rapid progress through the last few changes our fictitious society’s money needs to make.

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