Prof. Bryan Caplan

Econ 918

Spring, 1998

Week 12: Privatizing Money, III: Further Alternatives to Central Banking

  1. The "New Monetary Economics"
    1. The "New Monetary Economics" is a broad label covering a wide variety of alternatives to traditional single-base-money systems (whether fiat or commodity).
    2. Three strands:
      1. Multicommodity standards
      2. Private fiat money
      3. Money without a monetary base
    3. Recurring themes
      1. Interest on currency and its ramifications.
      2. Monetary disequilibria created by existence of a single monetary base.
  2. Multicommodity Standards
    1. Historical commodity standards typically have only one good serve as the monetary base, but why do this? I.e., instead of defining $1=1/20 oz. gold, define $1=(1/100 oz. gold + 5 lbs. tin + 3 liters of Coke +...). Or even $1=$1 in 1997 CPI.
    2. It is not particularly convenient to redeem $1 worth of the 1997 CPI. But that is not a problem. Just pay out $1 worth of the 1997 CPI in the most convenient single commodity - which could even be gold. No need for banks to keep a bizarre warehouse stocked with finely divided quantities of every good on the market.
    3. So every day the CPI value of $1 is constant, but each day the amount of gold - or pork bellies, or human blood - you can receive in exchange for $1 fluctuates. If public ceases to hold base money, then banks nevertheless use the same multicommodity standard to settle clearings.
    4. Inflation is virtually by definition eliminated under a sufficiently broad multicommodity standard - although if important items are difficult to include (e.g. labor) the price stabilization will be imperfect.
    5. Main macro benefit of the (ideal) multicommodity standard: never any need for overall price level adjustments so long as all prices are denominated in terms of the multicommodity standard (or "valun").
    6. Notice the difference between multicommodity standard and traditional bimetallism.
      1. Under bimetallism, the government would fix an exchange rate between silver and gold at e.g. 16:1. One money was thus always in excess demand, the other in excess supply, and Gresham's law prevailed. In effect, $1 was defined as both 1/20 oz. gold and 4/5 oz. silver.
      2. Under a multicommodity standard, $1 would be defined as e.g. (1/40 oz. gold + 2/5 oz. silver), leaving the relative prices of gold and silver free to fluctuate. $1 can always buy the multicommodity bundle, but 1 oz. of gold can neither buy a fixed number of dollars nor a fixed weight of silver.
    7. A multicommodity standard would in practice probably be much easier for a government to get off the ground than it would be for a private banking system, since it would be necessary to effect a massive joint deviation to a new payments system. A government-created multicommodity standard would amount to forcing the Fed to redeem current dollars for the multicommodity bundle at a fixed ratio. Financial market arbitrage would do the rest.
      1. Somewhat similar early proposal: Fisher's compensated dollar.
    8. A free banking system, once on a multicommodity standard, would work like any other free-banking system. Some reserves for clearing purposes would be needed, but the reserves would still probably consist in a small number of commodities that fluctuate in relative value against the other components of the multicommodity bundle.
      1. How would banknotes and deposits be created? As under free banking generally, banks can issue as many as they like, subject to the need to redeem them.
    9. Questions about multicommodity standards:
      1. How many commodities are necessary to get close-to-perfect price level stability?
      2. Does omission of commodities not traded in financial markets create any difficulties for multicommodity standards?
      3. What happens under a government-administered multicommodity standard if real money demand rises?
      4. What happens in a free banking system on a multicommodity standard if real money demand rises?
      5. Any reasons - other than coordination failure - why multicommodity standards have never been observed? (Is movement to single commodity a PD rather than a coordination failure?)
  3. Competing Fiat Currencies
    1. Hayek proposed a system of competing fiat currencies, in which multiple firms within a nation issue their own currency, denominated in their own "brand-name" unit.
    2. Value of such money does not necessarily fall to equal the value of the "paper it's printed on," since issuers have monopoly over their brand names. (Similarly, the price of Coke does not inevitably fall to equal the price of generic soda, since Coke limits the use of its brand name).
    3. Big coordination problem: How do you get the public to start taking your Hayeks, Rothbards, and Caplans? How would anyone have any idea what one Caplan is worth?
      1. Possible solution: Give new money a commodity jump start. Make it initially redeemable for gold; once it is widely accepted, cut the cord.
    4. Trade-off between initial terms of exchange and subsequent rate of seigniorage (which could be negative). Commitment to deflate currency increases real value of total stock, but hurts current revenues of fiat-money issuer. Commitment not to hyperinflate makes private fiat money at least a reasonable alternative to government currency once the coordination problem is overcome.
    5. Main problem with private fiat currency (apart from coordination problem): Time consistency. Firm needs to credibly commit not to hyperinflate to get the public to accept a new currency, but once the public accepts the money, the firm can effectively expropriate the whole value by hyperinflating.
    6. Reputation can solve time consistency problem for private fiat issuers, just like it can solve it for CB. But: Private fiat issuers do not face elections and have no other source of new revenue other than seigniorage.
    7. So a private issuer may be more likely to find defection worthwhile. Which implies not that we will observe a lot of defections to hyperinflation, but rather that private fiat money won't be accepted in the first place.
    8. Another alternative: Buyback offer (akin to buyback offers on collectors' items). Effectively commoditizes private fiat money.
    9. Multicommodity standard at least still allows convenient pricing in valuns. What would menu costs look like under private fiat money?
    10. Questions about private fiat money:
      1. What advantages does it have over commodity (or multicommodity) base money?
      2. What advantages does it have over government fiat money?
      3. Why don't international currencies exchange domestically already? (Except in pathological cases).
      4. What about menu costs?
  4. Systems Without a Monetary Base
    1. In some usages, a multicommodity standard with enough commodities in it already counts as a system without a monetary base. But I'll reserve the "no monetary base" designation for two kinds of systems:
      1. Purely abstract monetary units.
      2. Real bonds (or other securities) system.
    2. Purely abstract units: Prices of everything quoted in "quadloos," but there are no quadloos. Imagine if all of the base money in the world disappeared. We might still do mental accounting, bargaining, pricing, and so on in dollars (and in a way, the mental accounting gets easier!), but actually close deals with a real commodity.
      1. Risk of systemic shortages and surpluses if relative scarcities fluctuate.
    3. Real bonds systems. People use real bonds or other securities as money. But these are never net wealth, so trade exists without any base money.
      1. Prices could still be quoted in dollars or e.g. 1987 dollars, but everyone pays for real goods by issuing interest-bearing bonds or other securities.
      2. How are the bonds ever settled? At the maturity time, the issuer has to pay the value in present goods.
      3. Main difference from multicommodity standard: All means of payment are interest bearing, and "backing" is not necessarily in current goods.
    4. Legal restrictions theories: Argues that the only reason currency does not currently pay interest is due to "legal restrictions" on competitive supply. In a free market, all means of payment would earn interest.
      1. Problems:
        1. Historically contradicted.
        2. In-kind payments in banking services more convenient (lower tc) than interest on currency or serial number lotteries.
    5. Questions about systems with no base money:
      1. Isn't this virtually a return to barter?
      2. How would such systems come to exist in the first place?
      3. Others
  5. Evaluation of the "New Monetary Economics"
    1. Multicommodity standards:
      1. Clear advantage over single commodity standards in terms of purchasing-power stability, vulnerability to runs, etc.
      2. But unclear that these advantages outweigh the transactions costs, even if the coordination problem could be cheaply overcome.
    2. Private fiat money has more severe problems:
      1. It seems like if Hayek were right, then pounds, DMs, francs, and dollars would all be used in the U.S. right now.
      2. This may be a case where the weaker profit-motive of CB keeps them from devaluing as much as private issuer.
      3. Major coordination problem and serious menu cost problems.
    3. Systems with no base:
      1. Same advantages of multicommodity standards (and there is some overlap in the definitions).
      2. Big transactions costs, coordination problems, and menu costs.
  6. Evaluation of Privatization of Money Generally
    1. Transition difficulties aside, what aspects of the monetary system are best privatized?
    2. Including transition difficulties, what aspects are best privatized?
    3. Suggested transitional schemes?