Yesterday we
mentioned that there is always a solution, even to a mess like the banking
system in Country Y, where the central bank doesn’t perform the function of a
central bank (few do in any country, for that matter), and the commercial or
mercantile banks can’t make loans to private sector businesses because people
don’t trust private sector credit instruments (or the banks), and the currency
is backed 100% with government debt.
So, what can be
done in such a situation?
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| "Gresham's Law" operates when the same authority issues both bad and good money. |
Believe it or
not, similar situations have existed in the past. Economies have been flooded with bad money,
and good money ceases to circulate. This
is “Gresham’s Law,” usually stated as “bad money drives out good.”
That, however, is
only the case when the same authority that issued the bad money also issued the
good money. When you have two or more different
authorities issuing money in an economy, people quickly stop using the bad
money in preference to the good money.
That’s why so
many governments get so upset when foreign currency starts circulating where
they presumably control everything. When
people use something other than the officially sanctioned currency to carry out
transactions, government loses power in direct proportion to people gaining
power.
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| As long as it's good, who cares where it's from? |
If governments
relied exclusively on taxation for revenue, of course, they wouldn’t care what
currency was used, as long as it was sound.
When government relies on its own debt to finance operations, however,
people refusing to accept or use the currency backed by that debt is a disaster
. . . for the government. If no one
accepts the currency, then the government can’t finance operations.
The first step,
then, is to set up a micro-financial system in Country Y (or any other country
with the same problem) to run parallel to the government system. Of course, this must be
government-sanctioned. For that, all
that need be done is for the head of state or the legislature to grant
quasi-legal tender status to the good money to be issued.
This is not as
crazy as it sounds. A number of places
in the world have been implementing “community currencies.” These would not be adequate as they now stand
to function at anything other than the local level, but the phenomenon proves
that it can be done. The “crypto
currency” (e.g., Bitcoin) phenomenon
also demonstrates that a parallel currency can catch on throughout the world .
. . although we do not accept the monetary theory that the Bitcoin and other
crypto currency people employ.
Implemented in strict conformity with the Banking Principle, however,
something similar to community currencies and crypto currencies would do the
trick.
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| Gold: good, but inadequate |
The parallel
currency would have to be pegged to some objective standard of value, not to
the national currency or even a global reserve currency. Traditionally this has been silver, more
recently (in historic terms, anyway), it has been gold. Even more traditionally, it has been draft
animals, usually cattle.
The problem is
that when using a commodity as the standard of value for a currency, when the
commodity is subject to speculative trading, the currency also has a speculative
value, and the gamblers have a field day.
The authority holding reserves of the commodity also experience a drain
on their reserves as people cash in the currency in preference to holding the
commodity.
Energy is
probably the soundest measure of value, as it is the most basic commodity apart
from food, and less subject to speculative changes in value. The problem is that in a place like Country
Y, the educational level is very low, and most people might not grasp the fact
that the standard of value is just what you measure the currency in terms of,
not what backs the currency.
The standard of
value may have to be a “basket of commodities,” determined by the market price
of a list or index of basic commodities in Country Y — food, fuel, and fiber —
somewhat analogous to the Dow Jones (formerly) Industrial Average. X
number of units of the parallel currency would always buy y units of the index of basic commodities. Eventually, the food and fiber commodities
could be taken out of the index, leaving fuel — energy — as the standard of
value, but that change can be gradual.
Next week we’ll
look at the practical application of this solution.
#30#