Denationalisation of Money: The Argument Refined

XI. THE POSSIBILITY OF CONTROLLING THE VALUE OF A COMPETITIVE CURRENCY

The chief attraction the issuer of a competitive currency has to offer to his customers is the assurance that its value will be kept stable (or otherwise be made to behave in a predictable manner). We shall leave for Section XII the question of precisely what kind of stability the public will probably prefer. For the moment we shall concentrate on whether an issuing bank in competition with other issuers of similar currencies will have the power to control the quantity of its distinctive issue so as to determine the value it will command in the market.

The expected value of a currency will, of course, not be the only consideration that will lead the public to borrow or buy it. But the expected value will be the decisive factor determining how much of it the public will wish to hold, and the issuing bank will soon discover that the desire of the public to hold its currency will be the essential circumstance on which its value depends. At first it might perhaps seem obvious that the exclusive issuer of a currency, who as such has complete control over its supply, will be able to determine its price so long as there is anyone who wants it at that price. If, as we shall provisionally assume, the aim of the issuing bank is to keep constant the aggregate price in terms of its currency of a particular collection of commodities it would, by regulating the amount of the currency in circulation, have to counteract any tendency of that aggregate price to rise or fall.

Control by selling/buying currency and (short-term) lending

The issuing bank will have two methods of altering the volume of its currency in circulation: it can sell or buy its currency against other currencies (or securities and possibly some commodities) ; and it can contract or expand its lending activities. In order to retain control over its outstanding circulation, it will on the whole have to confine its lending to relatively short-time contracts so that, by reducing or temporarily stopping new lending, current repayments of outstanding loans would bring about a rapid reduction of its total issue.

To assure the constancy of the value of its currency the main consideration would have to be never to increase it beyond the total the public is prepared to hold without increasing expenditure in it so as to drive up prices of commodities in terms of it ; it must also never reduce its supply below the total the public is prepared to hold without reducing expenditure in it and driving prices down. In practice, many or even most of the commodities in terms of which the currency is to be kept stable would be currently traded and quoted chiefly in terms of some other competing currencies (especially if, as we suggest in Section XIII, it will be mainly prices of raw materials or wholesale prices of foodstuffs). The bank would therefore have to look to the effect of changes in its circulation, not so much directly on the prices of other commodities, but on the rates of exchange with the currencies against which they are chiefly traded. Though the task of ascertaining the appropriate rates of exchange (considering the given rates of exchange between the different currencies) would be complex, computers would help with almost instantaneous calculation, so the bank would know hour by hour whether to increase or decrease the amounts of its currency to be offered as loans or for sale. Quick and immediate action would have to be taken by buying or selling on the currency exchange, but a lasting effect would be achieved only by altering the lending policy.

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Current issuing policy

Perhaps I ought to spell out here in more detail how an issuing bank would have to proceed in order to keep the chosen value of its currency constant. The basis of the daily decisions on its lending policy (and its sales and purchases of currencies on the currency exchange) would have to be the result of a constant calculation provided by a computer into which the latest information about commodity prices and rates of exchange would be constantly fed as it arrived. The character of this calculation can be illustrated by the following abridged table (Table II). (I am neglecting here the question how far the costs of transport from the chief market to some common centre, or perhaps separate items representing the costs of different forms of transport, should be considered or not.)

The essential information would be the guide number at the lower right-hand corner, resulting either from the quantities of the different commodities being so chosen that at the base date their aggregate price in Ducats was 1,000, or 1,000 was used as the base of an index number. This figure and its current changes would serve as a signal telling all executive officers of the bank what to do. A 1,002 appearing on the screen would tell them to contract or tighten controls, i.e. restrict loans by making them dearer or being more selective, and selling other currencies more freely; 997 would tell them that they could slightly relax and expand. (A special write-out of the computer in the chairman’s office would currently inform him which of his officers did promptly respond to these instructions.) The effect of this contraction or expansion on commodity prices would be chiefly indirect through the rates of exchange with the currencies in which these commodities were chiefly traded, and direct only with regard to commodities traded chiefly in ducats.

TABLE II

ILLUSTRATION OF A CURRENCY STABILISATION SCHEME

Commodity	Quantity	Currency in which quoted	Price in that currency	Rate of exchange	Price in own currency
Aluminium	x tons	$	.	.	.
Beef	.	£	.	.	.
Camphor	.	Ducats	—	—	.
Cocoa	.	.	.	.	.
Coffee	.	.	.	.	.
Coal	.	.	.	.	.
Coke	.	.	.	.	.
Copper	.	.	.	.	.
Copra	.	.	.	.	.
Corn	.	Ducats	—	—	.
etc.	.	.	.	.	.
				Total	1,000

The same signal would appear on the currency exchange and, if the bank was known for taking prompt and effective measures to correct any deviation, would lead to its efforts being assisted by more of its currency being demanded when it was expected to appreciate because its value was below normal (the guide number showing 1,002), and less being demanded when it was expected slightly to depreciate (because the guide number had fallen to 997). It is difficult to see how such a policy consistently pursued would not result in the fluctuations of the value of the currency around the chosen commodity standard being reduced to a very small range indeed. **

The crucial factor: demand for currency to hold

But, whether directly or indirectly via the price of other currencies, it would seem clear that, if an institution acts in the knowledge that the public preparedness to hold its currency, and therefore its business, depends on maintaining the currency value, it will be both able and compelled to assure this result by appropriate continuous adjustments of the quantity in circulation. The crucial point it must keep in mind will be that, to keep a large and growing amount of its currency in circulation, it will be not the demand for borrowing it but the willingness of the public to hold it that will be decisive. An incautious increase of the current issue may therefore make the flow back to the bank grow faster than the public demand to hold it.

The press, as pointed out, would closely watch the results of the efforts of each issuing bank and daily quote how much the various currencies deviate from the self-set standards. From the point of view of the issuing banks it would probably be desirable to allow a small, previously-announced, tolerance or standard of deviation in either direction. For in that event, and so long as a bank demonstrated its power and resolution to bring rates of exchange (or commodity prices in terms of its currency) promptly back to its standard, speculation would come to its aid and relieve it of the necessity to take precipitate steps to assure absolute stability.

So long as the bank had succeeded in keeping the value of its currency at the desired level, it is difficult to see that it should for this purpose have to contract its circulation so rapidly as to be embarrassed. The usual cause of such developments in the past was circumstances which increased the demand for liquid ‘cash’, but the bank would have to reduce the aggregate amount outstanding only to adjust it to a shrunken total demand for both forms of its currency. If it had lent mainly on short term, the normal repayment of loans would have brought this result fairly rapidly. The whole matter appears to be very simple and straightforward so long as we assume that all the competing banks try to control their currencies with the aim of keeping their values in some sense constant.

Would competition disrupt the system?

What, however, would be the consequences if one competitor attempted to gain in this competition by offering other advantages such as a low rate of interest, or if it granted book credits or perhaps even issued notes (in other words, incurred debts payable on demand) in terms of the currency issued by another bank? Would either practice seriously interfere with the control the issuing banks can exercise over the value of their currencies?

There will of course always be a strong temptation for any bank to try and expand the circulation of its currency by lending cheaper than competing banks; but it would soon discover that, insofar as the additional lending is not based on a corresponding increase of saving, such attempts would inevitably rebound and hurt the bank that over-issued. While people will no doubt be very eager to borrow a currency offered at a lower rate of interest, they will not want to hold a larger proportion of their liquid assets in a currency of the increased issue of which they would soon learn from various reports and symptoms.

It is true that, so long as the currencies are almost instantaneously exchangeable against one another at a known rate of exchange, the relative prices of commodities in terms of them will also remain the same. Even on the commodity markets the prices of those commodities (or, in regions where a high proportion of the demand is expressed in terms of the increased currency, prices in terms of all currencies) will tend to rise compared with other prices. But the decisive events will take place on the currency exchange. At the prevailing rate of exchange the currency that has increased in supply will constitute a larger proportion of the total of all currencies than people have habitually held. Above all, everybody indebted in the currencies for which a higher rate of interest has to be paid will try to borrow cheap in order to acquire currencies in which he can repay the more burdensome loans. And all the banks that have not reduced their lending rate will promptly return to the bank that lends more cheaply all of its currency they receive. The result must be the appearance on the currency exchange of an excess supply of the overissued currency, which will quickly bring about a fall in the rate at which it can be exchanged into the others. And it will be at this new rate that commodity prices normally quoted in other currencies will be translated into the offending currency; while, as a result of its over-issue, prices normally quoted in it will be immediately driven up. The fall in the market quotation and the rise of commodity prices in terms of the offending currency would soon induce habitual holders to shift to another currency. The consequent reduction in the demand for it would probably soon more than offset the temporary gain obtained by lending it more cheaply. If the issuing bank nevertheless pursued cheap lending, a general flight from the currency would set in; and continued cheap lending would mean that larger and larger amounts would be dumped on the currency exchange. We can confidently conclude that it would not be possible for a bank to pull down the real value of other currencies by over-issue of its currency—certainly not if their issuers are prepared, so far as necessary, to counter such an attempt by temporarily curtailing their issues.

Would parasitic currencies prevent control of currency value?

A more difficult question, the answer to which is perhaps not so clear, is how far the unavoidable appearance of what one may call parasitic currencies, i.e. the pyramiding of a superstructure of circulating credit through other banks carrying cheque accounts and perhaps even issuing notes in the denomination of the currency of the original issuer, would interfere with the issuer’s control over the value of his own currency. So long as such parasitic issues were clearly labelled as debts to be paid in the currency of the issuer it is difficult to see how this could be or should be prevented by law.

Clearly not all banks would wish to issue, or probably could issue, a currency of their own. Those that did not would have no choice but to accept deposits and grant credits in terms of some other currency, and would prefer to do so in the best currency available. Nor would the original issuer wish altogether to prevent this, although he might dislike the issue of notes more than the mere running of accounts subject to cheque in terms of his currency. Notes issued by a secondary issuer would, of course, have to show clearly that they were not the original ducats issued by the bank that owned that trade mark, but merely claims for ducats, since otherwise they would simply be a forgery. Yet I do not see how the ordinary legal protection of brand names or trade marks could prevent the issue of such claims in the form of notes, and very much doubt whether it would be desirable to prevent it by law, especially in view of the essential similarity between such notes and deposits subject to cheque which even the issuing banks would hardly wish to prevent.

What the original issuer of such a currency could do and would have to do is not to repeat the mistakes governments have made, as a result of which control of these secondary or parasitic issues has slipped from their hands. It must make clear that it would not be prepared to bail out secondary issuers by supplying the ‘cash’ (i.e. the original notes) they will need to redeem their obligations. We shall see later (Section XVI) how governments were led into this trap and allowed their monopoly of the issue of money to be watered down in the most undesirable manner. (They shared the responsibility for control of the total amount of the standard denomination, yielding to the constant pressure for cheap money that was supposed to be met by the rapid spread of banks which they assisted by securing their liquidity; and in the end nobody had full power over the total quantity of money.)

The answer to the most serious problem arising from the scheme seems to me that, though private issuers will have to tolerate the appearance of parasitic circulations of deposits and notes of the same denomination, they ought not to assist but rather restrain it by making it clear in advance that they would not be prepared to provide the notes needed to redeem parasitic issues except against ‘hard cash’, i.e. by sale against some other reliable currency. By adhering strictly to this principle they would force the secondary issuer to practise something very close to ‘100 per cent banking’. So far as there would still be limited fiduciary parasitic issues they would have to be kept in circulation by a policy which assured that their value was never questioned. Though this policy might limit the circulation and thus the profit of the original issuer, it should not seriously impair his ability to keep the value of his currency constant.

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To achieve this the original issuer of a currency with a certain label would have to anticipate the effects of the over-issue of such a parasitic currency (or any other currency claiming to maintain a value equal to its own) and ruthlessly to refuse to buy it at par even before the expected depreciation manifests itself in the rise of some commodity prices in terms of that other currency. The dealings of an issue bank in other currencies would therefore never be a purely mechanical affair (buying and selling at constant prices) guided only by the observed changes in the purchasing power of the other currencies ; nor could such a bank undertake to buy any other currency at a rate corresponding to its current buying power over the standard batch of commodities; but it would require a good deal of judgement effectively to defend the short-run stability of one’s own currency, and the business will have to be guided in some measure by prediction of the future development of the value of other currencies. * *