Tuesday, January 10, 2017

A New Monetary System From Scratch, Part 7: Decentralized Recordkeeping

Andy, the proud owner of the fastest mule in the universe, was planning to start fortnightly round-trips to the village (see Part 6), taking apples with him to sell to the villagers, while buying copper from them. He would sell the copper once he got back in town.

Andy had a problem to solve. His trade with the villagers was going to be a deficit trade: if things went as planned, on every trip he would sell apples worth (market price) SK400 and buy copper worth SK1,200. This would have posed no problem if the village had been on-the-grid, but as things stood, there was no connection to the ETRS (see Part 4) from anywhere near the village.

Andy had come up with a solution to his problem. He presented it to the central-banker whose co-operation was required.

Andy suggested that the central-banker could issue central bank credit notes with, say, SK100 face value. The bearer of the note would be entitled, upon handing the note over to the central-banker, to a credit entry on her account in the central bank ledger. This would allow a villager to sell copper to Andy and get her account credited for the sale once she was in town for business – usually once a month. If she wasn't going to attend the town market, she could buy goods from a fellow villager who was, and who could then present the note(s) to the central-banker.

The central-banker, interested in expanding the reach of his new institution, saw this as a great opportunity for the central bank to bring the village more fully under its influence. He approved Andy's request and told him to come back the following day, as it would take some time to print the credit notes.

The following day, before making any entries, the central-banker printed out an account overview:









Andy's positive balance of SK50 reflected the fact that Andy had previously received bananas worth SK100 from Betty, given apples worth SK100 to Carol and apples worth SK50 to Seven.

Next, the central-banker gave ten credit notes, with a face value of SK100 each, SK1,000 in total, to Andy. Then he debited Andy's account with SK1,000 and credited a new account called "Credit notes in circulation" with SK1,000. He printed out a new overview:



Andy9501,000Credit notes in circulation






The central-banker explained the situation to Andy:

As long as Andy remained in sight of the central-banker, it was as if Andy had had two accounts in the central bank ledger: one with a positive balance of SK1,000 and one with a negative balance of SK950. What really mattered was the net balance, which was so far unaffected. Andy had no liability to give goods to others; he had a right to take goods worth SK50 from others without incurring a liability.

Once Andy left the central bank premises, the central-banker became unaware of his net balance/position. Recordkeeping became decentralized. From that point onwards, the central-banker had to assume that Andy had a net liability worth SK950. If he was in possession of credit notes which reduced his liability recorded in the ledger (SK950), or even cancelled it altogether, it was up to him to prove this to the central-banker by presenting the notes to him. Once he did this, the central records could be updated to reflect Andy's actual position. (It was not a case of Andy paying a debt by handing over the notes.)

The central-banker wanted to make it very clear that this was not a loan of credit notes from the central bank to Andy. Andy was not obliged to return any credit notes. Having got rid of the credit notes by buying goods, and in this way having incurred an actual liability, he could sell goods to someone and thus get rid of his liability.

The effect of the issuance of credit notes was to introduce a lag between a trade and the reporting of the trade's effect on the trading partners' position[1] (their credits or liabilities); there was no real-time netting of credits (gifts given) and debits (gifts received) when credit notes were involved.

The logic behind the recordkeeping was unaffected by the issuance of credit notes. A net liability was still a liability to give goods to others. A gross liability recorded in the central bank ledger was assumed to be a net liability until the account-holder proved otherwise by presenting credit notes to the central-banker. A delayed netting of debits (personal account) and credits (credit notes) was no 'debt repayment', but a delayed update to the records.


[1] What is reported is not the trade per se, but the amount by which the trading parties' purchases exceed their sales, and vice versa. Usually there is no barter element involved; that is, there is only one buyer and one seller in a transaction; goods flow only in one direction; there is only one trade, not an exchange of goods (two trades).

Friday, January 6, 2017

A New Monetary System From Scratch, Part 6: Credit Limits

Within an 8-hour journey (in a mountainous terrain) from our town community with a new monetary system, there's an off-the-grid village. There's been small-scale trade between the village and our town as long as anyone remembers.

The trade has mainly taken the form of a few village merchants and tradespeople descending into the town once a month to attend a monthly market. At the market, they barter their wares for goods they either need themselves or know are in demand back home. In addition to barter, some credit has been involved, in form of bilateral debts between certain villagers and townspeople who know and trust each other. The debts have often been skilo-denominated (see Part 1), but in the absence of a medium of exchange, all the debts have been eventually settled by delivery of goods ("in-kind"), usually at the following month's market.

With the advent of the new monetary system, the villagers trading with townspeople became disadvantaged. The townspeople, having gradually got used to the new monetary system, and the related electronic trade reporting system (ETRS; see Part 4), found bartering with the villagers inconvenient.

It didn't take long before the central-banker agreed to open an account for any villager at request, on one condition: no negative balances were allowed. (He didn't know the villagers and no creditworthy townsperson was yet willing to step in as a guarantor.)

An account with the central bank, and the "ETRS gadget" that accompanied it, gave the villagers a chance to participate in "gift exchange" at the local market, on the condition that they gave up (sold) goods before accepting (buying) goods.[1]

Two questions:

Did the central-banker impose a Clower-constraint (cash-in-advance constraint) on the villagers?

Does money, after all, exist in our economy?


[1]  Of course, they could make a sale first while promising to deliver the goods later, assuming the buyer was willing to extend personal credit to them. From that, there was only a short step to no (physical) delivery of goods at all; the two parties could agree on a re-purchase of the sold goods, by the villager, later on. This would be like a "money loan", if money existed in our model economy.