Non-currency money

A reader has written to me today asking me to explain what I meant by personal cheques being “non-currency money” in my gold standard posting of yesterday. When bank-printed personal chequebooks first began to be used in the 1870s each cheque could, instead of being paid into someone’s bank account, be used again. All that a recipient had to do was to countersign the cheque on the back and use it again when paying someone else. Thus, although the cheque wasn’t currency it was, if counter-signed, acting as additional money in the system.

From the amount of space available on the back of a cheque it could be used at least twenty times. Thus a personal cheque for £10 could be successively used. taking the place of £200 of banknotes that would otherwise have been needed.  However, a little reflection will inform you that the personal cheque system could have been used for a ‘black economy’.  In due course, large numbers of transactions could be carried out between thousands of people without the knowledge of the bank or — much more importantly — the government’s tax system. This is why, about 50 years ago, countersigning was stopped and personal cheques became one-stop conveniences.

Thus, from the 1870s, although a gold standard was supposed to be in existence, personal cheques meant that considerable inflation was actually going on. It didn’t so much reveal itself as higher prices of goods in the shops — as it would today — but as much higher wages in the factories and fully absorbed in spending.  For the first time in a hundred years, workers were able to start spending  on the increasing variety of consumer goods appearing the shops as well as being able to enjoy themselves on holidays or paying to to watch soccer matches

During the First Great Depression (1873 to 1896), when much new industrial investment was failing due to lack of sound money, there was hardly any subsequent unemployment and the working classes in the textile, coalmining, shipbuilding and railway industries hardly noticed

If, however, someone with banknotes wanted to cash them at the bank for gold coins, the banks could usually do so quite comfortably because a good bank during that period would have least 20% of gold reserves. In Germany and America at that time — our main competitors — there were many times more banknotes than coins, far more than there were gold reserves in their banks. The so-called ‘gold standard’ was never strictly so, only partially effective.

Thus although we’ve had a currency standard ever since 1717 when Sir Isaac Newton fixed it, and a gold standard legally defined in the 1844 Banking Act, it has never come about that every single English banknote was fully covered by 1/3.83rd of an ounce of gold either in a high street bank or at the Bank of England. The Gold Standard was never fully brought into existence, only an approximation to it.

If the Chinese ever bring about a free digital yuan for use as a world trading currency, then they will certainly make sure that every single one will be covered permanently by a definite fraction of a gold yuan coin or of an ingot in the vault of its central bank. This is what the Americans were not able to do in 1972, thus allowing the dollar to inflate out of all sense and causing massive lop-sidedness between surplus countries and deficit countries. This is now producing an impasse which seems insoluble.

One thought on “Non-currency money

  1. From the amount of space available on the back of a cheque it could be used at least twenty times. Thus a personal cheque for £10 could be successively used — taking the place of £200 of banknotes that would otherwise have been needed. Of course, it never reached that much but it would have added to the cash being circulated

    Let me see how this works by using an analogy.

    A lends his car to B. B lends that same car to C. C then lends that car to D, … all the way to X, and then to Y and finally Z. So now 25 cars have been borrowed by this simple expedient, which otherwise would have required 25 cars.

    That’s patently illogical. What is being described is just one car (or one piece of paper) that gets passed on from person to person. There’s nothing magical going on. Money doesn’t multiply by being passed from hand to hand any more than cars multiply by being loaned.

    This reminds me of a simple puzzle. I heard it as “Who paid for the Englishman’s stay?” An Englishman had a long-standing habit of going on vacation to a particular small Pacific island, always staying at the same hotel. Over time, the hotel owner got to know him so well that he was OK with taking the Englishman’s check as payment.

    As it happened, one summer after the Englishman’s visit, the hotel owner did not deposit the check in his bank account and instead gave it to the grocer as payment for supplies.The grocer trusted the hotel owner. The grocer, in turn, gave the check to his landlord as part of his rent, etc, etc. The check went round and round the small island economy. But as the check was never encashed, the Englishman’s bank account was never debited. So who paid for the Englishman’s stay?

    That’s a simple question. Until the check gets cashed and the Englishman’s account is debited, the check just adds to the money supply of the island. Adding money supply through a debt instrument just devalues everyone’s holding of money, which means inflation.

    Note that the money supply goes up by only the amount of the check — not multiples of the check as it gets passed around the island.

    Anyhow, money is really a very simple IOU. There’s nothing mysterious about it that it should confuse so many smart people.

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