Money After Fiat

(Posted: Sunday 14th February, 2021)

(back to article index)

Suppose that, as I have previously suggested, fiat money (including un-backed cryp) confronts a cascading confidence collapse whose contagion catastrophically contracts its commercial convertibility. This would naturally propel and promote monetisation of a variety of other assets, settling over time onto a new standard. There are, of course, many possibilities as to what such a standard could or should be — ask three economists and you'll get five answers — but some of the most popular are monometallism, bimetallism, symmetalism and the tabular standard.

These four systems are the chief approaches to the design of a currency whose value is automatically regulated by its commodity tie. They rely on the monetary unit either consisting of, or being convertible to, some defined quantity of a commodity or bundle of commodities; the regulation comes from the ability of any arbitrageur to convert coinage to the commodity, or vice-versa, should the price shift far enough from par to cover the costs of conversion (e.g. melting and assaying coins into bullion, or minting bullion into coins).

Of these, monometallism is the easiest to understand. The coins are simply pieces of metal (typically gold, although silver has also been used historically) of a known weight and fineness, stamped with difficult-to-counterfeit designs such that one who trusts the stamper can trust the coin without needing to weigh or assay it. There is also representative monometallism, where the circulating currency consists of paper notes freely convertible to either coins or bullion at some fixed rate of exchange.

Bimetallism, on the face of it, seems strange and unworkable. Under a bimetallic standard, two metals (typically gold and silver) are both coined, with a price ratio enshrined in law; consequently, if the worldwide market price ratio drifts too far from this ratio, one metal will be presented to the mint for coining and the coins of the other metal will be hoarded or melted (Gresham's lawbad money drives out good). However, Friedman argues¹ that when adopted by a sufficiently large economy bimetallism can nonetheless be successful, as it will influence global prices in the direction of the fixed ratio.² The advantages of bimetallism are that the money supply varies less with changes in the abundance of any single metal, and that a wider range of denominations can be accomodated by coins of convenient size and mass. (At today's prices, a Troy ounce of silver is about the price of a steak dinner, and an equivalent gold coin would weigh just 7¼ grains — less than half a gram — with a volume of just 25mm³. A gold coin less than 6mm across and 1mm thick would be extremely fiddly, easily lost, and rapidly debased by wear and tear. Conversely, a small dwelling-house might cost 100 ounces (about 3 kilos) of gold — fairly practical to transport for the purpose — but 200 kilos, the equivalent in silver, would be far more awkward.)

Under symmetalism, the currency unit is not a fixed quantity of gold or silver, but rather fixed quantities of gold and silver. This is usually proposed as a representative money, where a paper note is convertible for, say, an ounce of gold and ten of silver. However, it could conceivably be done as specie, by minting coins that contain both metals, either fused (with an appearance resembling the £2 fiat coin) or alloyed (electrum metal). Either way, the promise of the symmetallic standard is that, like bimetallism, it dampens the effect of changes in supply or demand of a single metal on the money supply (so, for instance, new discoveries of gold ore would cause less inflation than under a pure gold standard), while avoiding the Gresham problem of bimetallism (since if one extracts the silver from a symmetallic coin to sell as a commodity, one is left with the gold which, being no longer in a complete coin, can now also only be traded for its commodity value; the ratio of weights in the coin being irrelevant, there is no fixed or legal ratio of prices to arbitrage against the market ratio). The main problem of alloyed symmetallism is the difficulty of verifying the proportions of gold and silver in a coin without an assay (one cannot rely on density, as a counterfeiter could intermix heavier base metals); convincing simulacra of fine gold and fine silver are harder to create. A further problem with symmetallic coinage (of either kind) is that all the coins have the same value per weight and per volume, losing the convenience advantages of bimetallism.

The tabular standard takes the idea of representative symmetallism one step further; instead of pegging the monetary unit to a linear combination of gold and silver, it is pegged to a linear combination of a wide variety of commodities. Friedman the Younger describes such a commodity bundle system, where banknotes are redeemable for a defined basket of commodities, as an effective way to ensure that inflation (at least as measured by that basket) remains at or near zero. The downside of such a system, of course, is that it can only practically be operated on a representative basis; while one could possibly mint coins containing (say) steel, copper and rare earth metals in addition to gold and silver, they would be far less value-dense than those consisting only of monetary metals, and the construction of a coin containing oil, wheat or helium presents even greater difficulties! Representative money (‘warehouse receipts’, as Friedman calls it) avoids these problems, but at the cost of introducing counterparty risk (particularly in conjunction with fractional-reserve banking).

All of which discussion is merely a lengthy prelude to the actual topic I wish to essay, which might be termed floating bimetallism. The problems of the bimetallic system stem from its attempting to fix the ratio between the prices of its two metals, so that a single price quoted in commerce for other goods or services can be readily paid in either gold or silver coinage as is convenient. If this ratio is instead permitted to float, one has in effect two currencies circulating together, and other prices may be quoted either in gold, silver, or both, according as the buyer or seller prefers. For the sake of argument (and alliteration!), let us imagine a system of golden guineas and silver shillings, each of ¼ozt fine (in practice, sterling silver would probably be used, as it is more hard-wearing, so the actual weight of the coin would be greater), along with various other denominations (e.g. the silver penny could be ⅕ of a shilling, since 1ozt = 20dwt. The smallest practical high-fineness silver coins would probably be around about ½dwt (judging by the historical rarity of silver farthings); smaller denominations, for making change, would have to be alloyed).

To give a flavour of what this system might be like in practice, I shall consider how various goods and services might be priced, based on the current spot prices of the two metals³, which are about 1 GBP per dwt silver, and 66 GBP per dwt gold. So a shilling would be worth £5, while a guinea would be £330. Most retail (fast food, groceries, etc.) would probably operate on a silver basis — e.g. a footlong sandwich or a pint of beer might be a shilling (0.25ozt Ag) or sixpence (0.3ozt Ag), while a weekly shop for a family of four might come to, say, 18 and thruppence (93dwt, or 4.65ozt Ag). On the other hand, a rental contract for a flat might specify a monthly rent of two guineas and a gold penny (0.55ozt Au). For goods whose prices fell in ranges suitable for both silver and gold, retailers might use bimetallic pricing — e.g. a microwave oven could be offered for sale at ‘24 shillings or seven gold farthings’ (6ozt Ag or 0.0875ozt Au), with one or other price being slightly preferable at the prevailing exchange rate — or symmetallic pricing — e.g. the supermarket might print only silver prices on the shelves but then accept gold farthings at three shillings and a penny, so our family of four could pay for their shop with 1¼d gold plus 13d silver. Symmetallic pricing would probably be preferred for supermarkets, since it's much easier to update one number (the gold price in silver) when the ratio changes, than to go around changing every shelf ticket; on the other hand a store carrying a small number of distinct products might be more willing to quote bimetallic prices for each item separately.

All this might sound unworkably complicated to the modern Westerner, used to a single uniform currency (and generally smugly convinced of the superiority of decimalisation, regardless of the arguments against it); but in fact there are many countries around the world that already use multiple currencies in this way or have done in the past, typically combining their local domestic currency with a stronger foreign currency (which may or may not be officially recognised as legal tender). Since this nowadays commonly involves the US dollar, it is sometimes nicknamed ‘dollarisation’; one source of unofficial dollarisation is that the tourism industry in less-developed countries often finds it advantageous to accept dollars in addition to the local money.

So much for the problems, and how they might be dealt with; what are the advantages of this system? The fundamental advantage is the one it shares with all the other metallic systems: hard money with no counterparty risk. No government can inflate away your wealth (especially if coinage is minted privately), and no bank default can leave you holding worthless paper. But more than this, floating bimetallism manages to combine the advantages of the other systems while avoiding many of their pitfalls. The gold coins enable the compact transport and storage of large sums; the silver coins allow making change with fine metal down to much smaller denominations than would be practicable with gold; the monetary demand is spread over both metals, limiting its effect on the price of either (and thus the cost to society of producing the money it needs), without the Gresham problem of bimetallism; unlike symmetallism, the relative quantities of silver and gold in the total circulation can vary to accommodate changes in the mining ratio, distributing the agio in an overall efficient manner; and every citizen can contribute their estimate of the relative worth of gold and silver to the market (determining the ratio of their prices) by holding a greater or lesser proportion of their wealth in each metal, and by the prices they quote for what they themselves sell (whereas under symmetallism, both are constrained by the ratio in the coin).

Of course, in the modern world physical coinage alone will not suffice; we expect to be able to buy things over the Internet and pay for them electronically, so there would still need to be a banking system, and it would probably be fractional reserve for the simple reason that most people would accept fractional-reserve bank money as adequately secure (given that fractional reserve banks can pay interest on deposits out of their income from lending, whereas 100%-reserve banks would have to charge depositors a holding fee to cover the storage costs of coins or bullion). As long as the banking sector was free (that is, anyone could issue paper money without needing government approval, to any member of the public willing to accept it, and no bank's paper was made legal tender by government decree) there should be no risk of such a system gradually converting to a fiat system. Indeed, now that we have had time to learn the lessons of the historical examples of such conversion, any government attempting to start down that road again would face uproar from its people — if they decreed some bank's paper to be legal tender, a post-fiat public would immediately distrust that paper, on the grounds that that process is known to end with the closing of the gold window and ‘money printer goes brrt’; thus the attempt would collapse rapidly, rather than boiling the frog with a gradual inflation over decades as happened the first time.

As to whether (electronic) bank money would consist of cryptocurrency (stablecoins), or just rely on trustworthy counterparties (as with current payment processors and automated clearinghouses), I cannot predict. My own inclination is to doubt the practicality of widespread blockchain-based settlement, but if it can be made to scale, the decentralisation is certainly attractive. In any case, the important thing is ready convertibility, making it a proxy for gold and silver, rather than seeking to usurp their place as ‘real money’.

  1. Friedman, M. (1990). Bimetallism Revisited. J. Econ. Pers., 4 (4): 85-104.
  2. Modern readers may have encountered a fictional trimetallic system in the Harry Potter books (golden Galleons, silver Sickles and bronze Knuts); Yudkowsky has drawn attention to the problems arbitrage would present to this system. Similar things have been written about the polymetallic currency of fantasy roleplaying games such as Dungeons & Dragons (which also includes a totally unnecessary symmetallic electrum coin).
  3. In reality, the price of both metals would rise if they were used as circulating currency, owing to the increased monetary demand, especially in the case of silver — in the era of bimetallism, the gold/silver ratio generally stood at around 15 or 16.