One of our goals here is to try and provide links to information and resources that discuss the concept of money and monetary systems. On the one hand, most people probably don't think much about a discussion about "What is Money" or "What Monetary System Works Best". In the US for example, most people just think of the US dollar as their money and the monetary system is based on the US dollar and run by banks and the Federal Reserve. On the other hand, a growing number of people are interested in learning more about these kinds of issues.
In this recent article appearing in the Cato Journal by Claudio Borio, he takes a deeper dive into this topic. The article is a bit technical in spots, but also includes some time honored core principles that are critical to anything that wants to viewed as money; and monetary systems that attempt to administer the issuance and exchange of money to conduct business activity. Below are a few excerpts followed by the Conclusion Section of the article. I added the underlines below for additional emphasis.
(Claudio Borio - Head of the Monetary and Economic Department - BIS)
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"My focus will be on the monetary system, defined technically as money plus the transfer mechanisms to execute payments. Logically, it makes little sense to talk about one without the other."
. . . .
"First, two properties underpin a well-functioning monetary system. One, rather technical, is the coincidence of the means of payment with the unit of account. The other, more intangible and fundamental, is trust. In fact, a precondition for the system to work at all is trust that the object functioning as money will be generally accepted and that payments will be executed. But a well-functioning system also requires trust that it will deliver price and financial stability."
. . . .
"Society needs an institutional infrastructure to ensure that money is widely accepted, transactions take place, contracts are fulfilled and, above all, agents can count on that happening. Even the most primitive communities require generally agreed on, if informal, norms and forms of enforcement. Putting in place the corresponding supporting institutions — or institutional technology — in a way that ensures trust is a major challenge. And the challenge naturally becomes more complex as societies develop."
. . . .
"At the very least, a well-functioning monetary system has two properties.
First, technically, it will exploit the benefits of unifying the means of payment with the unit of account. The main benefit of a means of payment is that it allows any economy to function at all. "
. . . .
"Second, and more fundamentally, a well-functioning monetary system will enjoy the solid trust of participants. To be sure, trust that people will accept the corresponding instrument as a means of payment and that the transfer will be effective are absolutely necessary for the system to function at all. But a well-functioning system requires more. It requires trust that the value of the instrument will be stable in terms of goods and services, as fluctuations generate uncertainty, and trust that its value will not change strongly in one direction or the other."
. . . .
"A new and controversial payment scheme — cryptocurrencies — illustrates some of the difficulties in generating trust through a fully decentralized system that does not piggy-back on existing institutional arrangements. This is so quite apart from the issues concerning scalability, finality, and incentives to verify, discussed in detail in this year’s BIS Annual Economic Report (BIS 2018).28 The above analysis points to another problem that can undermine trust, as also mentioned in the report: the lack of elastic supply. Hence the cryptocurrencies’ extreme price volatility: changes in demand are fully reflected in the price. The volatility undermines the cryptocurrency’s role as a unit of account and as a means of payment. Not surprisingly, prices are still quoted and sticky in terms of national currencies."
"The problem cannot easily be solved. A fully unbacked currency in elastic supply will not succeed in gaining the necessary trust. Alternatively, seeking to tie it to the domestic currency would require some agent to arbitrage in possibly unlimited quantities between the two, just as when central banks seek to keep exchange rates stable. And simply backing it with a sovereign asset or means of payment on a demand-determined basis would not do either. Not only would it defeat the purpose of having a cryptocurrency in the first place, as it would explicitly piggy-back on sovereign money. As in the case of any mutual fund unbacked by a supply of liquidity and a lender of last resort, it would also be vulnerable to runs (breaking the buck) — the equivalent of having to break the promise of convertibility. Moreover, in all probability it would not to be profitable without taking on significant risk to pick up yield, which would increase the probability of such a run."
"The problem cannot easily be solved. A fully unbacked currency in elastic supply will not succeed in gaining the necessary trust. Alternatively, seeking to tie it to the domestic currency would require some agent to arbitrage in possibly unlimited quantities between the two, just as when central banks seek to keep exchange rates stable. And simply backing it with a sovereign asset or means of payment on a demand-determined basis would not do either. Not only would it defeat the purpose of having a cryptocurrency in the first place, as it would explicitly piggy-back on sovereign money. As in the case of any mutual fund unbacked by a supply of liquidity and a lender of last resort, it would also be vulnerable to runs (breaking the buck) — the equivalent of having to break the promise of convertibility. Moreover, in all probability it would not to be profitable without taking on significant risk to pick up yield, which would increase the probability of such a run."
. . . .
"The previous analysis suggests that the concepts of price and financial stability are joined at the hip. They are simply two ways of ensuring trust in the monetary system. Inflation, deflation, and price volatility induce instability in the value of money — and its close cousin, debt — in terms of goods and services, undermining its means-of-payment (and store-of-value). Financial instability effectively undermines it through the threat and materialization of default, which can bring the payments system to a halt when bank deposits are involved. Price and financial instability amount to broken promises."
. . . .
"Finally, studies indicate that financial booms tend to misallocate resources, not least because too many resources go into sectors such as construction, which depresses productivity growth persistently once the boom turns to bust (Borio, Disyatat, and Zabai 2016 and references therein). Furthermore, a large amount of empirical work indicates that the financial busts that follow booms may depress output for a long period, if not permanently. It is hard to imagine that interest rates are simply innocent bystanders. At least for any policy- relevant horizon, if not beyond, these observations suggest that monetary policy neutrality is questionable."
. . . .
"Strong monetary system anchors are crucial. As argued in more detail elsewhere, putting them in place requires action on two fronts. It calls for effective regulation and supervision. This must be so both in relation to banks (and other financial institutions) assessed on a stand-alone basis (the so-called microprudential perspective) and with respect to the system as a whole (the so-called macroprudential perspective). And it calls for monetary policy regimes that secure long-term price stability while taking advantage of any room for maneuvering to respond to financial stability threats."
. . . .
Conclusion
"The monetary system is the cornerstone of an economy. Not an outer facade, but its very foundation. The system hinges on trust. It cannot survive without it, just as we cannot survive without the oxygen we breathe. Building trust to ensure the system functions well is a daunting challenge. It requires sound and robust institutions. Lasting price and financial stability are the ultimate prize. The two concepts are inextricably linked, but because the underlying processes differ, in practice price and financial stability have often been more like uncomfortable bedfellows than perfect partners. The history of our monetary system is the history of the quest for that elusive prize. It is a journey with an uncertain destination. It takes time to gain trust, but a mere instant to lose it. The present system has central banks and a regulatory/supervisory apparatus at its core. It is by no means perfect. It can and must be improved. But cryptocurrencies, with their promise of fully decentralized trust, are not the answer.
Paraphrasing Churchill’s famous line about democracy, “the current monetary system is the worst, except for all those others that have been tried from time to time.”
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My added comments: As you can see from the underlined portions of the text above, it is critical that anything that wants to be viewed as money has the widespread trust of the population in general. Without that, it is doomed to failure eventually. This seems obvious, but examples of projects and monetary systems that failed to obtain this vital trust abound both in history and around us today.
I encourage readers to read the full article by Claudio Borio. It is an analysis of how the present system values the public trust in the monetary system and the ways it attempts to maintain that trust. It is clear when you read this article that monetary officials understand that if they lose general public trust in money and the monetary system, it is very difficult to get it back as history has shown many times.
Also, another thing I have learned is that if you want to offer up anything as money with hope of achieving wide scale adoption by the general public, you must be able to convince the public it is trustworthy above all else. You can have the greatest theoretical concept for money or a monetary system ever devised by man, but if you cannot convince the public at large to trust it, it won't matter and it will fail eventually.
Added notes: The comments in this article about cryptocurrencies are interesting in light of the announcement by Facebook to launch the Libra. The second paragraph above related to cryptocurrencies seems to me to be directly pointed at something like the Facebook Libra even though the Libra plans to have full fiat currency backing for each coin. As I read it, that paragraph suggests Libra will just be "piggybacking" on existing national currencies and that it could be vulnerable to a bank run under some conditions.
Also, the BIS has just issued a new report that looks at the pros and cons of "Big Tech" like Facebook entering into the financial services industry.
Added notes: The comments in this article about cryptocurrencies are interesting in light of the announcement by Facebook to launch the Libra. The second paragraph above related to cryptocurrencies seems to me to be directly pointed at something like the Facebook Libra even though the Libra plans to have full fiat currency backing for each coin. As I read it, that paragraph suggests Libra will just be "piggybacking" on existing national currencies and that it could be vulnerable to a bank run under some conditions.
Also, the BIS has just issued a new report that looks at the pros and cons of "Big Tech" like Facebook entering into the financial services industry.
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