The short history of private sector money

In 1832 the youthful American government decided to stop issuing banknotes backed by the state. As any business could get hold of a modern security printing press and issue notes, the politicians reasoned, government had no need to be involved. Create choice in money supply and let the best currencies win became the mantra.

The choice was undeniable. America’s three decades of “free banking” spawned thousands of incompatible money systems across the country. Some were honestly run. Some established niche sectors in which they were genuinely useful; a currency aimed at farmers in New York state was one example. But too many others were driven by directors who felt compelled to put their resources into short term returns and marketing rather than less visible facilities that might give a currency enduring value for its users. Some currencies were good for limited purposes. Many were distrusted and useless.

In this environment, making any kind of purchase had to be preceded by negotiations about the form of payment. All users of cash had to monitor the contents of their wallet for fear of holding money in which everyone else had lost confidence. Of course, the inherent dynamism of capitalism could be relied on to address these problems.

Booklets called “detectors” started to be sold every week listing the currencies that had begun loosing value in the last seven days. They had to be read promptly; if you had a pocket full of duff notes it become imperative to buy anything off anyone who had not yet read the latest detector. Predictably, not all the detectors were accurate or honest in their intent. So, a new trade emerged: “shavers” would – at a discount - buy notes in which townspeople in one area had no confidence while the cash still had value elsewhere.

The one choice Americans were not given through the 1830’s, 40’s and 50’s was the facility we take for granted today: a coherent, ubiquitous, too-big-too-fail, money supply broadly trusted by everyone. Faced with all the confusion, and time-consuming requirements for using cash, swathes of the population simply reverted to barter. Reluctantly in 1862 the government started to issue state-backed notes as an option for the populace. In 1871 the Supreme Court ruled that government issued notes were entitled to an enduring and unique status among money systems.

Perversely, free banking worked against the wishes of the market. It’s reasonable to assume that almost everyone wanted a convenient (which means dominant) money system to emerge. And it’s likely that each of the 15,000 or so note-issuers would have loved their system to be the one that filled that lucrative position. But none of them could come up with any enduring advantage over the others across the whole economy.

For banknotes in 1840’s America, read non-corporate electronic markets today. Anyone can start a marketplace and establish some perceived advantage - in pricing, positioning, pools of users, or technology - over competitors.

That creates endless confusion for users and makes the cost of achieving lasting dominance over other players untenable. Some niche sectors are well served, eBay is the New York farmers’ bank of its time. But the muddled, time consuming, nature of online trade means most transactions occur without it. Outside of the corporate sphere we don’t yet know what this technology could do for us because its potential has always been so dissipated.

As with “detectors” and “shavers”, attempts to resolve this confusion tend to become part of the bewilderment and add unnecessary overheads for users. Think of the countless portals, directories, consolidation sites and ranked-by-users sites with grandiose claims but, in reality, access to only a sliver of the market in each of hundreds of online sectors. Except in small niches, no-one can break out of this cycle of potentially useful services being eroded by dozens of start up competitors as soon as they appear to be succeeding.

As with printed money, only one body can create an economy-wide focus for the benefits of this facility by ensuring enduring advantage for one system. That’s government. No entity in the private sector can pass the laws that allow such a service to be underpinned by the highest authorities in the land. Similarly no company has an incentive to create a completely transparent, genuinely accessible, service in even the lowest level markets with fixed pricing for years ahead and any chance of user lock-in renounced.

 Fiat Money is now the norm. In each country, the state has given one currency system stability, endurance and ubiquity. That brings the overheads - in cost and time - of using that system to the lowest possible level while giving users confidence in printed paper rather than less portable assets.

 Instead of the meaningless short-term activity of new currency issues that kept free banking dynamic, state-backed money has encouraged lasting innovation. We would not have the credit industry or financial instruments for instance without one money system becoming the dominant, no-thought-required, platform we take for granted today. Similarly, NEMs would be a stable facility on top of which others can endlessly innovate without having to constantly re-invent the basics.

•  Existing frameworks