Competing Currencies

A new book draws the wrong lessons from privately issued money.

Rethinking Money: How New Currencies Turn Scarcity Into Prosperity, by Bernard Lietaer and Jacqui Dunne, Berrett-Koehler, 288 pages, $27.95.

In the charming town of Great Barrington, among the hills of Berkshire County in western Massachusetts, you can buy antiques, organic produce, and gourmet pizza. If you want, you can pay for them with the most successful local currency in the United States, the "Berkshare." Denominated in U.S. dollars and accepted at more than a hundred establishments in and around the county, Berkshares are issued by a local non-profit group and can be exchanged for dollars at the branches of local banks. Anyone who recognizes that money is naturally a creature of commerce, not government, has to admire the way that the Berkshares project keeps some of the profit on currency from going to the Federal Reserve System and the U.S. Treasury. Private banknotes circulated just about everywhere in the 19th century. Like the private notes that continue to circulate today in Scotland, Northern Ireland, and Hong Kong, Berkshares show by example that privately issued currency remains feasible in the 21st century as well.

In Rethinking Money, economist Bernard Lietaer and journalist Jacqui Dunne offer interesting accounts of community currency projects more or less like Berkshares around the world. But they admire them for rather different reasons. The dominant monetary system is problematic, in their view, because it "perpetuates scarcity and breeds competition," stifles cooperation, makes life stressful, concentrates wealth at the top, causes financial instability, and threatens the environment. It does so chiefly because the need to pay interest is "structurally embedded" in the system. In many ways their new book is a popular restatement of the message of Lietaer's 2001 book The Future of Money. A reader who approaches either book hoping to find common ground with modern arguments for free banking will unfortunately find very little.

Today's government-dominated monetary and financial systems do of course exhibit instability. But the book's other indictments of them are more dubious. Any monetary system "perpetuates" (does not abolish) "scarcity," as economists use the term, and so too does any barter system. Scarcity, meaning that we do not have enough time and resources to accomplish all of our imaginable goals, is an ineluctable feature of human life. Competition is not a problem: Indeed, to bring about greater prosperity we need more competition, not less, and especially so in money and banking. Freer competition promotes rather than stifles greater social cooperation. Free-market banking and money-issue would end the government's monopoly on basic money and its control over the interbank transfer system. It would end both special privileges for commercial banks and special restrictions on their activities. Greater efficiency, stability, and prosperity would follow. But to think that "monetary scarcity can be a thing of the past" is to engage in wishful thinking.

The book's greatest conceptual problem is its confused thinking about interest rates. It gives only passing lip service to the key non-monetary reasons that interest rates are positive apart from risk. It fails to understand the vital role that interest rates play as signals of the time-value of resources. To the authors, interest is "a built-in feature of the monetary system." They write that the discounting of future goods "is due only to the interest feature of the money used," as though interest—and its flip side, discounting—would not exist under barter or in a monetary economy using only coins (as in the centuries before money-issuing banks). In place of an economic argument they offer a parable suggesting that interest is due to the scarcity of money, and that the scarcity of money is an artificial contrivance, even a conspiracy, to force people to pay interest. From this staring point they proceed to a number of false conclusions.

The authors declare ruefully: "Debt-based money requires endless growth because borrowers must find additional money to pay back the interest on their debt." This sentence harbors multiple confusions. "Debt-based money" refers to checking account balances, which are spendable IOUs owed by banks to their checking depositors. There is no 1:1 correspondence between checking accounts (one kind of bank liability) and bank loans (one kind of bank asset). Banks use only some of the funds given to them by depositors to make loans; the rest they mostly use to purchase securities and to hold reserves. Meanwhile "borrowers" in our economy have many debts to non-bank lenders, such as consumer and car loans from finance companies and home mortgages held by investors in mortgage-backed securities. What borrowers must do to repay their loans is independent of whether the loans are funded by bank deposits.

The notion that bank lending creates a shortage of income needed to repay the loans with interest (the point of the above-mentioned parable) is a very old fallacy. It implies that banks burn their interest income. In fact they recycle it by paying out interest to depositors, wages to employees, and (to the extent that profit is left over) dividends to shareholders. There is no need to print extra money each period so that borrowers can pay their debts.

Even without bank-issued money, risk-free interest rates are normally positive. They are positive even in an economy that is not growing. They are positive so long as savers are impatient at the margin (preferring one more unit now to one more unit later) when given a zero reward for waiting, and investors have opportunities to produce more output by taking more time. People who want shelter (say) are naturally willing to pay more to get 1,000 board-feet of lumber delivered today than to get 1,000 identical board-feet delivered 10 years from now.

It only discredits a case for monetary reform to found it on the paranoid notion that it is sinister to pay a premium for present stuff when borrowing, or receive one when lending. We do need decentralizing monetary reform, but it is vain to hope that monetary reform would abolish the premium on present goods.

The authors' account of how fractional-reserve banking works is about half correct, half erroneous. They correctly note that banks fund their loans partly with the money lent to them in the form of checking account balances. But they commit a non sequitur when they say that if all bank loans were repaid then "money would simply disappear." Not only would the basic circulating currency still exist, but banks could and presumably would use checking account funds (to a greater extent than they already do) to purchase and hold securities instead of making loans.

The fourth chapter begins with an epigraph suggesting that any scarcity of money is artificial, attributed (but with no specific publication cited) to the American poet and fascist Ezra Pound. I could not find the quotation in Pound's works. Pound did denounce interest as "usury" and issued a booklet entitled Social Credit: An Impact promoting the crackpot ideas of the inflationist Major C.H. Douglas. Ezra Pound and Major Douglas are not reliable sources for understanding or reforming money.

But Lietaer and Dunne have little use for orthodox economics. They declare that economists share a "collective blindness" because they "define money by what it does…rather than what it is." This is a curious charge given that they themselves tacitly adopt the same approach some pages later, defining money as "not a material object" but anything commonly accepted as a medium of exchange. They assert that textbooks and "traditional economics" have "never decoupled" the various roles of money (conventionally listed as commonly accepted medium of exchange, unit of account, and store of value) and have never questioned "the assumption that the same monetary tool is needed to play all three roles." It is a shame that the authors are unaware of the large economics literature since 1980 that has in fact debated the feasibility and desirability of payment systems that decouple the media of exchange from the unit of account and the medium of redemption.

The authors create a conceptual muddle when they characterize the status quo system as grounded on "fiat, scarcity-based, interest-bearing national currencies." Fiat, yes. Scarcity-based? Economic reality is scarcity-based, so in that sense all workable kinds of money are scarcity-based. Interest-bearing, no. Federal Reserve notes do not pay interest, nor do any nation's fiat currency notes. (The Fed has begun paying interest on bank reserves, but the authors never refer to that.) Elsewhere they write of "the monopoly of one type of money, namely, national currencies, all created through bank debt." National currencies like Federal Reserve notes are irredeemable fiat currencies, created by slapping ink on paper, and not debt. Checking accounts are bank debt, but their creation is not a monopoly.

The book embraces community currency projects that charge a "demurrage fee" for holding a currency note too long, to penalize its use as a store of value and thereby to confine its use to that of a rapidly circulating medium of exchange. This idea is historically associated with Silvio Gesell, not cited in the book, another monetary crackpot.

In sum, Rethinking Money misses the opportunity to mount an effective critique of our monopolistic monetary system and propose reforms that can appeal to both progressive and libertarian critics of central government domination. Lietaer and Dunne could have developed an interesting critique and positive program from their correct observations that conventional economists fail to critically examine the government's present monopoly issue of basic money, and that such a system has the fragility of an undiversified ecosystem. They unfortunately never mention F.A. Hayek's unconventional work The Denationalization of Money, nor any of the literature of the last 30 years concerning non-fiat, redeemability-based free banking. They might also have drawn on Nassim Taleb's very relevant observations on the fragility of our financial system due to one-size-fits-all regulation and "too-big-to-fail" policies. The path to greater prosperity that they offer is paved with sincere intentions but illuminated by moonbeams.