Thursday, August 10, 2017

Why is a one pound coin worth more than four pennies?

The new 12-sided pound coin released earlier this year


The UK's recently-introduced one pound coin is made of 8.75 grams of metal, 76% of that copper and the remaining 24% a combination of zinc and nickel. At market prices, this amount of metal is worth around four pennies. So why do pounds trade for 100 pennies? Why are Brits passing these coins around as tokens—i.e. far above their metal content—rather than at their intrinsic melt value of four pennies each?

One answer is tradition. Brits accept that pound coins should trade at a 2000% premium to their metallic content because they've always done so. This isn't a very satisfactory answer. We need an explanation for why this tradition emerged in the first place.

It could be that the British government simply says that coins must be worth more than their metallic content, and Brits have fallen in line with this order. If they pass on these tokens at an illegal price, they'll be fined, or thrown in prison, or forced to drink tea without crumpets.

This too is an unsatisfactory explanation. Coin and banknote payments are highly decentralized—it's simply not possible to police against trades that deviate from the stipulated price. We have centuries of examples in which government proclamations about currency exchange rates have been ignored. Just today I can mention two. The Venezuelan government's official price for the bolivar is 2,870 to the dollar, but bolivars trade unofficially at 13,077, despite jail sentences to anyone caught trading in the black market. Zimbabwe's leaders say that their recently-printed issue of bond notes must trade at par to U.S. dollars, but in practice a 10-15% discount has emerged, one this will probably only widen over time.

So if governments can't will a monetary instrument like a coin to trade at a premium, where do these premia come from?

A bit of history about token coins—i.e. coins that carry a large premium—may help.

One strange feature about the world before the 1800s is that everyone—you, me, and our grandmas—had access to the mint. We could walk into the mint with a bag full of raw gold or silver and ask the mint master to have this material coined. Upon leaving we'd be provided with the same weight of metal (less a small fee for the mint), except that it had been transformed into coin form. This was called free minting: access was available to everyone.

Free minting meant that coins couldn't carry a premium over raw metal value, at least not for long. To see why, imagine a coin that contains one ounce of silver. When demand for that coin suddenly shoots up a shortage develops, the coin developing a 'fiat component'—it starts to trade at a large premium to its silver content, say one coin can buy two ounces of silver. At this point it has become a token. If I had one of these coins in my pocket, I'd sell it for two ounces of silver, take that silver to the mint, and get two coins in return. Voila, I've turned one coin into two coins! Because many people would conduct this same arbitrage, a slew of coins would enter into circulation. The shortage resolved, the market price of the coin would return to its intrinsic value. With the coin's fiat component gone, it has ceased to be a token.

If coins to are exist permanently as tokens, free minting needs to be halted. If people can't bring in silver to be minted, there is no way for the public to draw out a new supply of coins to remedy a shortage. It is then possible for a coin's value to have a permanent fiat component, or, put differently, for the coin's market price to forever above the intrinsic value of its metal content. 

As an economy grows, people need more coins to conduct transactions. With the mints being shut to the public, how would this supply be created? The answer is that government itself must introduce new coins into circulation by purchasing metal, bringing it to the mint to be coined, and issuing the coins into the economy. If it puts too many coins into circulation, the artificial scarcity that feeds the fiat component of a coin's value will cease to exist and the price of these tokens will fall to their intrinsic melt value. By carefully regulating this supply, coins should always contain a fiat component—their token nature continuing in perpetuity.

These were precisely the steps taken by the British authorities when they introduced their first official issue of silver token coins in 1817. In the centuries before, the British monetary authorities had always maintained a policy of free minting of silver, the Royal Mint—owned by the government—producing only full bodied silver coins, not mere tokens. In 1817, the era of free minting was suddenly brought to an end. The Mint would now only make new coins for the government's account, not for the public. At the same time a token coinage was introduced, the silver content of the new coins being set such that it was now significantly below the coin's face, or par, value. The crown in the picture below, which has the legend of Saint George and the Dragon engraved on it, is an example of one of these early tokens.


To maintain the premium on its tokens, the Mint began to carefully regulate the supply of new coins. Here is monetary historian Angela Redish:
The Mint bought silver at the prevailing market price in the quantity it thought necessary and believed that by limiting the quantity of silver coin supplied it could maintain the value of the coins above the value of their silver content; that is, the supply limitation would give value to the fiat component of the currency. (pdf)
While this worked at first, over the next decade the mechanism for maintaining an artificial shortage—and thus the fiat component of the government's new tokens—broke down. From Redish, we learn that throughout the 1820s the new tokens began to accumulate at the Bank of England, still then a private bank, which had a policy of accepting tokens at their official value from the public, providing gold in return. (The Mint itself had no conversion policy.) The Bank had effectively become the only redemption agent for government tokens. Without the Bank's sopping up the public's unwanted supply at par, the market value of silver tokens would have quickly become unhinged from the coin's face value, eventually falling in price to the market value of their metal content.

Having the Bank of England act as the lone redemption agent for the government's token coins wouldn't do, so in 1833 the government officially took on the task of maintaining the par value of tokens. The Bank of England still accepted all silver coins from the public at par, but now the Bank was allowed to return this stockpile to the Mint for redemption in gold at the coin's par value.

And that, ladies and gentleman, is why your new pound coins, despite containing just 4 pennies in metal content, are worth a full pound. Since 1833 the British Treasury has promised to act as a backstop for all its token coinage, buying them back at their full face value so as to prevent any decline in the fiat component of its coins. Put differently, your one pound coin is worth 2400% more then its metal content because the government promises to uphold that premium by using funds it has raised out of tax revenue.

Coins are thus very much a liability or IOU of the government. This IOU nature of coins tends to operate far in the background, but it becomes much more apparent when a denomination of coins is cancelled. Take for instance the 2013 termination of the Canadian cent, in which the Royal Canadian Mint began to withdraw the lowly penny, the nickel being given the duty of serving as our nation's smallest denomination coin. Ever since then Canadians have been dutifully bringing their hoard of pennies into the local bank in return for cash or a credit to their bank accounts, banks in return sending the coins onward to the government for redemption.

We know from its initial report that the government budgeted $53.3 million to pay the face value of pennies redeemed. Which means that it anticipated the return of 5.3 billion pennies. According to the Mint's 2016 Annual Report, some 6.3 billion pennies have been since brought in, a small amount compared to the roughly 35 billion produced since 1908 and presumably still languishing under mattresses and in dumps—but still above the budgeted amount. Which means a larger chunk of Canadian taxes will have to go to paying penny IOUs then originally expected.

So as you can see, it isn't by mere diktat or tradition that coins trade above their metal content. It's the government's promise to buy them back that provides coins with their fiat component. In the case of the UK's new one pound tokens, should Her Majesty's Treasury refuse to backstop them its quite probably they'd be worth, say, just 90 pence a few years from now; 50 pence a decade hence; and finally 4-5 pence much further down the road. The market value of the pound coins wouldn't fall below that. At 2 or 3 pence per coin, Brits would start withdrawing them from circulation and illegally melting them down for their metal value.




To write this post, I relied on these two fine sources:
1. Angela Redish, The Evolution of the Gold Standard in England, pdf
2. George Selgin, Good Money, link

I also got inspiration from the conversation with Dinero and Antti on this post

28 comments:

  1. JP: *If* the demand for currency were to fall, the government's/central bank's commitment to reduce the supply ("buy it back") is what *would* prevent its value falling. But in a growing economy, the demand for currency *normally* rises. If so, the govt/central bank need never buy it back to preserve its value. It can sell more, to prevent its value rising. And with a 2% inflation target, the real interest rate on that "IOU" is minus 2%. Which makes it an asset, rather than a liability, to the issuer. The only liability is the implied option to resell if demand falls, which will likely never be exercised.

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    1. Nick, I 95% agree with you.

      "...if demand falls, which will likely never be exercised"

      Will likely never be exercised? I gave two examples, Britain in the 1820s and Canada in 2013, where it did need to be exercised. Also, you are right that in a growing economy, demand rises on a year-to-year basis. But don't forget about seasonal demand. For instance, after New Years the demand for currency usually takes a sharp fall.

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    2. Compare with stock markets, where demand and supply determine the price but only in the short run. In the long run fundamentals are more important.

      Is this true for money as well? Or why it is different? Which one is more important: government's/central bank's ability or its commitment to buy back (mostly by collecting taxes) its liabilities?

      Great post btw.

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  2. The government of England is fairly democratic and they have tax cops armed with legal right to use force.

    But the general rule is that once we have market price of the base unit, then the denominational algebra is accepted. The ratio of pence to pound is accepted once we have marked the pound to the enforced tax market.

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  3. > JP
    good research, well done.

    In principle the government could pay for the gold, with coins, and so as long as the coins remain at issue they exist as token with a permanent state of potential exchange with the gold.

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    1. Thanks!

      Yes, in principle the Treasury could have minted new coins to buy the gold used to redeem unwanted coins. Doesn't this set off an unstable dynamic, though? Coins need to be withdrawn to prevent them falling to a discount, like in 1820s England, but if this withdrawal is achieved by issuing new coins in to the economy (to buy the gold), how is the initial surplus ever fixed? Coins will still fall to a discount to face value.

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    2. There is not a dynamic instability where redemption is accompanied by re-issue. The no of coins at issue is the same. It is comparable to treasury debt where payment of maturing bonds is financed by new issue bonds.

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    3. Dinero, if an issue of bonds is coming up for redemption, and there is not enough demand on the part of investors for the bonds to be rolled over, then the bonds will have to be issued at a discount i.e. a higher interest rate, as only a sweetened rate will attract new investors.

      Likewise, if there is an excess of coins in circulation, they will fall to a discount in order to attract holders. That discount won't be fixed by buying back old coins with new coins, since the quantity of coins is not being reduced.

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  4. > JP

    how do you feel about the withdrawal of the Canadian cent.
    In the UK I don't think people would like the same with the penny. It would be a coinage without a coin to denominate the others. We don't think of a penny as 1/100 of a pound. Its the other way around, a pound is 100 penny. Up untill the 80's there was a half penny coin. The US has the half $ coin , but in the UK there is no half £ coin , it is a 50p coin.

    We also regularly have special edition 50p £1 and £2 coins. This year there are beatrix potter theme 50ps and £2 Jane Austin and and aviation themes

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    1. "We don't think of a penny as 1/100 of a pound. Its the other way around, a pound is 100 penny."

      Interesting observation. And I see that the U.S. quarter is called a "quarter dollar", not 25 cents. Whereas in Canada it is referred to as "25 cents."

      I gotta say, my life has become far better without the penny. Far less change in my pockets. Easier to make transactions. I haven't noticed that the 25 cent piece, which is denominated in cents, no longer has an associated 1 cent penny.

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  5. I'm trying to get my head around this and am not sure yet to what extent I agree or disagree with you. Consider the following cases:

    Citizen A works for 1/2h and to earn £1 worth of gold from his neighbour (say, the gold mine owner), brings it to the mint and receives the same gold back but with a pretty face imprinted on it. The face tells future owners of the coin that it can be exchanged for £1 of goods (approx. 1/2h of labour) and can be used to discharge taxes and other debts.

    Citizen B works 1/2h for the government (providing services for society paid for by tax payers) and receives a receipt in the shape of a £1 copper alloy coin that can be exchanged for £1 of goods (approx. 1/2h of labour) and can be used to discharge taxes and other debts. The tax payers pay the £1.00 + £0.04 for the alloy + other expenses and receive the services in return.

    Citizen C works 1/2h for his private employer (providing services for paying customers) who then orders his bank to debit a digital receipt over £1 on the employee's bank account. It functions the same way as coins. The bank charges the employer a fee for this service.

    Would you agree with the above?

    If so, would you agree that Case A is categorically different from cases B & C, while the latter two are funtionally identical?

    Because that tells me the following:

    1. Governement money and private money (cases B & C) are functionally equivalent. Both are de facto receipts for things given. Those receipts can, if people decide so, be passed on for other things of equivalent value or used to pay off debt.

    2. In case A, the act that earned the owner the £1 worth of gold (his labour) happened before he went to the mint, while in cases B & C the acts coincide. Cases B & C are payments, case A is not.

    3. In case A, the market value of gold must roughly coincide with the face value imprinted on it for the system to function. In cases B & C, the receipts must reflect the market value of the goods / services given up for the system to function. Also, owners of receipts (B&C)must have faith that they will receive goods of equivalent value in future.

    4. You can have either A or B&C, but they can't be mixed.

    5. In all three cases, the demand for money is basically made up of two other components: the supply of labour (or fruits of nature) and the demand for labour / fruits. Both must be equivalent, otherwise the transactions don't take place and no receipts (money) are issued / no gold changes hands.

    6. In neither of the three cases does the issuer of money act independently. He can over- oder undervalue the transactions, but only with the approval of both transacting parties. OTOH, owners of receipts can choose not to redeem them for goods. And suppliers of labour / fruits can choose not to supply.

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    1. "2. In case A, the act that earned the owner the £1 worth of gold (his labour) happened before he went to the mint, while in cases B & C the acts coincide. Cases B & C are payments, case A is not."

      I suppose. I mean, it depends how you set it up. The gold miner could also bring the raw gold to the mint and then pay Citizen A with a full bodied coin.

      "If so, would you agree that Case A is categorically different from cases B & C..."

      I think the main difference I see is that in B & C the exchanges involve promises, (or claims or IOUs, whatever you want to call them), whereas in A no IOUs are involved.

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    2. You're right, my line of argument is sloppy. The gold miner could bring his gold directly to the mint, the gold mine could also belong to the government and, as for B & C, the giving of goods / receiving promises could easily take place separately from the acts of production.

      Thinking over it again, I'd say my main point is that nothing of particular economic interest happens at the mint. The acts of production (or finding gold) are one thing one could focus on, and the the change of relations among economic agents (emitting and retiring promises) are the other 'primary' (macro)economic phenomenon to consider. In a flow sense, I also posit there must / should be some relation between the two, but that's another discussion.

      What happens at the mint, OTOH has at best a marginal economic effect in a chartalist sense, in that whatever is being minted gets an official seal of approval and becomes legal tender.

      I could just as well imagine wheat being taken to the official government weighing station, packed into bushels and furnished with an official government seal. Nobody would claim that government was printing bushels. The economically significant acts are those of growing and selling wheat.

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    3. "What happens at the mint, OTOH has at best a marginal economic effect in a chartalist sense, in that whatever is being minted gets an official seal of approval and becomes legal tender. I could just as well imagine wheat being taken to the official government weighing station, packed into bushels and furnished with an official government seal. Nobody would claim that government was printing bushels."

      Yes, that's fair. At least, assuming free-minting and coins are full-bodied.

      Once the mints are shut down and coins become tokens, things are different.

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    4. I agree they are different, but I'm still not sure I agree with you on how exactly they differ. Generally, I tend to end up agreeing with Antti in these matters.

      I'll expand my wheat analogy a bit, at the risk of boring you.

      A real gold standard in wheat terminology is the case I described above. Economic agents, including government, bring their wheat to the official weighing station and have it weighed, packed and sealed.

      A gold / wheat standard analogous to the international gold standard as it existed until 1971 works as follows, IMO:

      Economic agents, including government, exchange goods or services for officially underwritten promises by the buyers. The promises, underwritten by a granary, are promises by the buyers to sell goods or services of equal value to the market in future. Hence, they are IOUs by current buyers to future sellers. Value is measured in terms of wheat bushels whereby the price of wheat bushels is officially announced. The holders of promises, should they doubt the value of the promises, have the option to redeem them for actual wheat bushels at the official price at any granary. A prudent granary would keep a stock of wheat for redemption purposes. There is a central granary that oversees all subsidiary granaries.

      So, promises have a positive value, not primarily because of the amount of wheat the granaries keep, nor as a direct function of the amount of promises in circulation, but because of the belief of sellers in the ability of the market to produce real goods or services at the rate demanded. The central granary can buy and sell private or government IOUs from non-government with the aim of influencing the flow redemption of promises for goods and services. Depending on the which church of granaries one subscribes to, this policy is believed to be more or less effective.

      You can then drop the redemption by the granary for wheat in the example above and you're left with plain vanilla wheat fiat. All the central granary is left with, is buying and selling IOUs, i.e. swapping one class of assets extant for another by expanding and contracting its balance sheet. Importantly, under this system, granary promises are still promises by buyers to sell goods or services of equal value to the market in future, i.e. IOUs by current buyers to future sellers. They are liabilities of the granary only in the limited sense that it promises to do its utmost to uphold certain standards of conversion of other agents' promises into yet other agents' reald goods and services.

      I don't know where this leaves me with respect to your discussion with Antti below (or indeed whether I'm anywhere near on topic). Somewhere in between, I suspect. I think Antti is challenging whether there is, in economic terms, something like an IOU an IOU, or whether claims should always be netted onto 'natural persons' (or groups thereof) for better understanding. I'm not 100% sold on that idea - yet. But where I definitely do agree with Antti is when he says: all liabilities are ultimately 'stuff owed' - the operational term, in my opinion, being ultimately.

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    5. I think we need to be careful with the word IOU. An IOU is a promise that can be enforced in a court. Or a social compact, say like a central bank's promise to target inflation, that if broken has some sort of consequences, say like the firing of the head of the central bank. If I have a banknote, I am under no obligation to a future seller. They cannot sue me for failing to get rid of my banknote.

      But in general I think I agree with the gist of your comment. When redemption is dropped, the granary's notes are still IOUs/promises since it has the obligation to buy/sell these notes in a manner that keeps them stable.

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    6. Oliver and JP,

      Seeing that Oliver is bringing in a perspective which I’m introducing in my own blog (the blog is all about this perspective), I feel I need to interfere :)

      'IOU' is a word I avoid, because both I and U are in singular, while the monetary system seems to be a record-keeping system for an economy where individuals hold claims against, or have obligations towards, everyone else. Thus, a bank note is a TOM (they owe me) and a mortgage is an IOT (I owe them).

      If a bank is not the one who owes or is owed to, and I argue it isn’t, then it makes sense to see its balance sheet as a mirror image of what we are used to: on the LHS there are liabilities (mortgages, bonds, etc; the IOTs) and on the RHS there are claims/assets (TOMs).

      How does one get rid of a mortgage? One gives, i.e. sells, goods of a certain nominal value to others. How does one redeem a claim against everyone else? One receives, i.e. buys, goods from them.

      By adopting this perspective (it might require some brain torture…), we get rid of endless arguments about central bank liabilities.

      People like Pesek & Saving, Friedman & Schwartz, Tony Yates(?) and Eric Lonergan (see here, are right when they say that a ten-dollar bill is not a debt. Yet, they are wrong when it comes to the big picture. The people who oppose them, and argue that a ten-dollar bill is a CB/government liability, are much closer to the truth (this latter group includes people like JP Koning and Randall Wray). This is because the former group thinks of fiat money as net wealth for the community. Yes, a credit in CB books is an asset to its holder but no one’s liability (to quote Nick Rowe). No, it’s not net wealth, because for every credit there always exists a debit (my only formal education is in accounting, by the way). That debit we find on the LHS of the CB balance sheet (literally, as those accounts have debit balances). It’s a liability to its holder but no one’s asset.

      To me, what JP describes when he talks about a social compact is not an IOU. An IOU is a record, often depicted as a piece of paper, of a clearly defined debt from its issuer to its holder. A responsibility to do one’s best to maintain price stability, on the other hand, is not something one can put a price tag on. (It’s very hard at times, and not up to central bankers alone; the chairperson might get fired because the CB does buy the notes, just as JP says it is obliged to do.) How could that responsibility be said to be of a certain nominal value to a credit-holder? “The CB owes me $10 because it has a responsibility to try to maintain a stable price level”?

      Everything becomes much simpler if we can admit that what we are used to call CB liabilities aren’t really CB liabilities. This doesn’t mean we need to agree with afore-mentioned people who are mostly ignorant about accounting. Quite the contrary. We might be finally able to prove that they are wrong.

      (I've used three years of my life, thinking about little else during those years, to form this perspective, so I appreciate any feedback/critique.)

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  6. Oliver:

    Think about the effort that goes into preparing for a potential transaction.

    Case A--The miner finds and digs out gold, then has it formed into coin.

    Case B-- Government makes a coin, spending 0.04 pounds in the process.

    Case C--Our private employer FIRST earns money, accumulating enough to pay for labor.

    The take-away here, is that Cases A and C are similar in that productive work precedes a later productive exchange. In Case B, government expends only 0.04 pounds of productive work to prepare for a later productive exchange.

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    1. Hi Roger,
      You're right. My examples are not precise. There are many more possible combinations. See my second reply to JP.

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  7. It is probably off-topic but I am struggling with the macro-economic presumption that "production is traded for production" or "work is traded for work".

    I see money as a symbol for "production" or "work". Symbolically, some amount of money can become an enduring symbol of past performance.

    The symbolism of money breaks down when value can not be projected into the future.

    It is of no value to me to be able the look at a pile of coins and remember that I worked one day in the heat to earn that pile.

    I need to look at the same pile and know that I can trade part of the pile for bread. Of course, that would be a "future" trade. I need to know what ratios of trade are likely to exist.

    When government pays for work using coins it just made for 0.04 pounds, it may achieve our example "1 pound for 0.04 pound" trade for a while. I struggle with the limits that must exist, ultimately causing economic failure. Venezuela is apparently running an experiment exploring these limits as I write.

    Probably I am too mechanical in my thinking. I use words that imply breakdown, as if the economy will fail and be discarded like a broken car along side the road. Instead, the economy should continue to run in some fashion; never completely coming to a stop. Like a car still rolling, without engine, doors, fenders and windows; pushed by a donkey in a peculiar harness.

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  8. JP, I was happy to find out that you continue our earlier discussion in form of a new post!

    You, I and Tony Yates already exchanged some opinions on Twitter. I'd like to continue from where we left it [link]. That is, I'd like to try to prove that United States Notes (and Silver Certificates) -- which Tony, rightly, sees as equivalent to coins -- are in a very concrete way Treasury/government liabilities.

    First of all, U.S. Notes are officially part of public debt of the United States (see this report, p. 13, "Other debt"). (I think coins should be too, but currently they are not accounted as such. But I think your example of the redemption of Canadian pennies would apply to US coins as well, and if so, coins would be comparable to U.S. Notes?)

    U.S. Notes remain legal tender and there are still over $200 million worth of them outstanding.

    Let's say I had in my possession $1 million of U.S. Notes. Let's imagine the government put up for sale a building it no longer had use for, for $1 million (I could use tax payments as an example, but I think this is more concrete, and more fun). I could actually buy this building by handing over all of my U.S. Notes, either directly to the government or via the Fed (the outcome is the same, so it doesn't matter if the first option is somehow restricted, as it might be in real life).

    Tony Yates has argued on more than one occasion that the government accepts this money, or any other money, NOT because the money represents its liability/IOU, but because it can re-use the money to finance its future expenditures. In the case of U.S. Notes, this would either mean that the government can (re-)spend the U.S. Notes (which it cannot, as we'll see) or that the government's account gets credited in another form for the U.S. Notes (say, a credit to its TGA at the Fed, by the Fed).

    I've been looking at this in detail and have found nothing which would support Tony's argument. It seems the Treasury would cancel and destroy the U.S. Notes after having received them from me (see "31 U.S. Code § 5119 - Redemption and cancellation of currency", (b) (2)). There wouldn’t be any credit to TGA, because the Fed has nothing to do with this -- it wouldn’t have any account to debit (U.S. Notes in circulation are not on its ledger). Instead, the Treasury would make a debit that reduced the amount of public debt (U.S. Notes in circulation), and the corresponding credit(s) would be to record the sale of an asset.

    Part 2 follows.

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  9. JP, you already know how this would work if I first handed the U.S. Notes to the Fed (we discussed it here; see my source links behind that link).

    The Fed would give me $1 million in its own notes (or credit my checking account…), credit account “Currency in circulation” and debit the Treasury’s account after having destroyed the U.S. Notes (Treasury cash reduced). Then, I’d pay for the building I buy from the government with the Fed notes (Treasury cash increased). Outcome just as in the direct example: The government sold a building with no effect on its cash position, but with an effect on its liabilities (reduced).

    To understand liabilities as “money owed” is way too narrow a viewpoint. All liabilities are ultimately “stuff owed”. For instance, my grandparents paid Finland’s war reparations to the Soviet Union in real stuff: “Approximately 340,000 railroad carloads were needed to deliver all reparations” (see here).

    Tony said on Twitter that he would be surprised if what I say above is really true, so it would be interesting to find out if I'm right or wrong.

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    1. Hi Antti, I couldn't follow the Twitter discussion; my mind blanks on Twitter thanks to threading and thought compression.

      I actually agree with the gist of Tony's point that government accepts cash "because everyone else accepts it."

      Even though I accept Tony's point, I still think cash is an IOU. The distinction between redeemability and an IOU is important here. In the old days, banknotes were directly redeemable on demand for gold. So governments might accept a banknote not because "everyone else accepts it," but because they were fulfilling a unique request for redemption in specie.

      By 1971, this redeemability promise had been killed. But just because an IOU is no longer redeemable on demand (for gold) doesn't mean it has stopped being an IOU. For instance, puttable stock is an IOU, but once the put option (i.e. redeemability) has been removed, the stock is still a valuable IOU. Google stock isn't puttable--but it is still worth quite a bit. Mike Sproul often draws attention to this point.

      On to U.S. Notes. When the U.S. government receives a Federal Reserve note, it acts like any other agent in the economy, depositing the note with its banker (in this case the Fed), as Tony says. But as you point out, in the case of U.S. notes it actually redeems them directly. A put option has been embedded into these notes that the Treasury is obligated to comply with. Federal Reserve notes, on the other hand, are not puttable.

      However, as I suggested earlier, we shouldn't assume that an irredeemable IOU is not an IOU. Iredeemable or not, U.S. notes and Federal Reserve notes are ultimately promises of the government--and that is why they are valuable. (Strictly speaking Federal Reserve notes are Fed-issued IOUs, but ultimately they are Treasury IOUs since the Treasury stands behind the Fed.)

      I've written here, here, and here on the idea of money being an IOU (despite no longer being redeemable on demand.)

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    2. I am trying to think about cash logically . Coins are cash. In this comment, I am thinking only of fiat money.

      Government has taken on the role of supplying money. To me, this means supplying cash or the deposit equivalent.

      I (also) agree with Tony's point about cash "because everyone else accepts it". Unquestioning acceptance allows governments to produce cash-as-a-product, without backing in the direct IOU sense. Instead, government produces cash on a "here it is" basis.

      Hence, we have the Federal Reserve producing green cash (or deposit equivalent) and Treasury issuing bonds promising to repay cash received. An obliging Federal Reserve never demands one-time repayment, so effectively Treasury never needs to pay down "loans of cash".

      Assuming cash is just a product, what gives money value? I suggest that value is maintained by keeping cash in short supply. Numerous nations have demonstrated that value of currency can be lost but the loss of value is never associated with lack of supply.

      With government as the only supplier of money, the first valuation occurs when payment is accepted for service to government. Secondary valuation occurs when those who receive money direct from government begin spending.

      If money is taxed at every transaction, eventually all originally issued money would be returned to government. Hence, taxation is a mechanism at acts to control the value of money.

      Still trying to think logically, why does government borrow money when it can print money at nearly no cost? Government can borrow from the Fed, and never repay in the complete loan-payoff sense. Why doesn't government just pay it's bills by forever borrowing and issuing money?

      I don't think the answer goes to the IOU properties of money. I think the answer relates to the potential value of money and it's use as a facilitator of trade. When money is unquestioningly accepted, it acts like a national gift certificate, good anyplace for anything. This acceptance by itself gives money nation-wide value. Acceptance of money as payment is acceptance of a future money revaluation, no matter how far into the future that revaluation might occur.

      Following this logic, I don't see fiat money as an IOU. I see it as a simple product, worth only what the next seller-of-product will give me in exchange for my money .

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    3. JP,

      Well, the government represents "everyone else", acts on their behalf, so I wouldn't separate it from "everyone else". If I've understood correctly, Tony views money as eternally circulating (old money being occasionally replaced by new money), and for him government is just a user of it once it has issued it.

      As you correctly point out, the US government is a user, and not an issuer, of Fed notes. And whatever liabilities the government/Treasury directly issues (bonds, gold certificates, U.S. Notes, etc… even coins), it mostly redeems them in Fed notes, or the electronic equivalent thereof (TGA). So, as the rules of the game currently stand, it cannot itself issue what it redeems its liabilities in. (No matter what MMT folks might say, as they try to consolidate the government and the CB.)

      I think you make a good point about redeemability/irredeemability. I just wonder if we could talk about redeemability on demand of the holder and redeemability at will of the issuer? I know many think the latter is a questionable concept, because they think of a private issuer of IOUs: it would be weird if I was able to decide when, if ever, to redeem my IOUs. But in case of the government, it’s the holder vs. “everyone else” (the latter often includes the holder as a member of the public, too). This means that the holders as a group ARE pretty much the «everyone else». The holders decide together how and when the IOUs are to be redeemed.

      What counts as a redemption? Does the government open a “redemption window” for U.S. Notes every time it decides to sell an asset, and every time it imposes taxes, duties or fines on someone? I would think so.

      You said that Federal Reserve notes are not “puttable”. But doesn’t what I said above regarding U.S. notes’ “redemption window” apply in part to Fed notes as well? Every time the Fed decides to sell an asset, Federal Reserve notes can be redeemed. Every time there are payments due on the MBSs the Fed holds, Fed notes can be redeemed (if early repayment is allowed, then the window is open all the time?).

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    4. Roger: "Assuming cash is just a product, what gives money value? I suggest that value is maintained by keeping cash in short supply."

      So if private banks entered the banknote industry, the value of banknotes would collapse to zero?

      Antti:

      " So, as the rules of the game currently stand, it cannot itself issue what it redeems its liabilities in. (No matter what MMT folks might say, as they try to consolidate the government and the CB.)"

      Agreed.

      "I just wonder if we could talk about redeemability on demand of the holder and redeemability at will of the issuer?"

      I think you make a very useful distinction.

      "...it would be weird if I was able to decide when, if ever, to redeem my IOUs."

      I'm not sure what you mean by weird. Corporations often build a call feature into their debts. It allows a firm to force investors to redeem the debts that the firm has issued. (This "callability" is the opposite of puttability). In the case of monetary instruments, banknotes are callable by their issuer. Take India, for instance, which just called in all 500 and 1000 notes.

      "But in case of the government, it’s the holder vs. “everyone else” (the latter often includes the holder as a member of the public, too). This means that the holders as a group ARE pretty much the «everyone else». The holders decide together how and when the IOUs are to be redeemed."

      Not sure I get your point.

      "You said that Federal Reserve notes are not “puttable”... Every time the Fed decides to sell an asset, Federal Reserve notes can be redeemed."

      If I was a corporation and I wanted to reduce the quantity of IOUs I have outstanding, I would either exercise the call feature I've embedded into these IOUs, forcing investors to bring them back for redemption. Or I would wade into the open market and buy them back by selling a few assets. Both methods achieve the exact same goal.

      Likewise with the Fed. When the Fed does open market sales, it is following the second path to cancelling its IOUs--wading into the open market with buybacks. Strictly speaking, it isn't calling in notes. But given that the endpoint of these two techniques is the same, we can probably take a short cut and say that in doing open market sales, the Fed is forcing the public to redeem notes.

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    5. JP,

      What I meant was that it would be weird if the holder of my IOU could never force me to redeem it (as you say, there's nothing weird in my being able to call it before original maturity date). That's kind of the case with government, and I argued that it's OK because at least in a democratic country the people, the holders of the IOUs, choose the government and can affect its actions (I'm from Finland and live now in Norway, which no doubt affects my view on government). But I think I ventured too far. What I said would probably have more relevance if we were talking about the trillion dollar coin or zero coupon perpetuals in CB books. Those don't need to be redeemed, but the government might well decide at one point that it's in the best interest of the nation/economy to redeem them.

      I'm trying hard to find something I disagree with in what you say... I don't think you really meant it that way, but when you say "the Fed is forcing the public to redeem notes", then it sounds like the public has no other option. Yet, anyone buying securities on the open market does it from free will, and most likely doesn't even know he's buying from the Fed (or doesn't care).

      There's perhaps a wider point here to be made: From an individual's perspective, Fed notes are redeemed all of the time, every time we buy stuff using them. When the Fed actually redeems the notes, I'd say the counterparty is not actively/purposefully presenting the notes for redemption. Say, when someone makes a payment on a mortgage which happens to be part of an MBS the Fed holds.

      Somewhat related to this (or not), I've always wondered how can the public be holding too much money (I think Tobin, for instance, wrote about this in his "Commercial Banks As Creators of 'Money'"). How would this excess of money manifest itself at micro level? After all, I've never heard of anyone who, having decided to sell something, has ended up with too much money. The buyer, who took the loan, wanted the money. The seller wanted the money. If he doesn't want to keep it, he can always buy something from someone who wants the money.

      I think Tobin said that if people end up with too much money, they will pay back debt and this reduces the money stock. Having lived in Norway the past seven years, I can tell you that the wealthier people get, the more they take on debt, and the more the money stock grows. I haven't heard of any contemporary economy where people would have started to pay back debt because they in aggregate held too much money (while no individual felt he had too much money).

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    6. (It wasn't Tobin, at least not in the article I mentioned.)

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