16: The Evolution of Fiduciary Media
Reminder: "fiduciary media" represent claims to a payment on demand which are not covered by a fund of money, but whose characteristics make them acceptable as a money substitute in commercial exchange.
The notion of "acceptability" merits a bit more detail: it is ultimately the willingness of the individual who accepts fiduciary media that enables it to substitute for money. Backing of a legal system may be useful in gaining assistance, but is entirely incidental.
In accounting terms, fiduciary media constitute a debt to the issuing bank, and are entered as liabilities on its balance sheet, as they represent an obligation to make payment. They may be countered by a credit when they are exchanged for cash, reduce other liabilities when used to pay a debt, or reduce equity.
The sale of fiduciary media constitute income to the bank, whereas their redemption constitute a cost. This is similar to the bank extending itself an interest-free loan, the capital for which is provided by the (original) purchasers of its fiduciary media.
Here are two ways to put fiduciary media into circulation: to issue bank notes to individuals in lieu of currency, and to provide bank notes to a mint in exchange for issuing (creating) new currency. The difference is largely inconsequential to economics.
A bit of history is given on the use of banknotes: they are largely used for small transactions as a substitute for money. In larger transactions, payment by check is preferred to payment by banknote. (EN: And to bring it up to date, the use of payment cards, credit/debit, have made banknotes and even state-issued notes less popular in even small transactions. In the present day, transactions are the result of direct electronic transfers among accounts.)
Fiduciary Media and the Clearing System
Von Mises indicates that the "banking theorists" of his day neglect the difference between money certificates and fiduciary media.
The author returns to the concept of direct barter for physical goods. If A trades cloth to B for sheep, then trades the sheep to C for a horse, his intention was clearly to obtain a horse for his cloth. A must assume the effort of coordinating these trades and accept the risk that, when he has obtained sheep to trade for the horse, that C still wants the sheep. If money is substituted for all goods in the previous example, this exchange could be facilitated and executed with greater confidence.
Another example follows of the exchange of pigs for cows, where traders must negotiate the quantities involved. A cow might be worth an odd number of pigs (2.5 - how can one trade half a pig. And if the cowherd has limited use for pigs, the swineherd may not be able to obtain a cow at all. So even in direct exchange, having a medium that can be traded for other goods, and is more readily divisible and exchangeable for a wider array of goods facilitates trade. In effect, both producers sell their produces for money to one another, effecting a more precise exchange without altering the terms of the exchange by rounding indivisible units.
Thus far, money of any kind is sufficient to facilitate trade of goods in exchange for "ready cash." But to take the previous example, what of the swineherd that has an immediate need of cows, and has only a litter of piglets to offer in exchange? An exchange can likely be effected where the cow is obtained immediately in exchange for a certain quantity of pigs when they have matured, in future.
Another example is the baker who provides bread to a cobbler for three months in exchange for a pair of shoes: this is still the immediate possession of a good in exchange for a future good If the shoes are given in advance of bread, credit is extended from cobbler to baker; if the shoes are given after three months of bread delivery, credit goes the other way.
In the absence of money, such transactions are conducted with debt: when a person obtains a good for future payment, they are in effect incurring a debt with the other party, which is cancelled upon fulfillment of the debt.
Specific to the use of fiduciary media, two parties may engage in an exchange of debts: your debt to me cancels my debt to you. And where other parties are involved, one may arrange to obtain from a third-party a debt from a party with whom you seek to trade debts.
Returning to the original cloth-sheep-horse trade, the weaver would have been as well-served to provide his cloth to the shepherd not in exchange for sheep, but a debt instrument that entitles him to obtain a horse from the horse-trader. There is no reason such trades would be unacceptable.
And when the debt is expressed in terms of money rather than physical goods, this is the exact nature of fiduciary media, and its exact value: the banker in this instance fills the role of a clearing-house for debts expressed in money, regardless of the goods of exchange in question.
The author then relates this to the difference between a "note" and a "bill" - the former being backed by goods already provided, the latter being backed by a promise to pay in future. And again, the difference is of little consequence to commercial transactions in which notes and bills are used in payment, only the acts of issuance and redemption differentiate them. Also, both notes and bills reduce the amount of hard currency in circulation.
Returning to the notion of a "clearing house," such an institution handles both notes and bills and arranges the redemption of notes and cancellation of bills, though its focus tends to be upon the bills. In effect, the clearing house sorts the intricate web of exchanges to tell each participant that "your debt to X is cancelled by the debt of Y to you," translating two (or more) exchanges to a direct exchange from X to Y.
Fiduciary Media in Domestic Trade
In the Europe of the author's time, the actual use of money for transacting exchanges had largely been replaced by the use of money substitutes, especially among business for whom exchanges were cleared by matching claim against counterclaim. This is not the case in countries and cultures where there is little confidence in the ability of a firm to meet its obligations, or little willingness upon the part of debtors to do so.
In highly developed countries, and in cultures where a promise can be relied upon, it is theoretically possible to do away with commodity money entirely and conduct exchanges based entirely on fiduciary media.
Some attention is given to the conversion of money from the silver standard to the gold, at a time in which the countries of Europe had traded away much of the domestic silver to the countries of Asia (chiefly, India and China), and the delicate balance of managing the exchange rate so that gold would have sufficient value to foreign markets to continue international trade, but no so much value as to damage domestic trade.
There is a great deal of detail here, but my sense is that the use of fiduciary media and clearinghouses n European markets meant that people (or more aptly, institutions that traded with one another in significant quantity) had little need of metal-backed currency, and as such the European governments were able to retrieve from Asia a significant quantity of silver for a modest quantity of gold and, eventually, to revert from the gold standard to the silver standard in domestic trade.
(EN: My sense is that this was very successful for Europe, but not so good for Asia. India, in particular, was once a very wealthy country with the silver it gained from centuries of spice trading, and is today a nation in desperate poverty - and my sense is that this gold-for-silver swindle may have been a significant factor in the impoverishment of India.)
Fiduciary Media in International Trade
The practice of making exchanges by trading debt ("reciprocal cancellation") is not restricted by the boundaries of state or country, though the singularity of a legal system that grants certainty to the fulfillment of debt (in effect, forcing people to make good on promises they freely made) facilitates domestic trade in fiduciary media.
The value of money substitutes in international trade facilitates commerce and eliminates, for traders, the considerable cost, time, and risk of transporting money, which constitute an even greater degree of expense and danger than in domestic trade.
Historically, there is "quite early" evidence of the use of checks, bills, and funds transfers in international trade, which eventually formed the basis of an "interlocal" clearing system as a method of settling transactions in fiduciary media across international markets, even without the presence of state government and its ability to use threat of force to ensure fulfillment of obligations.
The international giro system (i.e., the "circular" transfer of funds among financial institutions, chiefly those that exchange currencies) was a precursor to international trade in fiduciary media, though the two are of a similar nature when one considers that fiat currency is, in effect, a debt promise made by a government that issues fiat or credit currency. So, I effect, the trade of British pounds for German marks is a reciprocal cancellation of the debt instruments of the two governments.
A historical note is that post offices generally handled international currency transactions, by transmitting money orders (in much the same way as a parcel containing money would be sent) from one nation to another. In effect, the post office in Berlin would accept Marks and issue an order for a payment of Florins in Vienna, and vice versa, and the two offices would settle accounts at a later date, providing the exchange service on behalf of their customers. Ultimately, this was risk-mitigation for the postal service to avoid carrying parcels of currency from one country to another.
(EN: I've always found it curious that individuals in countries such as Scotland and Japan manage their banking affairs at the post office - but this would explain how the mail delivery system got into the banking business. In the US, the postal service still issues money orders, but is otherwise uninvolved in banking.)
The author discusses the notion of "the world bank," an business that operates independently of any given government for the sake of acting as a clearinghouse and exchange service for international trade (EN: the "world bank" today is a commercial bank in Washington DC, founded in 1944 - my sense is that Von Mises either meant a different institution, or perhaps merely a notion that would apply to whatever bank ins primarily used by parties engaging in international trade in his own time.)
Von Mises comments on proposals in his time to establish a world bank as an institution to mange international fiduciary media, and he ponders some of the ways in which such a system might be approached and governed. (EN: The establishment of the International Monetary fund by the United Nations likely makes this moot. While the primary function of the IMF to be balancing international exchange rates, I suspect it is involved in fiduciary media as well.)
It's suggested that if the balances of the books of the world bank were to be acquired only by the cash payment of the full some of money, and that if this bank were to restrict itself to issuing notes, it would have the potential to completely eliminate the need to transport large amounts of physical cash among nations. In effect, the acceptance of a world bank could for an international economic union independent of state governments, providing its own notes as a single form of currency that is acceptable in any world market.
And this is precisely the reason that states are opposed to the notion of participating in a world bank: to relinquish their ability to control the value of state currency as a means of power (over its own citizens, and to seize the assets of foreign nationals and other governments in time of war) in an age of "irreconcilable antagonism" among nations.
It is suggested, however, that a world-banking system that deal entirely in fiduciary media would be less of a threat to the power of nations, and could well be implemented for the purpose of exchange by debt-cancellation while attracting "hardly any notice" from national governments.