Currency Hierarchy
Eric Tymoigne
Associate Professor of Economics at Lewis & Clark College
Research Associate at the Levy Economics Institute of Bard College
Monetary Policy Institute Blog #148
“The larger the network of debtors that owe an issuer of monetary instruments, the broader the area of acceptance of its monetary instruments …
The ability of debtors to pay the issuers, depends on their ability to access the monetary instruments accepted by the issuers has means of payment. If in short supply, the monetary instrument may trade at a premium.”
In Stabilizing and Unstable Economy, Minsky noted that “[a]n economy has a number of different types of money: everyone can create money; the problem is to get it accepted” (p. 228). While governments and banks usually get the spotlight, tens of thousands of monetary instruments have been issued by localities, ecclesiastic domains, local seigneurs, taverns and other private agents in many periods of monetary history, worldwide, up to the present [see Burn (1853); von Glahn (1996); Fletcher (2003); Blanc (2017)]. All these instruments are part of a “hierarchy of money” (Bell, 2001), “debt pyramid” (Olivecrona, 1957), “pyramid of credit” (Murad, 1954), or “scale of credit” (Wilson, 1811); a concept used to categorize the variety of monetary instruments available in a given area common to all of them, and the extent of the operation of a payment system and its integration within other, usually broader, payment systems. While the given common area is often the domestic economy, the international scale can also be considered (see de Conti et al., 2013; Palludeto and Abouchedid, 2016).
At the top of the pyramid are monetary instruments with the widest acceptance, circulating at parity over the whole considered area. These monetary instruments are unconvertible. Below them are instruments that circulate less widely and may be convertible into the top monetary instruments. Under this second layer are monetary instruments that circulate at par over an even narrower subspace of the given area, and that may be convertible into the top- or second-layer instruments.
Over space and time, the instruments in the different layers change. In modern times, unconvertible domestic government monetary instruments are at the top of the pyramid of many national economies. If the domestic government currency is convertible into a foreign government monetary instrument, the latter is at the top. Countries that fully dollarized do not have any domestic government monetary instruments. Below are instruments issued by private banks, which are convertible into the top instrument. Below bank monetary instruments are non-bank instruments whose acceptance dwindles as the extent of the financial operations of the issuer narrows and its creditworthiness falls; complementary currencies may circulate in sub-regions of a national economy.
In the past, government monetary instruments were not necessarily at the top. The purpose of the creation of the Bank of England was to provide William III with the backing of merchants’s creditworthiness (whose bills circulated widely close to par or even at par despite a positive tenue) for the issuance of paper notes and accounts. The area of acceptance at par of a specific bank monetary instrument used to vary depending on the scale of its business activity in the domestic economy. “A first class banker in a city like 3 London or New York may be worth to a provincial banker somewhat more than his own money” (Innes, 1914, p. 154). Hawtrey (1919, p. 31) concludes that “if the banker fails, [its] note ceases to be worth its face value.” Government guarantees of par convertibility among all bank monetary instruments — so that “Bank of America ‘money’ is convertible into Citicorp ‘money’” at par on demand (Minsky, 1985, p. 16) — government resolution mechanisms put in place to deal with insolvent banks, as well as the integration of banking payment systems with the government payment system (Knapp, 1905), have standardized bank monetary instruments so they all trade at par with each other over the entire domestic economy.
The position of a monetary instrument in the hierarchy is determined by its degree of liquidity within the considered area, with liquidity defined by the stability of the nominal value of a monetary instrument. This liquidity depends on the existence of issuance and reflux mechanism that ensure an elastic supply of the monetary instrument exists to maintain the trading of a monetary instrument at parity overtime. Regarding reflux (i.e. the return of a monetary instrument to its issuer), a core determinant of that degree of liquidity is the ability to the issuer to “acquire credit” (Innes, 1913, p. 393), “to force cash flows” (Minsky, 1986, p. 71) from others. The issuer’s creditworthiness is a key determinant of acceptance, which depends on the ability and willingness of the issuer to make its monetary instruments reflux. As such, political power (like the ability to impose and collect tribute or tax debts) and economic power (the size of reserves if conversion is possible, or the ability to collect on bank debts) influence the place in the hierarchy. Such powers, in turn, depend on political capital, efficiency of debt collection, economic attractiveness of a country (and 4 so the scope of economic units willingly to become indebted to domestic banks), among other socio-politico-economic factors that influence monetary dynamics.
The larger the network of debtors that owe an issuer of monetary instruments, the broader the area of acceptance of its monetary instruments. “In modern capitalist system money is a debt of banks or of Treasuries and the value of money is maintained because of the need to make payments to banks and Treasuries by debtors and taxpayers” (Minsky, 1985a, p. 4). The ability of debtors to pay the issuers, depends on their ability to access the monetary instruments accepted by the issuers has means of payment. If in short supply, the monetary instrument may trade at a premium.
Works appearing in this blog with no hyperlinks:
Murad Olivecrona, K. (1957), The Problem of the Monetary Unit, New York: The Macmillan Company.
Wilson, G. (1811), Defence of Abstract Currencies, London: John Murray.
