Money Certificates

1. Certificates Physically Integrated with Money

The precious metals would have become monies even if coinage had never been invented, because even in the form of bullion their physical advantages outweigh those of all alternatives. There is however no doubt that coinage added to the benefits derived from indirect exchange, and that it therefore contributed to the spreading of monetary exchanges. Coinage allows the exchange of precious metals without engaging in the labor-intensive processes of weighing the metal and melting it down. One can determine a metal weight by simply counting the coins.^[1]

Coinage endows a mass of precious metal with an imprint that certifies its weight. The typical imprint says something to the effect that the coin weighs a total of so and so many grams or ounces (gross weight), with this or that proportion or absolute content of precious metal (fine weight). This is why coin names were typically the names of weights, for example, the pound, the mark, the franc, or the ecu.

Notice that the service depends entirely on the trustworthiness of the certifier, that is, of the minter. If the market participants cannot trust the certificate, they will rather do without the coin and go through the extra trouble of weighing the metal and possibly melting it down to determine its content of fine metal. A trustworthy coin economizes on this trouble and thus adds to the value of the bullion contained in the coin; for example, a trustworthy 1-ounce silver coin is more valuable than 1 ounce of silver bullion.^[2] People therefore pay higher prices for coins than for bullion, and the minter lives off this price margin.^[3]

Because the value of the certificate depends on the trustworthiness of the minter, coins are typically used within limited geographical areas. Only the people who know the minter are likely to accept his coins. All others will insist on being paid in bullion or in coins they trust. This does not mean that in practice every village needs a different set of coins. The geographical radius within which a coin is used can grow very large and it can even become world encompassing if the minter has an excellent reputation. This was for example the case with the Mexican dollar coins that in the early nineteenth century circulated freely in most parts of the U.S. and which have bequeathed their name to the present-day currency of this country.

Historically, minters have offered additional services that complement the certification of weights. Thus one of the perennial problems of coining precious metals is that used coins might contain a smaller quantity of precious metal than freshly minted coins. If this happens, people are inclined to hold back the good coins for themselves and to trade only the bad coins. To overcome this problem, minters could offer their coins in combination with an insurance service: they could offer to exchange any slightly used coin against a new one. This policy would guarantee the stability and homogeneity of the coinage through time. Thus the insured coins would trade at even higher prices, from which price differential (the premium) the replacement expenses can be paid.

A great number of monetary thinkers from the Middle Ages to our times have held that coinage should be entrusted to the princes or governments, who, because they were the natural leaders of society, were also the people to be naturally trusted. The medieval scholastics knew full well that the princes frequently abused this trust, placing for example an imprint of “one ounce” on a coin that contained merely half an ounce, pocketing the other half of an ounce for themselves. Therefore Nicholas Oresme postulated that the princes did not have the right to alter the coins at all, unless they had the consent of the entire community, that is, the entire community of money users.

Economic science has put us in a position to understand that competitive coinage is an even better way of preserving the trustworthiness of coins. There is no economic reason not to allow every private citizen to enter the minting business and to offer his own coins. It is true that a private minter too might abuse the trust his customers put in him and his coins. But punishment is immediate: he will lose all these customers. People will start using other coins issued by people they have reason to trust more. In a way, this competitive process also fulfills Oresme’s postulate that the entire community of money users decide about coinage. He held that “money is the property of the commonwealth.”^[4] On a free market, the money owners can assert this property right smoothly and swiftly. Each person who no longer trusts the minter A simply stops using A’s coins and begins to use the coins of minter B. Thus he leaves the A community and joins the B community.

Competition in coinage is no panacea. Abuses are always possible and in many cases they cannot easily be repaired. The virtue of competition is that it offers the prospect of minimizing the scope of possible abuses. And its great charm is that it involves the entire community of money users, not just some appointed or self-appointed office holders. Down here on earth this seems to be all we can hope for.

2. Certificates Physically Disconnected from Money

If certificates may add to the value of bullion then certificates may have a value on their own. Therefore they can also be traded without being physically integrated with the precious metal of which they certify the quantity. Then they are money substitutes.

Issuing such money substitutes was the generally accepted practice in the cities of Amsterdam and Hamburg for almost two centuries. The Bank of Amsterdam (established in 1609) issued paper notes that certified that the holder of the note was the legal owner of so-and-so much fine silver deposited in the vaults of the bank. These banknotes could be redeemed any time at the counters of the Bank, on the simple demand of the present owner.^[5] As a consequence, they were traded in lieu of the silver itself. Rather than exchanging physical silver, people made their purchases with the banknotes that certified ownership of a sum of silver deposited at the Bank.

Apart from paper notes, the main types of such substitutes are token coins, certificates of deposit, checking accounts, credit cards, and electronic bank accounts on the Internet. Despite the physical variety of these types, each of them features three fundamental characteristics: intermediation, titles, and the holding of “reserves.”^[6]

Certification in the present case is not as integral as in the case of imprints that are struck in to the money material itself—the regular coins that we discussed above. Rather, the money substitute relates to a quantity of money that is removed from the eyes of the partners to the exchange. The money itself is held at some other place, namely, at the bank or treasury department or whichever other organization has issued the certificate. Thus there is in the present case not only monetary intermediation in the weak sense that a third party certifies quantities of money exchanged by the other two parties; but also in the strong sense that this third party actually physically controls the money at the time of the exchange.

Furthermore, money substitutes do not merely certify the physical existence of a certain amount of precious metal; they are also a legal title to that amount. The rightful owner of a one-ounce-of-silver banknote, for example, is the rightful owner of one ounce of silver deposited in the vaults of the institution that issued the banknote.

Finally, the money supplies held by the issuer of the substitutes are called the “reserves.” This terminology is established in economic science, but it should be used with some caution. Many students of money and banking believe that certificates such as book entries in bank accounts are the real monies, because they are actually used in daily exchanges, whereas the money held by the institutions that make the account entries are just the reserves. But the truth is quite different. In all such cases, the so-called reserves are in fact the real money, whereas the account entries are only money substitutes.^[7]

What are the advantages and disadvantages of certificates disconnected from the money itself? The main advantage is that the costs of storage, transportation, and certification (minting) can be reduced. The main disadvantage is that the potential for abuse is greater than in the case of coinage. Fraudulent bankers can embezzle on the property of their customers far more easily than fraudulent minters. A look at the history of institutions reveals that this temptation was virtually impossible to resist, especially when certification was not competitive. In the case of the Bank of Hamburg it took almost 150 years before abuse set in (at any rate, before it became manifest). Other bankers fell from grace much more quickly. For example, the goldsmiths who in the mid-1600s had taken over the certification business in the city of London, after the English king had robbed the gold deposited in the Tower, very soon started using the deposits in their lending operations. Thus they turned themselves into “fractional-reserve bankers,” meaning that only a part (a fraction) of their issue was covered by underlying money reserves.

In short, the potential abuse of substitutes is a very considerable disadvantage. One may therefore justly doubt that on a free market they could have gained any larger circulation. Even David Ricardo, the great champion of paper currency, admitted that it was unlikely that such substitutes could withstand the competition of coins. The only sure way to bring paper notes into circulation was to impose them on the citizenry: “If those who use one and two, and even five pound notes, should have the option of using guineas, there can be little doubt which they would prefer.”^[8]

But our point is not to speculate about the significance that paper certificates would have on the free market. We merely wish to point out that paper certificates and token coins might conceivably play a role here, and that they have been used very widely in the past, though very often under some sort of imposition. In a free society, the market participants would constantly weigh the advantages and disadvantages of the various certification products. It is true that they would not be able to prevent all abuses. But again, the point is that a competitive system minimizes the possible damage.