The first ICO, or “unstable coin” as it might well have been called

In her excellent book Stuff and Money in the Time of the French Revolution, Rebecca Spang cautions against using the story of the attempted reinvention of money following the French Revolution as part of a superficial “transition to capitalism” narrative, but as a non-historian it did seem to me that there is something for today in comparing the evolution of money in industrialising Britain and the evolution of money in revolutionary France. To me, it is a contrast between British mercantile pragmatism to exploit bottom-up innovation with French idealism and top-down change, which is why I included a discussion of the assignats in my book “Before Babylon, Beyond Bitcoin”. All of which explains why I was intrigued by Tuur Demeester’s reference to assignats as the “first ICO”.


Now, in this context, I would probably have awarded the title of first ICO to John Law’s notorious Banque Royal (see “The Mississippi Bubble) but Tuur makes in interesting point which is worth reflection. How did the assignats come about?

In pre-revolutionary France it was the monarch’s prerogative to set the exchange rate between the money of account (livre) and the money of reckoning (the coins, such as the ecus). Rebecca notes that in the last 26 years of Louis XIV’s reign, this exchange rate changed 43 times! There was actually very little of this money out in the real economy because pre-revolutionary France was, as pre-industrial England had been, a reputation economy. The great majority of the population engaged in commercial activities with well-known and trusted counterparties. Buying and selling was done “on tick” as people maintained a web of credit relationships for periodic reckoning.

In an economy based on trust and once that trust fails (or fails to scale), the substitute of money is required to oil the wheels of commerce. This is exactly what happened in France where after the revolutio, a lack of trust in the state quickly became a shortage of credit in the marketplace and therefore an immediate demand for a circulating medium of exchange.

But from where? France did not have a central bank along the lines of the Bank of England, so one of the first acts of the new revolutionary government was to take over Church lands and use them as security to issue interest-bearing bonds with the redemption in portion of the land itself. Were the blockchain available to them, I am certain that Robespierre and the other would have certainly gone down the Venezuelan route and gone with an ERC-20 token in an ICO, but they were restricted to the technology of the time and thus the paper assignats were created.

They didn’t last that long. The interest and redemption were soon abandoned and the notes, the assignats, simply became state-issued inconvertible fiduciary notes. There followed what Professor Glynn Davies called in his magisterial History of Money from Ancient Times to the Present Day “the usual consequences”: inflation, dual-pricing (with note payers forced to give more than coin payers), hoarding and (Gresham’s Law again) the practical disappearance of coins as capital fled across international borders. By October 1795, 100 Franc assignats could be traded for only 15 sous in coin and the Paris riots of the time opened the door for Napoleon. It wasn’t until the Bank of France was founded in 1800 that the nation at last enjoyed the same kind of public institution that England, Holland and Sweden had had for more than a century.

There seems to me a useful comparison to made between those revolutionary times and ours. If we expect the state to come up with some grand plan to reinvent a money de nos jours, we run the risk of it going hopelessly wrong. If we leave a regulatory space for the merchants to play in, they may well come up a better idea.

Why am I so interested in these long-gone Latin precursors of the Euro? Well, Rebecca notes that when the assignats wentinto circulation, people treated the new paper currency as the bills of exchange that they were familiar with. They did not value the anonymity of the notes at all. In fact, they signed them as they passed them around. Who had used a note attested to its validity and the identity of the previous holders gave the notes value! A note signed by a trustworthy person such as Joanna Lumley or Sergio Aquero would be worth more than one signed by me, for example. For the citizens, fungibility was not all that.

Or, to look at it from a modern perspective, the new money was identity.

Show me the money

In 2016, the latest year for which information is available, cash was used for 44% of all consumer transactions in the UK. That was down from 50% the previous year and from 68% a decade earlier. Victoria Cleland, Chief Cashier at the Bank of England says that the value of notes “in circulation” has been increasing year on year for the past decade or so and that “we are still seeing growth in total demand for cash.”

What on Earth are these notes being used for if they aren’t being used to buy things? This isn’t a UK problem. The latest figures from the Bundesbank show that nine out of every ten euro banknotes issued in Germany are never used in payments but hoarded at home and abroad as a store of value, the Bundesbank has found. Not “rarely”. Not “infrequently”. Never. The notes are not in circulation at all but are stuffed under mattresses.

Down under, the Reserve Bank of Australia (RBA) Bulletin for September 2017 notes that the value of notes “in circulation” has gone up 6% per annum for the past decade while the use of has collapsed (from two-thirds of consumers payments down to one-third) over the same period. It goes on to note that higher cash usage may be concentrated in groups not included in the survey of consumers (who may well use cash more often than the average consumer) as well as the shadow economy.

Aha. The shadow economy.

A couple of years ago I was at an event where the Chief Cashier said that only about a quarter of the cash the Bank put’s into circulation is for “transactional purposes” (i.e., used). They have a richer categorisation than the Bundesbank for the rest of it, saying that it is either shipped overseas (i.e., exported), kept outside of the banking system (i.e., hoarded) or used to support the shadow economy (i.e., stashed).

Aha. Stashed.

I wrote a comment piece on this for The Guardian, looking at what the key drivers in each of them might be. The first, cash that is used, is easy. We know that the driver is technology but that the impact is weak. In other words, new technology does reduce the amount of cash in circulation, but very slowly.  Moving on to the next category, I know it’s a rather simplistic analysis, but if the amount of cash that is being hoarded has been growing then that would tend to indicate that people have lost confidence in formal financial services or are happy to have loss, theft and inflation eat away their store of value while forgoing the safety and security of bank deposits irrespective of the value of the interest paid. If, on the other hand the amount of cash that is being stashed has been growing then the Bank of England is facilitating an increasing tax gap that the rest of us are having to pay for. In this context cash is a mechanism for greatly reducing the cost of criminality while it remains a penalty on the poor who have to shoulder an unfair proportion of the cost of cash. In this case, we should expect to see a strategy to change this obviously suboptimal element of policy.

The amount of cash that is being exported is hard to calculate, although the Bank itself does comment that the £50 note (which makes up a fifth of the cash out there by value) is “primarily demanded by foreign exchange wholesalers abroad”. I suppose some of this may be transactional use for tourists and business people coming to the UK, and I suppose some of it may be hoarded, but surely the strong suspicion must be that these notes are going into stashes. Note “primarily”. 

My personal feeling is that stashes have grown at the expense of hoards. In a fascinating paper by Prof. Charles Goodhart (London School of Economics) and Jonathan Ashworth (UK economist at Morgan Stanley), they note that the ratio of currency to GDP in the UK has been rising and argue that the rapid growth in the shadow economy has been a key cause. If you look at the detailed figures, you can see that there was a jump in cash held outside of banks around about the time of the Northern Rock affair, but as public confidence in the banks was restored fairly quickly and the impact of low interest rates on hoarding behaviour seems pretty marginal, there must be some other explanation as to why the amount of cash out there kept rising. Two rather obvious factors that do seem to support the shape of the curve are the increase in VAT to 20% and the continuing rise in self-employment (this came up a couple of times in comments to The Guardian piece), both of which serve to reinforce the contribution of cash to the shadow economy.

There are a awful lot of people not paying tax and simple calculations will show that the tax gap that can be attributed to cash is vastly greater than the seigniorage earned by the Bank on the note issue. Cash makes the government (i.e. us) considerably worse off. In summary, I think think the Bank’s view on hoarding is generous and that it is the shadow economy fuelling the growth in cash “in circulation”. There’s something wrong about this, especially when we know that the cost of cash falls unfairly on the poor. It is time for Bank of England to develop an active strategy to start reducing the amount of cash in circulation, beginning with £50 notes.

China’s eight centuries of experiment with paper money is coming to a close

The Chinese were first with the great transition from commodity money to paper money. They had the necessary technologies (you can’t have paper money without paper and you can’t do it at scale without printing) and, more importantly, they had the bureaucracy. In 1260, the new Emporer Kublai Khan  determined that it was a burden on commerce and drag on taxation to have all sorts of currencies in use, ranging from copper coins to iron bars, to pearls to salt to gold and silver, so he decided to implement a new currency. The Khan decided to replace metal, commodities, precious jewels and specie with a paper currency. A paper currency! Imagine how crazy that must have sounded! Replacing actual stuff with apparently worthless paper! It’ll never work!

Crazy or not, it worked and just as Marco Polo and other medieval travellers returned along the Silk Road breathless with astonishing tales of paper money, so modern commentators (e.g., me) are tumbling off of flights from Shanghai with equally astonishing tales of a land of mobile payments, where paper money is vanishing and consumers pay for everything with smartphones. China is well on the way to becoming a cashless society, with the end of paper money in sight. Something like one-seventh of China’s population relies on mobile payments to get around, carrying no cash, according to a survey conducted by Renmin University of China. The natural step from there is to create digital currency so that settlement is in central bank money and there are no credit risks.

This thinking has been evolving for some time. Back in 2016, the Governor of the People’s Bank of China (PBOC), Zhou Xiaochuan, set out the Bank’s thinking about digital currency, saying that it is an irresistible trend that paper money will be replaced by new products and new technologies. He went on to say that as a legal tender, digital currency should be controlled by the central bank and after noting that he thought it would take a decade or so for digital currency to completely replace cash in China, he went to state clearly that the bank was working out “how to gradually phase out paper money”. Rather than simply let the cashless society happen, which may not led to the optimum implementation for society, they were developing a plan for a cashless society.

As I have written before, I don’t think a “cashless society” means a society in which notes and coins are outlawed, but a society in which they are irrelevant. Under this definition the PBOC could easily achieve this goal for China. But should they do this? Yao Qian, from the PBOC technology department wrote on the subject in 2017, saying that to “offset the shock” to commercial banks that would come from introducing an independent digital currency system (and to protect the investment made by commercial banks on infrastructure), it would be possible to “incorporate digital currency wallet attributes into the existing commercial bank account system” so that electronic currency and digital currency are managed under the same account.

This rationale is clear and, well, rational. The Chinese central bank wants the efficiencies that come from having a digital currency but also understands the implications of removing the exorbitant privilege of money creation from the commercial banks. If the commercial banks cannot create money by creating credit, then they can only provide loans from their deposits. Imagine if Bitcoin were the only currency in the world: I’d still need to borrow a few of them to buy a new car, but since Barclays can’t create Bitcoins they can only lend me Bitcoins that they have taken in deposit from other people. Fair enough. But here, as in so many other things, China is a window into the future, because Alipay, WeChat Wallet and other Chinese third party payment platforms use financial incentives to encourage users to take money out of their bank accounts and store it on their platforms. If commercial banks cannot fund loans from deposits, we are in a new place, economically speaking.

Thus you can see the potential problem with digital currency created by the central bank, even if it is now technologically feasible for them to do so. If commercial banks lose both deposits and the privilege of creating money, then their functionality and role in the economy is much reduced. Whether you think that is a good idea or not, you can see that it’s a big step to take. Hence the PBOC position, reinforced at the beginning of this year by Fan Yifei, Deputy Governor of the People’s Bank of China writing that the PBOC digital currency should adopt a “double-tier delivery system”.

Following this line of thinking, then, the PBOC is saying that it is not going to issue cryptocurrency and that it is not going to issue digital currency either (at least in the foreseeable future). But what they might do is to allow commercial banks to distribute digital currency under central bank control (this what they mean by “double tier”. You could have the central bank provide commercial banks with some sort of tamper-resistant smart chip or cryptographic permission that would create digital commercial bank money under the control of the central bank. (This, by the way, is exactly what was attempted a generation ago with the Mondex electronic cash system.)

(Note that this is entirely removed from the issue of whether to use shared ledger technology to manage the money in circulation. I’m open minded about this. I can certainly see how a system in which POS terminals were nodes in a shared ledger, thus obviating the need for a central system — that could, and does, go down — might be rather attractive but whether the resilience would be worth the expense of moving away from current solutions remains to be established.)

Not also that there is no implication in any of the PBOC’s comments that they will be issuing digital cash. Would any central bank go for this? Some form of digital cash that can be passed directly from person to person like Bitcoin rather than some form of digital money like M-PESA, using hardware rather than proof-of-work to prevent double spending? Well… yes. In fact the Uruguayan central bank has said it will test precisely this approach, having digital cash in the mobile phones pass person-to-person directly between the devices. This is not, I am sure, what the PBOC has in mind. On the contrary, the want to see every transaction, and consistent position adumbrated by last year’s decision to make mobile payment companies route transactions through a central switch.

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I’m fascinated by China’s long experiment with paper money and its imminent conclusion. Whatever you might think about their position on monitoring transactions, the PBOC has been strategic in its thinking.  Their comments on the topic from 2016, 2017 and now 2018 have been consistent. Digital currency is coming and China will take the lead just as it did with paper currency.