The unbanked, the post office, and fintech in the 1880s

"A large population of people are excluded from the financial system because they don't have bank accounts. Fintechs compete to connect them and parallel plans emanate from the government to reach the unbanked, including postal banking."

What year am I describing in the above paragraph? 

It could be 2021. But it also describes 1870s. 

It's 2021 and the U.S. still has a large population of unbanked, those who have so little money that banks would rather not serve them. An astonishing 5.4% of Americans—that's 7.1 million households—do not have bank accounts.

Financial technology companies (aka fintechs) like PayPal and Facebook's Libra have well-meaning plans to connect the American unbanked population. Government-run proposals abound too. Postal banking is probably the most popular option, but more exotic solutions like central bank digital currency (CBDC) have also been floated. But many economists are wary that these government efforts will cripple the private sector.

None of this is new. Concerns over the unbanked, fintech, and a government participation in the payment system were all present back in England in the 1880s. Since I enjoy when the past resurfaces in the present, I'll tell the story.

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Britain in the 1870s had a very sophisticated chequing system. Because banks were the only way for people to access cheques, and banks preferred to limit accounts to rich people and wealthy merchants, the poor and middle class were often left out. 

Luckily, the 1870s version of fintech came to the rescue. The PayPal of the day was something called the Cheque Bank. Established in 1873, the Cheque Bank—like PayPal today—was a bank-on-top-of-a- bank. What do I mean by this?

PayPal is a customer of Wells Fargo, a large commercial bank. Wells Fargo provides PayPal with banking and payments services. PayPal in turn passes these services on to PayPal account holders, folks who might not otherwise qualify as customers of Wells Fargo or, if they could, prefer the way PayPal rebundles underlying Wells Fargo services.

Stock certificate for the Cheque Bank, Limited

The Cheque Bank operated on the same principles. It opened accounts at bank branches all across United Kingdom and overseas. Like PayPal, it passed through underlying banking services to its unbanked customers. The Cheque Bank's main product was cheques, which today might seem quaint. But back then they were cutting edge.

Anyone could buy a book of Cheque Bank cheques at a stationer or cigar store, the Cheque Bank redepositing the cash it received with its bankers. The customer could then spend those cheques at stores, send them to family via the mail, or hold them as a form of saving in lieu of cash (which was always at risk of being stolen). People who accepted a Cheque Bank cheque as payment could promptly take the document to any bank and cash it.

Much like PayPal does today, the Cheque Bank held 100% reserves. That is, for every $1 in cheques it issued, it kept $1 locked up with its bankers. And so its cheques were considered to be as safe as cash. Put differently, regular banks engage in both lending and payments. But fintechs like PayPal and the Cheque Bank don't lend at all. They deposit all of their assets at an underlying bank and focus on offering the payments side of the banking business to their customers.

The Cheque Bank attracted the attention of William Stanley Jevons, one of the most important economists of the day and still very much a household name among economists today. Jevons was one of three economists (along with Carl Menger and Leon Walras) to discover the principle of marginal utility, a key economic principal which had eluded even Adam Smith. 

In his 1875 book Money and the Mechanism of Exchange, Jevons devotes a full chapter to the Cheque Bank, describing it as a "very ingenious attempt" to "extend the area of banking to the masses." Here is what one of the Cheque Bank's cheques looks like:

1899 cheque issued by the Cheque Bank [source]

The cheques could only be filled to an amount printed on the document, writes Jevons. So the above cheque, which had been purchased for £5, could be written out for anything up to £5, although in this particular case the cheque writer (H.L. Stevens) chose the sum of 3 pounds 3 shillings. 

Jevons isn't the only notable economist to write about the Cheque Bank. It also pops up over a hundred years later in economist Edward S. Prescott's work, who describes it as a "highly interesting experiment in extending the use of checks to the lower and middle classes." Prescott suggests that the ability to write a specific amount on the face of one of these cheques would have greatly facilitated payments through the postal service since there was no need for change. Unlike a regular cheque, which also offered this flexibility, the recipient of one of the Cheque Bank's cheques needn't worry about it bouncing.

Jevons was excited by the Cheque Bank. But he was not a fan of a subsequent competing payments innovation, the postal order.

The British Post Office, owned by the government, had long been engaged in the business of transmitting money orders, unofficially since 1792 and officially since 1838. A customer would walk into any money order office, put down, say, £2 and 2 shillings, and get a £2 2s money order. The recipient's name was then written on the order. It could then be sent via post to a distant office, upon which the recipient could take the money order to the counter to be cashed. The officer would first confirm the payment by referring to a separate letter of advice. This letter, sent from post office to post office, served an an extra layer of security against fraud. Only then would the £2 and 2 shillings be paid out.

The problem, according to then Postmaster General Henry Fawcett, is that the money order wasn't very useful to people who only wanted to send small amounts. "If a boy wanted to send his mother the first shilling he had saved, he would have to pay twopence for the order and a penny for postage," wrote Fawcett. In other words, to send a 12 penny (i.e. one shilling) money order, three pennies—a massive 25%—had to be sacrificed in fees. (A shilling in 1880 was worth around US$8 today.) And so it would have been an expensive payments option for the poor.

Prior to his appointment as Postmaster General in 1880, Fawcett had been both parliamentarian and the first professor of political economy at Cambridge. And while he wasn't as illustrious an economist as Jevons (he hasn't left us any bits of economic theory), Fawcett did write what was one of the popular textbooks of the day.

But if Fawcett wasn't going to change the study of economics, he did intend to change the payments system. As Postmaster General, Fawcett proposed complementing the money order with a new product called a postal note, or postal order. (The postal order had been earlier conceived of by George Chetwynd, the Receiver and Accountant General of the Post office). Like the cheques issued by the Cheque Bank founded just seven years before, postal orders would have a fixed denomination printed on them. These increments were to start at 1 shilling and go up to 20 shillings (US$8 to US$160 in 2019 dollars).

By contrast the post office's traditional payment product, the money order, was open-faced and had no denomination. Because postal orders would be issued in smaller amounts, the Post Office needn't bother sending separate letters of advice as a security measure, which meant that they would be far cheaper to process. And so the fees could be lower for postal orders than money orders, broadening the pool of customers.

In an 1880 essay, William Stanley Jevons blasted the idea of postal orders, which hadn't yet received legislative assent. Singling out Fawcett, Jevons wrote:

"The fact of course is that not only from the time of Adam Smith, but from a much earlier date, it has always been recognized that a Government is not really a suitable body to enter upon the business of banking. It is with regret that we must see in this year 1880 the names of so great a financier as Mr. Gladstone, and so sound an economist as Professor Fawcett, given to schemes which are radically vicious and opposed to the teachings of economic science and economic experience."

So that lays out the cast of characters in 1880. It includes exclusionary banks, hoards of unbanked, a set of opposed economists in Jevons and Fawcett, fintechs like the Cheque Bank, and a post office on the verge of issuing a novel product; postal orders.

2020 seems very much like 1880. To help connect the large population of American unbanked to the financial system, a number of modern day Fawcetts (Morgan Ricks, Mehrsa Baradaran, Rohan Grey) have floated public payments solutions including a return of postal banking, central bank digital currency (CBDC), or central bank-accounts-for-all.

Our modern day equivalents to the Cheque Bank includes non-banks such as prepaid debit card issuers Walmart and Netspend, both of which are trying to reach unbanked Americans. Online wallet companies like PayPal and Chime are also in the mix. And stablecoin issuers such as Facebook's upcoming Libra project talk a big game when it comes to financial inclusion. To round things out you've got your modern day Jevonses; economists who don't buy the idea that the government should get into banking (Larry White, George Selgin, Diego Zuluaga).

So how did things end up in 1880? Despite opposition from Jevons and the Economist, Fawcett's postal order dream came to fruition. After receiving legislative approval, the world's first postal orders were issued in 1881:

The world's first postal order was issued in 1881 by the British Post Office. The fee of a halfpenny on a one shilling postal order (~4%) was less than two pennies for a regular money order, which meant the not-so-wealthy could finally afford to make small remote payments. pic.twitter.com/KpbyoY0uHj

— John Paul Koning (@jp_koning) December 30, 2020

Postal orders would go on to become very popular. They largely displaced money orders, except for large amounts. Other postal systems including that of New Zealand, Canada, Australia, and the U.S. would go on to copy the idea. The UK's modern day incarnation of the post, the Post Office, still offers a version of the product.

And what about the Cheque Bank? Digging through old documents, Edward Prescott discovered that the Cheque Bank failed in the late 1890s. According to liquidation proceedings reported in the Banker’s Magazine, it was plagued by forgery problems and increased competition for less wealthy depositors from banks. Perhaps the emergence of the postal order also played a part.

I'm not invoking the 1880s as a prediction of what will occur in the 2020s. Rather, it fascinates me because it reveals how old these payments dilemmas are. The same tensions between public and private payments were present then as they are now. And it's also interesting to see how economists have always been engaged in questions of financial inclusion. Not just Fawcett but Jevons too, who we know primarily for his work on monetary theory. 

And over a hundred years later, Edward Prescott delved into the topic, too. In a 1999 paper (which mentions the Cheque Bank), Prescott discusses the idea of opening up an inexpensive type of bank account called an Electronic Transfer Account (ETA) so that all Americans, particularly the unbanked, might receive Federal benefit payments digitally. (Prescott was skeptical that ETAs might work out. The program, introduced in 1999, was discontinued in 2018 and has been replaced with a prepaid debit card program.)

In closing, the topic of how to help the unbanked is a complicated one with many moving parts. Which is why we should explore how things played out in different times. Perhaps history can get us to see the debate in a new light.

Merry Christmas and a Happy New Year!

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P.S. If you're interested in learning more about Jevons's thinking on payments, he was a big champion of the idea of creating an international coin standard. I wrote about it here. Think of it as a proto-version of the Euro. Jevons came up with a "tidy English solution" for fitting Britain into this proposed international coin union. The project never came to fruition.

Esperanto, money's interval of certainty, and how this applies to Facebook's Libra

Facebook recently announced a new cryptocurrency, Libra. I had earlier speculated about what a Facebook cryptocurrency might look like here for Breakermag.

I think this is great news. MasterCard, Visa, and the various national banking systems (many of which are oligopolies) need more competition. With a big player like Facebook entering the market, prices should fall and service improve, making consumers better off.

The most interesting thing to me about Facebook's move into payments is that rather than indexing Libras to an existing unit of account, the system will be based on an entirely new unit of account. When you owe your friend 5 Libras, or ≋5, that will be different from owing her $5 or ¥5 or £5.  Here is what the white paper has to say:

"As the value of Libra is effectively linked to a basket of fiat currencies, from the point of view of any specific currency, there will be fluctuations in the value of Libra."

So Libra will not just be a new way to pay, but also a new monetary measurement. Given how Facebook describes it in the brief quotation provided, the Libra unit will be similar to other unit of account baskets like the IMF's special drawing right (SDR), the Asian Monetary Unit (AMU), or the European Currency Unit (ECU), the predecessor to the euro. Each of these units is a "cocktail" of other currency units.

Facebook's decision to build its payments network on top of a new unit of account is very ambitious, perhaps overly so. When fintechs or banks introduce new media of exchange or payments systems, they invariably piggy back off of the existing national units of account. For instance, when PayPal debuted in 2001, it didn't set up a new unit called PayPalios. It used the dollar (and for the other nations in which is is active, it used the local unit of account). M-Pesa didn't set up a new unit of account called Pesas. It indexed M-Pesa to the Kenyan shilling.

I couldn't find a good explanation for why Facebook wants to take its own route. But I suspect it might have something to do with the goal of providing a universal monetary unit, one that allows Facebook users around the globe to avoid all the hassles of exchange fluctuations and conversions.

Global monetary harmony an old dream. In the mid 1800s, a bunch of economists, including William Stanley Jevons, tried to get the world to adopt the French 5-franc coin as a universal coinage standard. Jevons pointed out that the world already had international copyright, extradition, maritime codes of signals, postal conventions—so why not international money too? He wrote of the "immense good" that would arise when people could understand all "statements of accounts, prices, and statistics." It would no longer be necessary to employ a skilled class of foreign exchange specialists to take on the "perplexing" task of converting from one money to the other.

But the plan to introduce international money never worked out. (I wrote about this episode for Bullionstar).

Global money like Libra might seem like a great idea. But ultimately, I suspect that the decision to introduce a new unit of account will prevent Libra from ever reaching its full potential. Units of account are a bit like languages. If you are an English speakers, not only do you communicate to everyone around you in English, but you also think in English. Likewise with the dollar or yen or pound or euro. If you live in France, you're used to describing prices and values to friends and family in euros. You also plan and conceptualize in terms of them.

It's hard to get people to voluntarily switch to another language or unit of account once they are locked into it. For instance, in the 1800s L.L. Zamenhof attempted to get the world to adopt Esperanto as a language in order to promote communication across borders. To help facilitate adoption, Zamenhof designed it to be easy to learn. But while around 2 million speak Esperanto, it never succeeded in becoming a real linguistic standard. The core problem is this: Why bother learning a new language, even an easy one, if everyone is using the existing language? 

Facebook's Libra project reminds me of Zamenhof's Esperanto project. Nigerians already talk and compute in naira, Canadians in dollars, Indonesians in rupiahs, and Russians in rubles. Why would any of us want to invest time and effort in learning a second language of prices?

Let me put it more concretely. I do most of my families grocery shopping. Which means I keep track of an evolving array of maybe 30 or 40 food prices in my head. When something is cheap relative to my memory of it, I will buy it—sometimes multiple versions of it. And when it is expensive, I avoid it. But this array is entirely made up of Canadian dollar prices. I don't want to have to re-memorize that full array of prices in Libra terms, or keep two arrays of prices in my head, a dollar one and a Libra one. I'm already fluent in the Canadian dollar ones.

Nor will retailers like Amazon or the local corner store relish the prospect of having to advertise prices in both the local unit of account and Libra, plus whatever unit Google and Netflix choose to impose on us. 

So Facebook is inflicting an inconvenience on its users by forcing us to adopt a new unit of account. To make for a better user experience, it should probably index the Libra payments network to the units of account that we're all used to. 

If not, here is what is likely to happen. We'll all continue to think and communicate in terms of local currency. But at the last-minute we will have to make a foreign exchange calculation in order to determine out how much of our Libra to pay at the check-out counter. To do this calculation, we'll have to use that moment's Libra-to-local currency exchange rate. This is already how bitcoin transactions occur, for instance.

But this means that Libra users will lose one of the greatest services provided by money: money's interval of certainty. This is one of society's best free lunches around. It emerges from a combination of two fact. First, most of us don't live in a Libra world in which we must make some sort of last-minute foreign exchange calculation before paying. Rather, we live in a world in which the instruments we hold in our wallet are indexed to the same unit of account in which shops set prices.

Monetary economists call this a wedding of the medium-of-exchange and unit-of-account functions of money. This fusion is really quite convenient. It means that we don't have to make constant foreign exchange conversions every time we pay for something. A bill with a dollar on it is equal to the dollars emblazoned on sticker prices.

Secondly, shops generally choose to keep sticker prices fixed for long periods of time. Even with the growth of Amazon and other online retailers, Alberto Cavallo (who co-founded the Billion Prices Project) finds that the average price in the U.S. has a duration of around 3.65 months between 2014-2017. So for example, an IKEA chair that is priced at $15 will probably have this same price for around 3.65 months. This is down from 6.48 month between 2008-10. But 3.65 months is still a pretty long time.

Prices are getting less sticky thanks to online shopping: https://t.co/AVikQrJjJ6

A price change endured for 7 months back in 2008. It now lasts just 3.7 months. This effect is particularly strong in sectors where Amazon has high market share i.e. electronics & household goods. pic.twitter.com/ncAYkagA0b

— JP Koning (@jp_koning) June 25, 2019

Why do businesses provide sticky pricing? In the early 1990s Alan Blinder asked businesses this very question. He found that the most common reason was the desire to avoid "antagonizing" customers or "causing them difficulties." Blinder's findings were similar to Arthur Okun's earlier explanation for sticky prices whereby business owners maintain an implicit contract, or invisible handshake, with customers. If buyers view a price increase as being unfair, they might take revenge on the retailer by looking for alternatives. (I explore these ideas more here).

Anyways, the combination of these two factors—sticky prices and a wedding of the unit of account and medium of exchange—provides all of us with an interval of certainty (or what I once called money's 'home advantage'). We know exactly how many items we can buy for the next few weeks or months using the banknotes in our wallet or funds in our account. And so we can make very precise spending plans. In an uncertain world, this sort of clarity is quite special.

Given Libra's current design, the interval of certainty disappears. Store keepers will still keep prices sticky in terms of the local unit of account, but Libra users do not benefit from this stickiness because Libras aren't indexed to the same unit as sticker prices are. Anyone who has ≋100 in their account won't know whether they can afford to buy a given item two weeks from now. But if they hold $100, they'll still have that certainty, since dollar prices are still sticky.

If money's interval of certainty is important, it is particularly important to the poor. The rich have plenty of savings that they can rely on to ride out price fluctuations. The fewer resources that a family has, the more it must carefully map out the next few day's of spending.  The combination of sticky prices and a wedding of the unit-of-account and medium-of-exchange affords a vital planning window to those who are just barely getting by.

This clashes with one of Libra's founding principles: to help the world's 1.7 billion unbanked. Here is David Marcus, Libra's project lead:

3/ Because it's time for the internet to have a protocol for money, and it's time to try something new for the 1.7 billion people who are still unbanked 30 years after the invention of the web.

— David Marcus (@davidmarcus) June 18, 2019

Most of the world's unbanked people are poor. But Libra won't be doing the poor much of a favor by choosing to void the interval of certainty that they rely on. If Facebook and David Marcus truly wants to help the unbanked, it seems to me that it would better to index Libras to the various local units of account.

I suppose there is an argument to be made that Libras could provide poor people in nations with bad currencies a haven of sorts. Better Libras than Venezuelan bolivars, right? But the nations with the world's largest unbanked populations—places like India, Nigeria, Mexico, Ethiopia, Bangladesh, and Indonesia—all have single digit inflation, or close to it. Extremely high inflation is really just a problem in a few outliers, like Zimbabwe and Venezuela.

Besides, providing those who endure high inflation with a better unit of account isn't the only way to help them. Offering locally-denominated Libras that offer a compensating high rate of interest would probably be more useful. Not only would these types of Libra offer inflation protection, but they would preserve the interval of certainty.

Thankfully, I suspect that Libra is very much a work-in-progress. The current whitepaper seems to give only a hint of what the project might become. If so, one of the changes I suspect Facebook will have to make if it wants to get traction is to link the Libra network to already-existing units of account. A new unit of account is just too Utopian.

The Haitian dollar

Haiti is home to a strange monetary phenomenon. Shopkeepers and merchants set prices in the Haitian dollar, but there is no actual thing as the Haitian dollar.

I've written before about an exotic type of unit-of-account known as an abstract unit of account. A nation's unit of account is the symbol used by its citizens and businesses to advertise and record prices. Here in Canada we use the $ while in a country like Japan people use the ¥. The national unit of account almost always corresponds to the national medium-of-exchange. In both Canada and Japan, the $ and the ¥ amounts advertised in shop aisles are embodied by physical dollar and yen banknotes and coins.

Abstract units of account, on the other hand, don't correspond to anything that exists. In the UK, for instance, race horse auctions are priced in guineas, a gold coin that hasn't been minted in over two centuries. The guinea is a ghost money, an accounting unit that according to John Munro is "calculated according to the precious metal content of some famous, once highly favoured coin of the past than no longer circulates."

There are some strange units of account out there. In the UK, race horse auctions are priced in guineas, a coin that hasn't been minted in over 200 years. Source: https://t.co/cGujWAmlO8 One guinea = Sterling £1.05 pic.twitter.com/vMv927yooU

— JP Koning (@jp_koning) January 29, 2019

Other examples of abstract units of account include include Chile's Unidad de Fomento, or UF, (which I wrote about here) and Angolan macutes (see here).

Like the guinea, the Haitian dollar is an abstract unit of account. I should warn you that I've never been to Haiti--all of this comes from what I've read in tourist guides, newspapers, Haitian blogs, and an academic paper on the topic from Federico Neiburg. But from what I understand, it is quite common for prices in Haiti to be set in a unit referred to as the 'Haitian dollar.' However, there is no corresponding Haitian dollar banknotes or coins. The U.S. dollar and the Haitian gourde, a currency managed by Haiti's central bank, circulate in Haiti and are used to consummate all payments. But the Haitian gourde is not the same as the Haitian dollar.

How does this work in practice? Say that a restaurant is selling sandwiches for fifteen Haitian dollars. Paying with Haitian dollars is impossible--they don't exist--so some other route must be taken to complete the deal. Haitians have spontaneously adopted a rule of thumb that the Haitian dollar is equal to five Haitian gourdes. So to pay for the sandwich, it will be necessary to hand over 75 gourdes (H$15 x 5$H/HG).

Here is a sign showing both Haitian dollar and Haitian gourde (HTG) prices. Source: Pawol Mwen blog

A certain degree of mental gymnastics is thus required of Haitians, since sticker prices must always be multiplied by five (to arrive at the gourde amount) and banknotes held in a wallet divided by five (to arrive at the Haitian dollar amount). For foreigners, this can be confusing, but for Haitians the motley of U.S. dollars, gourdes, and the Haitian dollar unit of account has become second nature. Says Nieburg:

"The adjective Haitian (aysien), as in dolà aysien, is only used when one of the participants in a transaction is foreign. Among Haitians, when people say dolà they always mean dolà aysien."

Nieburg provides some more colour by describing the monetary demographics of Port-au-Prince, Haiti's capital:

"...in the urban islands of foreigners scattered across various regions of the city, the US dollar predominates as a unit of account and means of payment in sectors such as the housing market, as well as in restaurants, hotels, night clubs, and supermarkets (which used to double as currency exchange bureaus) that cater for upper-class Haitians and the legion of ex-pats, relief workers, and consultants. As we move down the social scale, the US dollar begins to be used as a means of payment for transactions calculated in Haitian dollars. Lower down—where the majority of transactions are to be found—people calculate in Haitian dollars and pay in gourdes."

Where does the practice of using the Haitian dollar come from? I wasn't aware of this, but during WWI the U.S. invaded Haiti, occupying it till 1934. There was a strong German mercantile presence in Haiti and apparently the U.S. authorities feared that Germany might take over.

By 1918 the government's gourdes had become "so worn and torn" that a shortage of banknotes arose. As part of a 1919 U.S.-initiated monetary reform, all previous issues of gourdes were to be replaced by a new issue by the Banque Nationale de la Republique d'Haiti, which by then was owned and controlled by New York-based City Bank (and would eventually become Citigroup). The BNRH was granted a monopoly on banknote issuance, which meant that the Haitian government could no longer print its own currency.

The new banknotes were to be convertible into U.S. dollars at a rate of five gourdes to the dollar, a promise that the BNRH printed on the face of each bill, as the images below illustrate.

1919 one gourde note (source)

 

"This bill issued by the National Bank of the Republic of Haiti, under its concession contract and conforming with the agreement of May 2, 1919, is payable to the holder in legal money of the United States at the rate of five gourdes to the dollar upon presentation to the bank's office in Port-au-Prince or, after a delay, at its provincial branches."

Even after the U.S. occupation ended and City Bank sold the BNRH back to the Haitian government, the promise to redeem gourdes with U.S. dollars continued. This peg stretched right through the rule of "Papa Doc" Duvalier until the gourde was finally untethered from the dollar in the late 1980s.

So several generations of Haitians had become used to a five-to-one ratio between U.S. dollars and gourdes. Dividing a price by five in order to get the U.S. dollar price may have become such a standard piece of mental arithmetic that the practice continued into the 1990s and 21st century, even after the calculation's answer no longer corresponded to the correct U.S. dollar amount. The Haitian dollar may simply have been a placeholder that was invented in order to provide continuity for the age-old custom of dividing by five.

Since it was unpegged, the Haitian gourde has fallen consistently against the U.S. dollar, possibly contributing to the tradition of using the Haitian dollar unit. Quoting prices in Haitian dollars could be a non-violent way for Haitians to show their dissatisfaction with their government's finances. Or perhaps it is a marketing trick that Haitian merchants use to make their wares seem less cheap, sort of like how shopkeepers here in Canada often set prices at $4.99 instead of $5.00.   

According to Nieburg, the government has even tried to ban the practice of pricing in Haitian dollars. Intellectuals who support the measure have condemned the abstract unit as just "another sign of the country’s backwardness." But the attempt failed. Units of account are just a part of language. And language is very difficult to control.

The Haitian dollar is probably the best (and simplest) modern example I've ever run into of an abstract unit of account. For monetary enthusiasts like myself, it provides a great illustration of the many different functions packaged into the thing we call "money." These functions needn't be unified into one object or instrument. They can be split up, so that the instruments that we pass from hand to hand (or from phone to phone), the so-called medium-of-exchange, no longer correspond to the symbol used for pricing, the unit-of-account.

Nobel Prize winning economist Robert Shiller has written enthusiastically about so-called monetary separation. William Stanley Jevons's tabular standard, which was never implemented but has been considered by some to be the ideal monetary system, relies on a split between the medium-of-exchange and unit-of-account. Rather than being backwards, the sort of Haitian dollar standard that we see in modern Haiti could one day become the guiding principle of the monetary systems of the future.

Store of value

LSD tabs like these ones have an incredibly high value-to-weight ratio

When bitcoin first appeared, it was supposed to be used to buy stuff online. In his 2008 whitepaper, Satoshi Nakamoto even referred to his creation as an electronic cash system. But the stuff never caught on as a medium-of-exchange: it was too volatile, fees were too high, and scaling problems resulted in sluggish speeds. Despite losing its motivating purpose, bitcoin's price kept rising. The bitcoin cognoscenti began to cast around for a new raison d'etre. Invoking whatever they must have remembered from their old economics classes, they rechristened bitcoin as the world's best store of value.

Store of value is one of the three classic functions of money that we all learn about in Money and Banking 101: money serves a role as a medium of exchange, unit of account, and store of value. So presumably if bitcoin wasn't going to be a medium of exchange (and certainly not a unit of account thanks to its volatility), at least some claim to money-ishness could be retained by having it fill the store of value role.

In his 1867 Money and the Mechanism of Exchange, political economist William Stanley Jevons formally introduced the term store-of-value into monetary economics (although Nathan Tankus tells me that Marx may have originated the idea albeit with different terminology, and Daniel Plante tips Aristotle):

William Stanley Jevons (1867) was probably the first economist to introduce the 'store of value' function of money https://t.co/xqIs3Fym3a pic.twitter.com/dRcfLfMUya

— JP Koning (@jp_koning) October 8, 2017

Jevons's store of value function refers to the process of preserving value across both time and space. Now in one sense, every good that has ever existed has been a store of value, as Nick Rowe once pointed out. If a good isn't capable of storing value, we'd be incapable of handling and consuming it. Even an ice-cream cone needs to exist long enough for value to be transferred from tub to mouth.

What Jevons was implying in the above passage is that some goods are better than others at condensing value. Goods with the low bulk and weight, including the "current money of the land" (i.e. banknotes), are the best condensers. Below is a list of items ranked according to price per pound, which I get from Evilmadscientist (beware, these are 2008 prices). While all-purpose flour can store value, a $100 bill is better at the task, and while both are surpassed by championship thoroughbred semen, nothing does the job better than LSD.

To condense value over time and space, a store of value will need to be durable. Saffron has a fairly high value-to-weight ratio, but its quality depreciates much quicker than a dollar bill, thus compromising its ability to store value through time. Same with copper and silver, both of which will steadily corrode whereas gold does not. It also helps to have low storage costs. Oxen may have been a great way to store value across space, yet feeding and sheltering them over long periods of time would have been quite expensive. 

Jevons was writing before computers and the internet had emerged. Nowadays, billions of dollars in value are represented digitally. These digital tokens—stocks, bonds, deposits, credit, bitcoin, and whatnot—are weightless and volumeless. Which means they far exceed the ability of any physical item to condense value over time and space.

How does bitcoin rank relative to other digital stores of value? Let's say you needed to condense a certain amount of value and had a choice between either holding bitcoin or Netflix stock. (I choose Netflix because its market cap is close to the market value of all bitcoins ever mined, and because both their prices have done exceptionally well over the last six years). Bitcoin is great for conveying value across space, especially if it involves crossing national borders. All you have to do is remember your private key and you can access your funds no matter where you are. Netflix isn't quite so fluid. While you can certainly access your online brokerage account when you are in Vietnam on holiday, you can't actually sell Netflix stock in Vietnam (as you presumably could with bitcoin). Instead, you'd have to sell the stock and transfer the proceeds to a bank account in Vietnam via the correspondent banking system. That could take a few days and you might run into some hassles.

What about for storing value across time? Bitcoin has a few neat features, including censorship resistance. Since bitcoin isn't centrally managed, there is no way for an administrator to censor you, i.e. erase your bitcoins. With Netflix (or any other centrally-housed digital asset), however, if you are a considered to be a bad actor by those who control the system, presumably your shares can be frozen or confiscated. Counterbalancing this, bitcoins are notoriously susceptible to being stolen. But I've never heard of a thief getting away with someone's shares. There's a bit of give and take.

But in general, I'd argue that bitcoin and Netflix stock are both pretty bad for temporally storing value, although bitcoin is particularly bad. For an asset to do a good job condensing property over time it has to provide its owner with predictable access to a future basket of consumption goods. Assets with prices that have gone parabolic do not fulfill this requirement. After all, there is no reason that the price won't reverse and start to plunge, thus compromising that instrument's ability to store predictable amounts of consumption through time. Anything with a highly stable price across all time frames (minute-by-minute and year-to-year) provide the requisite predictability. Assets that gyrate do not.

The chart below shows the relative variability of the prices of bitcoin, Netflix, and gold since 2011.

Specifically, the chart measures each assets' median change in price over a given month. For instance, in November 2017 bitcoin had the tendency to close up or down by around 3.2% each day, Netflix by 0.8%, and gold by 0.3%. Averaging out all months since 2011, gold's variability comes in at 0.5%, Netflix at 1.5% and bitcoin at 2.2% (see dashed lines above), which means the yellow metal has done a much more predictable job of storing value over time than the other two assets, and Netflix is more up to the task than its digital counterpart. 

In late 2016 bitcoin's volatility seemed to have fallen permanently below Netflix levels and—for a month or two—approached that of gold. The digital stuff had become a mature asset! That wasn't to be, however, and bitcoin volatility has since reverted to levels significantly above its long term average.

I'd argue that bitcoin's high volatility is inherent to its nature. As such, it will always do a fairly bad job of storing value over time. The problem, as I outlined in my recent BullionStar article, is that bitcoin is a pure Keynesian beauty contest asset. People only buy bitcoins because they expect others to buy them at a higher price. The markets for gold and Netflix, on the other hand, are populated by a second set of participants who value those assets for reasons apart from whether others will buy them later. In the case of gold, industrial buyers step up whereas with Netflix it is value investors. The buying and selling of this second set of participants has a calming effect on prices.

The most predictable way to condense value through time is a U.S. dollar deposit. Anyone who has $100 in their account knows with a high degree of accuracy what they'll be able to buy next week. This stems from the fact that consumer good prices are measured in terms of the units issued by the central bank, and retailers keep these prices fairly rigid over the short term. For longer time periods, say one year out, the U.S. dollar will have naturally suffered from some inflation. But this decline in purchasing power is a known quantity. The Federal Reserve has an inflation target of 2%. So it's a safe bet that $100 will be worth $98, not $92, or $84, or $104. That's pretty good predictability. Interest earned on the deposits will make up for the lost purchasing power.

So is bitcoin a store of value? Sure, everything is to some degree... and bitcoin certainly does a good job of condensing value across distances. But relative to other assets, in particular U.S. dollar deposits, it does a poor job storing value across time. I don't think this is going to change, but I could be wrong.

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P.S: In the interest of full disclosure, I still own some bitcoin and XRP, not much though. Own some gold too, but no Netflix.
P.P.S: Here is a rewrite of Satoshi's whitpaper, substituting in store of value system for electronic cash system:

From ancient electrum to modern currency baskets (with a quick detour through symmetallism)

Electrum coins [source]

First proposed by economist Alfred Marshall in the late 19th century as an alternative metallic standard to the gold, silver and bimetallic standards, symmetallism was widely debated at the time but never adopted. Marshall's idea amounted to fusing together fixed quantities of silver and gold in the same coin rather than striking separate gold and/or silver coins. Symmetallism is actually one of the world's oldest monetary standards. In the seventh century B.C., the kingdom of Lydia struck the first coins out of electrum, a naturally occurring mix of gold and silver. Electrum coins are captured in the above photo.

While symmetallism is an archaic concept, it has at least some relevance to today's world. Modern currencies that are pegged to the dollar (like the Hong Kong dollar) act very much like currencies on a gold standard, the dollar filling in for the role of gold. A shift from a dollar peg to one involving a basket of other currencies amounts to the adoption of a modern version of Marshall's symmetallic standard, the euro/yen/etc playing the role of electrum.

The most recent of these shifts has occurred with China, which late last year said it would be measuring the renminbi against a trade-weighted basket of 13 currencies rather than just the U.S. dollar. Thus many of the same issues that were at stake back at the turn of the 19th century when Marshall dreamt up the idea of symmetallism are relevant today.

So what exactly is symmetallism? In the late 1800s, the dominant monetary debate concerned the relative merits of the gold standard and its alternatives, the best known of which was a bimetallic standard. The western world, which was mostly on a gold standard back then, had experienced a steady deflation in prices since 1875. This "cross of gold" was damaging to debtors; they had to settle with a higher real quantity of currency. The reintroduction of silver as legal tender would mean that debts could be paid off with a lower real amount of resources. No wonder the debtor class was a strong proponent of bimetallism.

There was more to the debate than mere class interests. As long as prices and wages were rigid, insufficient supplies of gold in the face of strong gold demand might aggravate business cycle downturns. For this reason, leading economists of the day like Alfred Marshall, Leon Walras, and Irving Fisher mostly agreed that a bimetallic standard was superior to either a silver standard or a gold standard. (And a hundred or so years later, Milton Friedman would come to the same conclusion.)

The advantage of a bimetallic standard is that the price level is held hostage to not just one precious metal but two; silver and gold. This means that bimetallism is likely to be less fickle than a monometallic standard. As Irving Fisher said: "Bimetallism spreads the effect of any single fluctuation over the combined gold and silver markets."  Thus if the late 1800s standard had been moved from a gold basis to a bimetallic one, the stock of monetary material would have grown to include silver, thus 'venting' deflationary pressures.

Despite these benefits, everyone admitted that classical bimetallism had a major weakness; eventually it ran into Gresham's law. Under bimetallism, the mint advertised how many coins that it would fabricate out of pound of silver or gold, in effect setting a rate between the two metals. If the mint's rate differed too much from the market rate, no one would bring the undervalued metal (say silver) to the mint, preferring to hoard it or export it overseas where it was properly valued. The result would be small denomination silver coin shortages, which complicated trade. What had started out as a bimetallic standard thus degenerated into an unofficial gold standard (or a silver one) so that once again the nation's price level was held hostage to just one metal.

The genius of Alfred Marshall's symmetallic standard was that it salvaged the benefits of a bimetallic standard from Gresham's law. Instead of defining the pound as either a fixed quantity of gold or silver, the pound was to be defined as a fixed quantity of gold twinned with a fixed quantity of silver, or as electrum. Thus a £1 note or token coin would be exchangeable at the Bank of England not for, say, 113 grains of gold, but for 56 grains of gold together with twenty or so times as many grains of silver. The number of silver and gold grains in each pound would be fixed indefinitely when the standard was introduced.

Because symmetallism fuses gold and silver into super-commodity, the monetary authority no longer sets the price ratio between the two metals. Gresham's law, which afflicts any bimetallic system when one of the two metals is artificially undervalued, was no longer free to operate. At the same time, the quantity of metal recruited into monetary purposes was much larger and more diverse than under a monometallic standard, thus reducing the effect of fluctuations in the precious metals market on aggregate demand.

While symmetallism was an elegant solution, Alfred Marshall was lukewarm to his own idea, noting that "it is with great diffidence that I suggest an alternative bimetallic scheme." To achieve a stable price level, Marshall preferred a complete separation of the unit of account, the pound, from the media of exchange, notes and coins. This was called a tabular standard, a system earlier proposed by William Stanley Jevons. The idea went nowhere, however; the only nation I know that has implemented such a standard is Chile. As for Fisher, he proposed his own compensated dollar standard plan, which I described here.

The urgency to adopt a new standard diminished as gold discoveries in South Africa and the Yukon spurred production higher, thus reducing deflationary pressures. None of these exotic plans—Marshall's symmetallism, Jevons tabular standard, or Fisher's compensated dollar—would ever be adopted. Rather, the world kept on limping forward under various forms of the gold standard. This standard would be progressively modified through the years in order to conserve on the necessity for gold, first by removing gold coin from circulation and substituting convertibility into gold bars (a gold bullion standard) and then having one (or two) nations take on the task of maintaining gold convertibility while the remaining nations pegged to that nation's currency (a gold exchange standard).

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Let's bring this back to the present. In the same way that conditions in the gold market caused deflation among gold standard countries in the late 1800s, the huge rise in the U.S. dollar over the last few years has tightened monetary conditions in all those nations that peg their currency to the dollar. To cope, many of these countries have devalued their currencies, a development that Lars Christensen has called an 'unraveling of the dollar bloc.'

A more lasting alternative to re-rating a U.S. dollar peg might be to create a fiat version of electrum; mix the U.S. dollar with other currencies like the euro and yen to create a currency basket and peg to this basket. China, which has been the most important member of the dollar bloc, has turned to the modern version of symmetallism by placing less emphasis on pegging to the U.S. dollar and more emphasis on measuring the yuan against a trade-weighted basket of currencies. This means that where before China had a strictly made-in-the U.S. monetary policy, its price level is now determined by more diverse forces. Better to put your eggs in two or three baskets than just one.

Bahrain, Oman, Qatar, Saudi Arabia and United Arab Emirates are also members of the dollar bloc. Kuwait, however, links its dinar to a basket of currencies, a policy it adopted in 2007 to cope with the inflationary fallout from the weakening U.S. dollar. In an FT article from April entitled Kuwaiti currency basket yield benefits, the point is made that Kuwait has enjoyed a more flexible monetary policy than its neighbours over the recent period of U.S. dollar strength. Look for the other GCC countries to mull over Kuwaiti-style electrum if the U.S. dollar, currently in holding pattern, starts to rise again.

Modern day electrum can get downright exotic. Jeffrey Frankel, for instance, has suggested including commodities among the basket of fiat currencies, specifically oil in the case of the GCC nations. Such a basket would allow oil producing countries to better weather commodity shocks than if they remained on their dollar pegs. If you want to pursue these ideas further, wander over to Lars Christensen's blog where Frankel's peg the export price plan is a regular subject of conversation.