The evolution of the Federal Reserve's promises as recorded on their banknotes

Since they began to be produced in 1914, Federal Reserve notes have always had a promise or obligation printed on their face. But over time this promise has changed. I thought it would be fun to go through the evolution of the promise as an exercise in understanding how the U.S.'s monetary plumbing has changed.

The original 1914 series of Federal Reserve notes had the above stipulation printed on it. It's tough to read, so I've reproduced it in full below:

"This note is receivable by all national and member banks and Federal Reserve Banks and for all taxes, customs and other public dues. It is redeemable in gold on demand at the Treasury Department of the United States in the city of Washington, District of Columbia or in gold or lawful money at any Federal Reserve Bank."

There were really four promises here. The first was that all banks who were members of the Federal Reserve system would accept notes at their counter, as would the Reserve banks themselves—i.e. the twelve district banks. The second promise was that the government would accept the notes in payment of taxes. This is what I described in last week's post as twintopt, or the MMT/Wicksteed idea of tax receivability. The third promise was to uphold the gold standard, both the Fed and the Treasury being obliged to redeem notes with the yellow metal. And the fourth and final promise was to redeem notes with something called lawful money.

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Let's focus on this last promise, which is the most curious. What does lawful money mean? The Fed gives a brief description in their FAQ, the summary of which is: it's complicated.

Before the Fed's founding in 1913, the U.S. issued a smorgasbord of different government currencies, as the chart below illustrates. The most important of these issues was United States notes, otherwise known as greenbacks. The Treasury was first authorized to issue them when the Civil War broke out, and only in 1994 was it relieved of its its obligation to redeem old United States notes with new ones.

The 1862 act that authorized United States notes declared them to be lawful money and a legal tender, phraseology that implied that to be lawful was distinct from being legal tender. While the act never explicitly defined lawful money, legal tender was already a well-known term—meaning any instrument that by default can be used to discharge a debt. So if James owns Judith $20, legal tender is any instrument that Judith cannot refuse to accept when James wants to discharge his debt.

People often assume that government money and legal tender are synonymous, but in actuality there are many examples of government banknotes that have not been legal tender. Take Scotland, for instance, where neither Scottish banknotes nor Bank of England notes currently have legal tender status. U.S. silver and gold certificates, two forms of circulating paper money that were issued by the Treasury through the 19th and 20th century, were not legal tender—at least not till 1919 in the case of gold, and 1934 for silver. Nor were National bank notes a form of legal tender. These were private banknotes issued by banks chartered under the National Bank Act (see chart above). The Treasury promised to accept National bank notes at par in discharge of most Federal taxes, effectively adopting them as their own IOU, yet refused to grant them legal tender status.

While there is no formal definition of lawful money in the 1862 act, we know that it wasn't necessarily legal tender, and we do know that greenbacks fell into said category. Thus a narrow reading of the lawful money promise on a 1914 Federal Reserve note simply meant that they were convertible into United States notes, which by chance happened to be legal tender.

A much broader definition of lawful money would emerge later. By 1935, Fed Chair Mariner Eccles included not only United States notes—greenbacks—but also silver certificates and National bank notes in the category of lawful money (see pdf). William McChesney Martin, who served as Chair from 1951 to 1970, defined lawful money as "any medium of exchange which frequently circulates from hand to hand as money under sanction of the law." (pdf) By this generous definition, lawful money referred to the entire mongrel collection of government currencies, including legal tender United States notes and non-legal tenders such as silver/gold certificates and National bank notes, and finally legacy notes no longer being printed including Treasury notes of 1890, fractional currency, and old demand notes.

The upshot is that the original promise to redeem Federal Reserve notes with lawful money effectively linked what was then a novel currency to the medley of recognizable government currencies already in use. This promise would have provided the public with much-needed continuity between the familiar and not-so-familiar. After all, the Fed was a new institution that had not yet earned credibility. Tying its obligations closely together with greenbacks and/or every bit of paper then in existence would have helped its cause.

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Having dealt with the idea of lawful money. Let's go on to look at how the promises on Fed notes changed after 1914. I've included the 1928, 1934, and 1963 series:

You can see that the 1928 series no longer included either the first (receivability at banks) or second promises (tax receivability). This was probably for brevity's sake. Even though these promises no longer appeared on Fed notes, they continue to be enshrined in Section 16.1 of the Federal Reserve Act. So when you do your taxes in 2018, the Treasury is obligated to accept notes as payment, just as they were in 1914, even though this isn't indicated on the face of a banknote.

When the 1934 series was printed, the third promise—to redeem in gold on demand—was dropped, both from the face of banknotes and the Federal Reserve Act itself. The U.S. had formally gone off the gold standard that year. Where before any member of the public could have walked into any Treasury office or Federal Reserve district bank and asked to have their banknotes redeemed with gold, neither institution was obligated to uphold this promise anymore. As of 1934, the Treasury would only buy gold from miners and other central banks at a rate of $35 per ounce—but this obligation didn't show up on the face of a Federal Reserve note, nor in the Federal Reserve Act. The promise to purchase gold at $35 was an informal one, with President Roosevelt remarking that the price "may be changed by the Secretary of the Treasury at any time without notice."

In addition to removing the gold redemption promise from the face of a Federal Reserve note, the 1934 series included a new feature: Federal Reserve notes were now legal tender for all debts public and private. It may seem strange to us now, but for the first twenty years of the Fed's existence, Federal Reserve notes could not legally discharge a debt. If James owed Judith $20, Judith could refuse to accept Federal Reserve notes from James, asking for something else instead, say United States notes which were legal tender. Thanks to the 1933 Thomas Amendment (pdf), Judith was now obligated to accept James's Fed notes as payment for the debt. I can only speculate on why Federal Reserve notes weren't originally made legal tender, but one reason is probably due to the memories of the inflation in the 1860s caused by legal tender greenbacks. If something isn't granted legal tender status, it can't do as much damage to the price level.

For almost thirty years nothing changed on the face of Federal Reserve notes until 1963 when the redeemable in lawful money promise was dropped, leaving only the stipulation that a note was legal tender for all debts, public and private.

By 1963, America's mongrel currency was pretty much a thing of the past. Ever since 1934 it had been illegal for gold certificates to circulate publicly. As for National bank notes, they had begun to be retired in 1935. The effort to remove silver certificates in denominations of $5 and above was initiated by John F. Kennedy in 1961. Getting rid of the $1 silver certificate was a bit more tricky. Believe it or not, but at the time there was no such thing as a $1 Federal Reserve note. For decades the nation's entire demand for $1 notes had been met solely by the Treasury's silver certificates. However, in 1963 the Fed finally debuted its first $1 note, upon which the Treasury began to cancel $1 silver certificates.

The Fed didn't start issuing $1 bills till 1963. Before then, all $1 notes were in the form Treasury-issued silver certificates (see top). pic.twitter.com/AZEEwPLKVX

— JP Koning (@jp_koning) August 3, 2017

With most of the government's parallel currencies retired, the promise to redeem Federal Reserve notes in lawful money probably seemed pointless, if not confusing. Thus it no longer shows up on bills, despite being still encoded in section 16 of the Federal Reserve Act. In 2017, you can bring your note to a Federal Reserve for redemption in lawful money, but they will only give you another Fed note in return. The category of lawful money is meaningless.

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Most members of the public don't know how the underlying monetary systems work, but they do see what is printed on its banknotes. To the public, the morphing set of promises on the face of a Federal Reserve note would have been one of the more visible manifestations of a shift from a mish mash of paper currencies issued by two different institutions and pegged to gold... to one single legal tender currency issued by the U.S.'s now-dominant monetary institution, the Fed—the Treasury receding into the background.

It's been over fifty years since the promise on Federal Reserve notes was last changed. What promises will be printed on U.S. money in the future? That's hard to say since we don't even know if paper money will be a part of the future. If the Fed were ever to update its currency by introducing a digital version to circulate along with its paper issue, those in charge of its design would have to think hard about the sorts of promises that will be granted to the bearer of those tokens. Would they be lawful money, tax receivable, and/or legal tender? These are questions that U.S. monetary authorities haven't had to ask themselves in a long time, not since the mongrel currency era when new money was introduced every decade or two.

An example of tax-driven money during the greenback era

Cartoon from 1864 poking fun at politicians and greenbacks (source and explanation)

During the greenback era, the Union government issued irredeemable paper money to help pay for its war against the Confederates. What many people don't realize is that there were actually two different strains of greenbacks—those printed before March 1862 and those printed after. Although these two strains had only slightly different properties, they were not fungible with each other and would go on to have drastically different values in the marketplace. Looking at the respective properties of each type gives some insights a thorny problem: why do colored bits of paper money have value?

One classic explanation for the value of fiat money is so-called 'tax-backing.' If the government stipulates that taxes must be paid using government-issued chits of paper, then that will be sufficient to give those chits a positive value. Back in 1910 economist Philip Wicksteed was one of the first economists to champion this explanation:

The Government, then, levying taxes upon the community, may say: "I shall take from you, in proportion to your resources, as a tribute to public expenses, the value of so much gold. You may pay it to me in actual metallic gold or you may pay it to me in anything which I choose to accept in lieu of the gold. If you do not give it me I shall take it from you, in gold or any other such articles as I can find, and which would serve my purpose, to the value of the gold. But if you can give me a piece of paper, of my own issue, to the face value of the gold that I am entitled to claim of you, I will accept that in payment." Now, as these demands of the Government are recurrent, there will always be a set of persons to whom the Government paper stamped with a unit weight of gold is actually equivalent to that weight of gold itself, because it will secure immunity from requisitions to the exact extent to which the gold would secure it. - The Common Sense of Political Economy, Book II Ch 7

The idea that a tax obligation can be the basis of money, or what Randall Wray has termed twintopt, is at the core of modern monetary theory, or MMT.

Let's see how the tax backing theory holds up during the greenback period. To set the context, South Carolina had seceded from the Union in December 1860, soon followed by ten other states. Hostilities between the Union and newly-formed Confederate states began in April 1861. To help fund the Union side of the war effort, an initial $50 million issue of greenbacks was authorized in July. This was to be the first government paper money emitted since the Second Bank of the United States had been wound up.

The act ruled that these notes were to be redeemable on demand in gold, a promise that was also inscribed on the face of each note (see below). They thus earned the nickname demand notes. This promise meant that, at the outset at least, their price could not deviate from par since any movement above or below their gold value would be arbitraged away. When redemption was rescinded a few months later on December 30, 1861, demand notes began to trade at a 1-2% discount to their face value in gold.

Greenbacks were introduced in 1861. Note the progression from the first issue—ie 'demand notes'—to the second in 1862—'legal tender notes'. pic.twitter.com/ELnSg3QRtB

— JP Koning (@jp_koning) October 10, 2017

The second vintage of greenbacks, known as legal tender notes, was authorized two months later by the Legal Tender Act of February 25, 1862. This act provided for an issue of $150 million, much larger than the first vintage. One novelty is that the second batch of notes was declared legal tender, which meant that a creditor could not refuse to receive them at par in discharge of a debt. The legal tender property was extended to demand notes in March 1862. The second vintage of notes was also irredeemable, putting them on the same basis as the demand notes, which became irredeemable at the end of 1861.

What distinguished legal tender notes from demand notes? As the tweet above shows, the two vintages had visible differences—unlike demand notes, legal tender note did not have the promise to redeem on demand printed on their face. Demand notes also had an extra promise inscribed on them: "receivable in payment of all public dues". What this meant in practice is that the government accepted demand notes in payment for all taxes, including customs dues, whereas legal tender notes were only receivable in a narrow range of internal revenue taxes—and not for customs dues—which at the time made up the majority of Union tax revenues.

Receivability for customs dues was an important point of departure between demand notes and legal tender notes. Duties were priced in gold and could also be discharged with gold coins. So if an importer was on the hook for $x in custom duties, they could certainly scrounge up $x in gold coin to get rid of the obligation, but $x in demand notes would be sufficient to "secure immunity" from the tax. Not so with legal tender notes.

A given importer might only need a small portion of the demand notes in his possession to pay customs duties. Anything above that amount would be worth less than their face value to him, since gold—not demand notes—was necessary to buy goods internationally. However, if that importer could find other importers who were themselves under obligation to pay customs duties, and who would therefore value his remaining stash of demand notes for their tax receivability, then he might sell them his remaining demand notes at a price quite close to the value of gold coins.

So all that was needed to have irredeemable demand notes trade near the value of gold was a permanent market of tax payers who demanded those notes, and a flow of new notes that did not exceed the rate of drainage provided by the tax outlet. After all, if the supply of notes overwhelmed the amount of tax that needed to be paid, then notes would accumulate in importers pockets with no one willing to bid for them. Once everyone's taxes had all been paid up, demand notes would trade at a discount to gold coins. 

Tax receivability was successful in keeping the value of demand notes close to their gold value. The chart below shows the price of both demand notes and legal tender notes relative to gold through 1862-63.  Demand notes never fell to more than a 10¢ discount relative to gold coin. Calomiris blames this discount on the risk that receivability for customs duties would be revoked by the government before notes had been paid in.

Legal tender notes, however, fell to an ever larger discount relative to both gold coin and demand notes, reaching a 40¢ discount by March 1863. While legal tender notes were receivable for domestic taxes, these taxes did not account for a very large share of government revenues. Nor were these taxes priced in gold. Which meant that, unlike demand notes, legal tender notes were not benchmarked to some real good or price index.

So what, if anything, determined the price of legal tender notes? Here I'll introduce another theory for the value of money; the metallist viewpoint. Rather than tax receivability driving a currency's value, a metallist looks to the currency's intrinsic value. When banknotes are fully redeemable, their intrinsic value is determined by the underlying gold on which the note is a claim, the value of which is set in the market for precious metals in technology and the arts.

In the case of legal tender notes, which were no longer redeemable, the realization of intrinsic value had only been delayed to some future point in time when gold convertibility would be re-adopted. This eventual re-mooring date was in turn a function of the Union government's ability to win the war, among other factors. According to this theory, the steady decline in the gold value of legal tender notes in the chart above can be blamed on the realization by the public that the war would last much longer than most originally thought, pushing the re-mooring date ever further into the future.

While the 1861 issue of demand notes had all been bought back and cancelled by the government by mid-1863, greenbacks remained outstanding even after the war had been won. Their discount to gold continued to widen till July 1864 at which point their price steadily rose. See the chart below. The steady return to par probably can't be explained by the tax-backing theory. Improved odds that the government's fiscal situation would allow it to resume gold convertibility—an event that finally occurred in 1879—is a better explanation. There have been a few interesting accounts written about the value of greenbacks over the full 1862-1879 period, including Wesley Clair Mitchell's A History of the Greenbacks in 1903, but also more recent contributions here (Calomiris), here (Smith & Smith) and here (Willard et al).

In sum, the U.S. government was issuing three non-fungible currencies by 1862. Coins and legal tender notes operated under the principles of a metallic money whereas the third, demand notes, seems to have been a purely tax-driven money as described by Wicksteed. So what about a modern dollar note? Is a Federal Reserve note like an 1861 demand note and mostly tax-driven, or like legal-tender notes and operating on a metallic basis?

I'm not entirely sure, but my guess is that it is a messy combination of both. When it comes to money, I'm not a believer in any one theory. Although the odds of a future return to the old 1972 gold redemption rule of 0.024 ounces per dollar is non-existent, the metallic explanation for the dollar's value continues to be relevant. Instead of redeeming currency with fixed amounts of metal as in days of yore, modern central banks repurchase notes with financial assets held in their vault in a manner that is consistent with hitting an inflation target. This is very much like 1800s-style metallism, except with an ever-shrinking CPI basket in the place of a fixed amount of gold.   


Sources:

Wesley Clair Mitchell, A History of the Greenbacks

PS: I recently started a discussion board here. Feel free to bring up topics not covered on my more recent blog posts, suggest posts, or discuss ideas that appear on my Twitter feed. I don't like Twitter for long-form discussion; I'd much rather divert them to the board.

PPS: Nathan Tankus responds here.

Orphaned currency, the odd case of Somali shillings

A few weeks ago, David Beckworth egged me on to write about Somalian currency. I can't resist—it's a fascinating subject. The material I'm drawing on comes from Luther & White (2011), Luther (2012), Symes (2005), and Mubarak (2003)

Orphaned banknotes

When Somalia collapsed into civil war in January 1991, the doors of the Central Bank of Somalia were blown apart, its safes were blasted, and all cash and valuables were looted.* But something odd happened—Somali shilling banknotes continued to circulate among Somalians. To this day orphaned paper shillings are used in small transactions, despite the absence of any sort of central monetary authority.

The strange case of circulating Somali shillings forces us to ask some fundamental questions about money. If the Federal Reserve and all other branches of the US government were to be suddenly swallowed up into the sea, would Fed banknotes, like Somali shillings, continue to be used? What forces conspire to keep coloured squares of paper in circulation when their original issuer has long since expired?

According to Luther & White (2011), the shillings' continued circulation within the context of a collapsed state casts doubt on the universality of the chartal theory of money. According to chartal theory, the requirement that people pay taxes with government-issued bits of paper is what drives the positive value of these bits. Since a world with no state is a world with no taxes, the continued use of shillings means that something other than tax acceptance must be driving their positive value. [As an aside, I'd note that the ongoing circulation of bitcoin also contradicts the taxes-only theory of chartal money. After all, bitcoin isn't used to pay taxes, it's used to avoid taxes].

Luther & White give what seems to me to be a very Misesian explanation for the shilling's continued positive value: the "inertia of historical acceptance". According to Ludwig von Mises's regression theorem, outlined in Theory of Money and Credit (1912), people's expectations about the value of bits of paper may "regress" into the past. An intrinsically useless bit of paper is valued today because it had a positive value yesterday, and it had a positive value yesterday because it did the day before, all the way back to day 1 when that useless bit of paper was anchored to some commodity.

This process is described as a coordination game in Luther & White. Though the central bank had collapsed in January 1991, a Somalian trader might choose to still accept shillings the day after the collapse because he had accepted them the day before and he knew that others had accepted them too. In a self conscious manner, the trader would also know that other traders knew that he had accepted them. Expectations about expectations about expectations, a Keynesian beauty contest of sorts, was sufficient to drive the use of shillings beyond the day of the central bank's demise.

Counterfeit notes and contingent redemption

Let's add some more texture to our example. Not only did old shillings continue to circulate, but several new issues of counterfeit notes joined them. These counterfeit 1000 and 500 shilling banknotes were created by warlords and businessmen subsequent to the country's collapse. Although the counterfeit notes had the same design as the pre-1991 legacy notes, small differences allowed for differentiation. According to Luther (2012), of the five known forged issues, four have the date 1996 printed on them, long after the central bank ceased to exist. The counterfeits dated 1996 are signed by central bank governor Ali Abdi Amalow who, having been appointed in 1990, had never held office long enough to have his signature affixed to genuine Somali notes. Even without these imperfections, fake banknotes would have been instantly recognizable to anyone—they would have been crisp and clean relative to the limp and dirty legacy issue.

Despite being easily differentiable, Somalians willingly accepted counterfeit 1000 and 500 shilling notes. Not only did they accept them, they considered them to be fungible with real 1000s and 500s. In other words, the market refused to place a discount on the fakes.

Mubarak (2003) offers a few reasons for the acceptance of counterfeits. Any reticence the public may have had concerning the legitimacy of counterfeit note was overcome by A) coercion on the part of issuing warlord; B) a financial inducement to accept new notes including an initial 5% discount to the price of legacy notes, and C) the claim that new notes were liabilities of the Central Bank of Somalia. According to Mubarak the latter instilled a "general public belief that the forged... banknotes must eventually be upheld and honoured when effective national government comes to power."

This last detail is interesting because it might explain not only why counterfeits were accepted, but also why legacy Somali banknotes continued to circulate after the Somali state collapsed. Upon the eventual reconstitution of the Somalian state, a new central bank would most likely be created. This newly recapitalized Central Bank of Somalia would hold a stock of assets funded, say, by the IMF.  The central bank might take upon itself the original central bank's note liability No longer orphans, old banknotes could now be convertible into deposits held at the new central bank and, insofar as the central bank targeted inflation via open market operations, these deposits would in turn be convertible into genuine backing assets.

Thus the promise of redemption by a not-yet existing central bank may have been enough to give present shillings, both genuine and counterfeit, a positive value.

This means that any changes in the purchasing power of shillings might be due not only  to variations in the quantity of outstanding Somali media-of-exchange. Reassessments of the probability of a central bank both being created and honouring the previous note issue would also affect their purchasing power. For instance, should the Transitional Federal Government, a government in-waiting of sorts, succeed in consolidating its position in Somalia by winning a key battle, the odds of redeemability would increase, as would the value of shillings.

Historically orphaned currencies

This tension between fiat-paper-as-redeemabale-financial-asset and fiat-paper-as-medium-of-exchange is an old one. It was at the centre of one of the greatest monetary debates of the 19th and early 20th century, a dustup that involved luminaries like Irving Fisher, Knut Wicksell, Laurence Laughlin, Benjamin Anderson, Ralph Hawtrey, and Ludwig von Mises. The discussion centered on the irredeemability of US Greenbacks.**

Greenbacks, which had been issued in 1861 to pay for the Union Government's expenses, were initially 100% redeemable in specie. The redemption clause was suspended later that year and subsequent issues of greenbacks didn't even claim to be convertible into gold. Greenbacks quickly fell to a large discount relative to the metal. By August 1864 the discount had hit its widest point as the paper traded at 38 cents on the gold dollar.***

As with Somali shillings, economists were curious about these seemingly-orphaned liabilities. Why were greenbacks still accepted? What governed their value? Wicksell, Mises, and Hawtrey held that if there is a demand for the medium-of-exchange as such, this demand would be sufficient to give value to whatever instrument was established by custom as the medium-of-exchange. Thus the continued acceptance of greenbacks at positive values was mostly due their already-favorable marketability.

Countering this panel of illustrious economists was J. Laurence Laughlin. Though Laughlin doesn't attract the same brand recognition as do these other long-dead economists, in his day he was considered to be America's leading monetary economist. In his book The Principles of Money (1903), Laughlin outlined the view that greenbacks should be treated like non-dividend paying common stock. Just as a stock might have some positive value now due to potential dividends several years down the road, the continued positive valuation of greenbacks was due entirely to the possibility of their future redemption.

To illustrate his point, Laughlin drew attention to the market's reaction upon the success of the Union Goverment in the Battles of Gettysberg and Vicksburg. After these battles the greenback's discount to gold dramatically narrowed, presumably because these victories were perceived by the market as increasing the probability of future redemption of greenbacks in specie. Laughlin also mentions the passage of the Redemption Act of 1875, in which the government declared its intention to redeem all greenbacks come January 1, 1879. Though still trading at a discount to gold, greenbacks began to steadily appreciate towards par as this date approached, just like a t-bill approaching maturity. Thus Laughlin's redemption theory held up nicely to the evidence.

While Wicksell described Laughlin's theory as "perverse and fantastic," it was hard for Mises, Hawtrey, or Wicksell to deny that the expectation of future redemption didn't have at least some effect on greenback's value. In his book the Value of Money (1917), Benjamin Anderson struck a middle ground between all parties. Anderson held that Laughlin was right to treat greenbacks like any other asset whose value was dependent on eventual redeemability. But Anderson also thought that Mises and the rest were correct to put an emphasis on greenback's unique monetary function. Anderson combined these views by illustrating how greenback's "money-use" would be captured by the market as an extra bit of ascribed value on top of redemption value, or a liquidity premium.

Just to make things more complicated: New Somali Shillings

Back to the Somali shilling. The last feature of the Somalian monetary economy that I find interesting is the presence of yet another media of exchange — the "New Somali Shilling".**** Just prior to the January 1991 collapse, Somalia had been experiencing accelerating inflation. The Somali government drew up plans to replace existing shillings with the New Somali shillings. Each New Shilling was to be worth 100 old shillings, and notes were to be printed in 20 and 50 shilling denominations

 According to Symes (2006), the first shipment of New Shillings arrived in Somalia several months after the collapse of the state. Ali Mahdi Muhammed, a factional leader in Mogadishu, seized several billion of these official New Shillings and spent them into the economy in November 1991. While New Shillings did gain acceptance, their use was limited to a small area in North Mogadishu—the area controlled by Ali Mahdi Muhammed. Nor were they fungible with the legacy notes. 500 worth of New Shillings, for instance, was not worth 500 worth of old shillings. Nor did New Shillings circulate at the pre-1991 intended value of 100 old shillings to one New Shilling. At the time of Mubarak's article, a New shilling was worth only a third of an old shilling.

This challenges Luther & White's theory that Somalians accepted shillings because of their previous experience with them. Why did Somalians accept New Shillings at all if they were not accustomed to doing so? Why not refuse and continue to trade in legacy shillings? Legacy shillings circulated in Mogadishu at the time, so traders would have presumably had a choice. Why take a bet on an untested currency?

New Shillings also challenge the Laughlin-esque theory that redemption underpins the positive value of fiat paper. If Somalians universally valued shillings because of their future redeemability, why would they not place a higher value on New Shillings relative to old? After all, according to its stated plan, the Central Bank of Somalia was willing to convert 100 old shillings into 1 New Shilling. If it was believed that a newly chartered central bank would take on the liability of Somalia's counterfeit notes, wouldn't that same central bank uphold a commitment to value New Shillings at a far higher rate than old ones? Why then do New Shillings trade a third the price of old shillings rather than at a multiple of 100?

As much as I dislike to leave more questions than answers, that's about all I can do for the time being. One major data point is yet to come. What actually happens to legacy and counterfeit notes when a new central bank begins to operate? The Central Bank of Somalia's website says this:

Towards fully assuming its functional and institutional responsibilities, the Bank has completed the reconstruction of its Headquarters in Mogadishu while the branch in Baidoa has been established and is already functioning with personnel in place.

Perhaps we don't have long to wait.
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*Abduraham in Luther (2012)
**Debate also surrounded the irredeemability of Austrian gulder banknotes. The Revolution of May 1848 resulted in the withdrawal of the convertibility of Austrian gulden banknotes into silver. The discount on gulder notes relative to silver averaged around 15% for the first 10 years and then dipped to an average of 28% from 1859 to 1865. Laughlin pointed out that by the 1860s speculation began to grow that Austria would switch from the silver standard to a gold standard. If the banknotes, still irredeemable, were to be honoured, it became increasingly evident that redemption would be in gold, not silver. At the same time, large silver discoveries were driving down the value of silver relative to gold. As a result of these forces, the market value of notes rose back to par with silver. As the market became progressively more confident that the notes would be redeemed, and redemption would be in much more valuable gold, gulder notes eventually exceeded their stated silver value. Laughlin's theory seemed to be borne out by the facts--the value of orphaned notes was dictated by their future potential redeemability.
*** From A History of the Greenbacks (1903), by Wesley Clair Mitchell
**** Mubarak refers to this instrument as the Na' Shilling.