Showing posts with label scrip. Show all posts
Showing posts with label scrip. Show all posts

Thursday, January 25, 2018

Paying interest on cash

Freigeld, or stamp scrip, is designed to pay negative interest, but it can be re-purposed to pay positive interest.

Remember when global interest rates were plunging to zero and all everyone wanted to talk about was how to set a negative interest rate on cash? Now that interest rates around the world are rising again, here's that same idea in reverse: what about finally paying positive interest rates on cash? I'm going to explore three ways of doing this. As for why we'd want to pay interest on cash, I'll leave that question till the end.

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The first way to pay interest on cash is to use stamping. Each Friday, the owner of a bill—say a $50 note—can bring it in to a bank to be officially stamped. The stamp represents an interest payment due to the owner. When the owner is ready to collect his interest, he deposits the note at the bank. For example, say that 52 weeks have passed and 52 stamps are present on the $50 note. If the interest rate on cash is 5%, then the banknote owner is due to receive $2.50 in interest.

Alternatively the note owner can collect the interest by spending the $50 note, say at a local grocery store. The checkout clerk will count the number of stamps, or interest due, and tack that on to the face value of the note. With 52 stamps, the owner of a $50 note should be able to buy $52.50 worth of groceries, not $50. After all, the store has the right to bring the $50 note to its bank and collect the $2.50 in interest for itself.

Stamped currency seems like a pretty big hassle to me. The clerk behind the counter must count out the stamps on the note by hand, and the owner of the note has to trek back and forth to the bank each week to get the stamp affixed. Instead, imagine that each banknote has a magnetic strip that records how long the bill had been in circulation. This would remove some of these hassles. Weekly trips to the bank for stamping would no longer be necessary, and a note reader installed at a bank or retailer would automatically record how much interest was due, precluding painstaking counting of stamps.

"They use this magnetic strip to track you." says Byers to Agent Scully, The X-Files

Apart from stoking conspiracy theories, there's still a major problem with a magnetic strip scheme. Because each note has entered circulation at a different time, each is entitled to a varying amounts of interest. And this means that banknotes are no longer fungible. Fungibility—the ability to cleanly interchange all members of a population—is one of the features of money that makes it so easy to use. Remove it and money becomes complicated, each piece requiring a unique and costly effort to ascertain its value.

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Our second way of paying interest on money doesn't destroy the fungibility of banknotes. The central bank needs to sever the traditional 1:1 peg between deposit money and cash, and then have cash slowly appreciate in value relative to deposits.

For instance, a central bank might start by setting an exchange rate of $1 note = $1 deposit on January 1, but on January 2 it adjusts this rate so $1 note is equal to $1.0001 deposits, and on January 3 adjust this rate to $1:$1.0002, etc. So the cash in your wallet is benefiting from capital gains. By December 31, the exchange rate will be around $1 note to $1.0365. Anyone who has held a banknote for the full year can deposit it and will have earned 3.65 cents in interest, or 3.65%. 

The major drawback with this scheme is the calculational burden imposed on the population by breaking the convenient 1:1 peg between cash and deposits. Assuming that retailers price their wares in terms of deposits, anyone who wants to pay in cash will have to make a currency conversion using that day's exchange rate. For instance, if the central bank's peg is currently being set at $1 note = $1.50 in deposits, then a popsicle that is priced at $1 will require—hmmm... let me check my calculator—$0.667 in cash. Phones will make this exchange rate calculation easy, but it is still likely to be a bit of a nuisance.

There are other hassles too. Would a capital gains tax have to be paid on the appreciation of one's cash? How would existing long-term contracts deal with the divergence? For instance, if my employer is paying me $50,000 per year, obviously I'd prefer this sum be denominated in steadily appreciating cash rather than constant deposits, and she will prefer the latter. What becomes the standard unit of account?

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The last way to pay interest (at least as far as I know) is to run lotteries based on banknote serial numbers, an idea independently proposed by Hu McCulloch and Charles Goodhart back in 1986.

Central banks would periodically hold draws entitling the winning serial numbers to large cash prizes. For example, if there was $100 billion in banknotes in circulation, the central bank could set the interest rate on cash at 5% by offering prizes over the course of the year amounting to 5% of $100 billion, or $5 billion.

This technique of paying interest on cash solves the fungibility problem that plagues the earlier stamping technique. Every note has the same chance of winning the lottery, and non-fungible winners are immediately withdrawn. And unlike the crawling peg idea, banknotes and deposits remain equal to each other so burdensome exchange rate calculations don't need to me made.

However, it introduces the threat of bank runs. The day before the big lottery is set to occur, everyone will withdraw deposits for cash so that they can compete in the draw. To prevent a bank run, it may be necessary to randomize the date of the big lottery so that no one knows when to withdraw notes, an idea proposed by Tyler Cowen. Another way to preclude bank runs is to have a regular stream of small weekly lotteries rather than one or two big ones each year.

Another drawback to note lotteries is the cost that is imposed on society by having everyone constantly checking serial numbers. As Brian Romanchuk points out, employees who are working behind their employer's tills may be tempted to switch out winning notes with losers. Employers may protect themselves by setting up scanning hardware to read in serial numbers as banknotes enter the tills, maintaining their own internal database of cash inventories so that winners can quickly be isolated and returned. But all of that is costly. Would it be worth it?

Interestingly, there is some precedent for these sorts of lotteries. In Taiwan, receipts are eligible for a receipt lottery, a neat way to incentivize people to avoid under-the-table transactions (ht Gwern). Lotteries can also be useful in attracting depositors, as outlined in this Freakonomics podcast (ht Ryan). George Selgin and William Lastrapes have gone into the idea of lottery-linked money in some detail:
Though the suggestion may appear far fetched, in many countries lotteries are presently being used with considerable success to market bank deposits. According to Mauro Guillen and Adrian Tschoegl (2002), “lottery-linked” deposit accounts have been especially popular with poorer persons, including many who might otherwise remain “outside the banking system.” ... In two popular Argentine schemes, for instance, depositors receive one ticket or chance of winning for every $200 or $250 on deposit (ibid., p. 221). Lottery-linked banknotes, in contrast, would themselves serve as tickets, allowing persons to play for as little as the value of the lowest note denomination, and with no apparent cost to themselves save that of occasionally inspecting their note holdings.
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Some readers may recognize these three techniques for paying interest on cash as the inverse of the three go-to ways of applying negative interest rates to cash being discussed a few years ago. For instance, one of the most well-known ways of imposing negative interest rates on owners of cash is to apply a Silvio Gesell style stamp scheme (see picture at top), whereby a currency owner must buy a stamp and affix it to the note in order to renew the validity of their currency each month. (I once discussed Alberta's experiment with Gesell's "shrinking money" here). Without the appropriate number of stamps, the note is illegitimate. In my first example above, Gesell's stamp tax has been re-engineered into a stamp subsidy. As for the magnetic strip modification, this is Marvin Goodfriend's 1999 update of Gesell, flipped around to award interest rather than docking it.

Miles Kimball has written extensively on escaping the zero lower bound to interest rates by setting a crawling peg on currency. But just as Kimball's crawling peg can impose a negative interest rate on banknotes, it can be used to pay interest, as I described above. Indeed, Miles (along with Ruchir Agarwal) frequently mention this possibility in his blog posts and papers (see this pdf).

Finally, remember Greg Mankiw's controversial 2009 article on imposing negative interest rates by serial number? He wrote:
Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.
Mankiw's idea is just the reverse of Goodhart and McCulloch's earlier lottery idea, the lottery replaced by with a demonetization.

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So why pay interest on currency? I can think of two reasons. One is based on fairness, the other on efficiency.

The decision to avoid paying the market rate of interest on currency amounts to a tax on currency users. Who pays this tax? Cash is often the only means for the poor, new immigrants, and unbanked to participate in the economy. So the tax falls on those who can least afford it. This hardly seems fair. By conducting note lotteries or stamping notes, those consigned to the cash economy can get at least the same return on banknotes as the well-off banked receive on deposits.

Now hold up JP, some you will be saying at this point. What about criminals? Yep, the other group of people who suffer from the lack of interest on banknotes are criminals and tax evaders. Rewarding them with interest hardly seems appropriate. One would hope that if central banks did adopt a mechanism for rewarding currency with interest, it would be capable of screening out bad actors. For instance, criminals may be leery of collecting their interest or lottery prize if making a claim at a bank means potentially being unmasked. Another way to set up the screen would be to pay interest or prizes on small denominations like $1-$10 notes, and not on $20s and above. Since criminal organizations prefer high denomination notes due to their compactness, they wouldn't benefit from interest.

As for the efficiency argument, this is nothing but the famous Friedman rule that I described in my previous post. All taxes impose a deadweight loss on society. When a good or service is taxed, people produce and consume less of it than the would otherwise choose, tax revenues not quite compensating for this loss. From a policy maker's perspective, the goal is to reduce deadweight loss as much as possible by selecting the best taxes.

In the case of cash, the deadweight loss comes from people holding less of it than they would otherwise prefer, incurring so-called shoe leather costs as they walk to the bank and back to avoid holding too much of the stuff. If a 0% return on cash is an inefficient form of taxation relative to other alternatives types of taxes, then it would be better for the government to just pay interest on the stuff and recoup the lost revenues elsewhere, say through consumption taxes or income taxes.
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Thursday, October 12, 2017

The ubiquitous Spanish dollar—a photo essay


"The head of a fool on the neck of an ass."

That's how Londoners described the strange silver coin pictured above, which first appeared in Britain in 1797. Due to worries that Napoleon was about to invade the British Isles, a run had developed on the Bank of England. In response, Parliament allowed the Bank to refuse to redeem its notes with gold coins, but this had only resulted in an inconvenient shortage of coins.

To remedy the shortage, the Bank of England decided to open its vault and put its hoard of silver coins into circulation. Complicating matters was the fact that these coins were not native shillings or pennies, but Spanish dollars, otherwise known as eight real pieces. As such, they had to be re-purposed into local currency. The Bank of England accomplished this task by stamping the head of King George III—the fool—on the neck of Charles IV of Spain—the ass—who occupied the obverse side of that era's version of the Spanish dollar. The Bank then declared that all stamped Spanish dollars were to be worth four shillings and nine pence. People flocked to the Bank of England's window to get their hands on the new coins.  

That the Spanish dollar temporarily became part of England's circulating media of exchange was due to its ubiquity—in its heyday the Spanish dollar, like today's U.S. dollar, was everywhere. After discovering huge amounts of silver in the new world, the Spaniards had set up a mint in Mexico City in 1536 to produce large quantities of silver coins. Mints in Potosi (Bolivia), Lima (Peru), and elsewhere soon followed. It is estimated that some four-fifths of the world's silver produced between 1493 and 1850 came from Spanish America, almost all of it in the form of Spanish dollars! 


Although their design changed over the centuries, by the 1700s the Spanish dollar—easily identified by the two "pillars of Hercules" on the reverse side of the coin—had become known and accepted all over the world. As the map above shows, the two pillars refer to the Rock of Gibraltar in Spain and its counterpart on the Moroccan side of the narrow strait separating Africa from Europe.

In addition to England, the Spanish dollar shows up in the Caribbean islands where it made up a major part of the local coinage. To provide small change, locals cut dollars up into pieces. Below, an 1806 dollar used in Guadeloupe has had its centre carved out of it and stamped with the letter "G". Earmarking of coins was done to prevent exportation and restrict usage within borders. In this way, local currencies were literally piggybacked into existence off of the ubiquitous Spanish dollar.

Source: The Spanish Dollar as Adapted for Currency in Our West Indian Colonies

In the next image, a Trinidadian version of the dollar has been carved up like a pizza. The half piece has been countermarked with a "6", the third with a "4", and the sixth with a "2". These numbers refer to the number of bits or bitts the piece was worth, the bit being a local accounting unit. By marking the letters "TR" on each dollar to indicate Trinidad, the Spanish dollar has been forked to create a second currency.

Spanish dollar marked with TR for Trinidad

All possible methods of cutting up Spanish dollars were used. Here's a 1797 dollar from Saint Lucia that has been cut up lengthwise, like a loaf of bread, with "SLucie" being countermarked on each section.

Saint Lucia Spanish dollar

The Spanish dollar also made a notable appearance on the opposite side of the globe. In 1813, the colony of Australia minted its first currency, the so-called holey dollar. To deal with a shortage of coins, the governor of New South Wales imported thousands of Spanish dollars. A convicted forger was contracted to cut the centre from each one, countermarking each of the resulting pieces with the name of the colony and its nominal value in shillings and pence. As in the case of the Caribbean Islands, this mutilation of the dollar was an attempt to render them useless outside of the colony. The outer ring was rated at five shillings and the centre—the dump—at fifteen pence, or one shilling and three pence. 


The Spanish dollar, which would become the Mexican dollar after Mexico won its independence from Spain, was also popular in China. Merchants and professional money exchangers, or shroffs, would test a coin to verify its silver content. According to James Gullberg, they went about this by balancing the coin on their finger and tapping it. If it rang, it was legitimate. The theory goes that once the coin had passed their purity test, a shroff would stamp that coin with his own peculiar chopmark—a Chinese character, an emblem, symbol, or a pseudo character. (I discussed this practice in more depth here). The more chops a Spanish dollar had, the better its quality—even after it had been chopped beyond recognition.

1807 Spanish dollar with chopmarks

Pictured above is a chopped Spanish dollar from 1807. According to Gullberg, Chinese merchants preferred the Carolus IIII dollar, which was issued between 1772-1810. They referred to it as four work, the IIII resembling the Chinese character for going to work. The influence of the Spanish/Mexican dollar continued even into the 19th century: the banknote below, issued in 1912 by the Sino-Belgian Bank, is redeemable in Mexican dollars.


Moving back west, the Spanish/Mexican dollar had a key role to play in the North American economy up to the mid-1800s. In both Canada and the U.S., the unit of account function of money was separated from the medium of exchange function. Early colonists kept prices in pounds, shillings, and pence unit of account, but Spanish dollars and their subdivisions were used to transact business. Because of the long distance from England, there simply weren't enough shillings and pennies to make do.

Even though a local U.S. dollar coin—which was modeled off of the Spanish dollar—had been minted as early as 1794, the Spanish version remained by far the most popular form of coinage in the U.S. The presence of the Spanish dollar was even enshrined in American law, the coins having been declared legal tender in 1793. Many people have even speculated that the famous dollar sign, $, has been bastardized from the symbol for peso.

Source: Evolution of the Dollar Mark (1912)


To illustrate the ubiquity of the Spanish dollar in the U.S., below I've included a 6¼ cent note issued in 1816 by Easton and Wilkesbarre Turnpike Company, which built and operated private toll roads. This odd denomination only makes sense if you consider it in the same context as the Spanish dollar. Unlike U.S. dollars, which were divisible by 100 into cents, the Spanish dollar was divisible into 8 reals. A one-real coin, a fairly common unit around that time, would have been worth 12½ cents, and a ½ real coin worth 6¼ cents. So while the turnpike company's decision to issue a 6¼ cent note might seem odd to us today, it was probably meant as a convenience to its users, who would have been more familiar with Spanish coins than any other type of coin.


As for Canada, below is an 1819 $5 bill from the Bank of Upper Canada. To help customers who couldn't read, the bank conveniently printed an image of five Spanish dollars at the bottom of the note.

This 1819 banknote has five Spanish dollars illustrated along its bottom

For a number of reasons, the Mexican dollar was eventually killed off . The U.S. had originally been on a bimetallic standard, but in 1834 the authorities changed the silver-to-gold ratio to 16:1 from 15:1, in the process slightly overvaluing gold. The discover of the yellow metal in California only further pressured the price of gold down relative to silver, exacerbating the legally-imposed undervaluation of silver. As a result, silver coins began to disappear. After all, anyone who had a stash of silver coins would have found it more profitable to melt them down and export them overseas where they traded at their true economic value. The U.S. had effectively flipped onto a gold standard. To compound matters, Spanish dollars lost legal tender status in 1856, which would have further crimped their demand.

As for Asia, several competing coins were created, including the Japanese yen, a near-replica of the Mexican dollar. The U.S. began to produce special trade dollars that were to be used solely in Asian trade (I wrote about the trade dollar here). Further reducing the demand for Mexican silver was the decision by many nations to follow the major western nations and officially adopt gold standards, including Japan in 1897 and the Philippines in 1904.

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Even though it was eventually eclipsed, there are still modern day echoes of the old Spanish dollar. The pejorative term two bit is still used in the U.S. as a synonym for cheap or insignificant, as in two-bit thief. One bit was ⅛ of a dollar, or 12.5¢, and two-bits 25¢, so a two-bit thief is a 25¢ thief. Amazingly, the practice of pricing in sixteenths continued on the New York Stock Exchange up till 2001. The Toronto Stock Exchange decimalized in 1996.


Up here in Canada, Quebecers use the word piasse for dollar. I had always assumed that they meant piece, but I recently discovered that the wording actually goes back centuries to piastre, the French word for the Spanish peso. Even more interesting is the vernacular usage of trente-sous (or 30 sous) to mean 25-cents, which I only understood after reading this from Frédéric Farid.
 
After the '87 market crash, a business man begs for 25¢ (Source)

The story goes like this. In the 18th and 19th Centuries, an English halfpenny was referred to in the colony of Lower Canada (i.e. Quebec) as a sou. The pound-shilling-pence unit of account (£/s/d) was still in use at the time but Spanish dollars were the most common coin in circulation in both Upper and Lower Canada. Dollars were officially rated by the British authorities at $4 for each £1. A quarter Spanish dollar (a two-real coin or 25 cent piece) would therefore be worth £0.0625.

Since an English pound contained 240 pence, that meant a quarter Spanish dollar was worth 15 English pennies, or 30 half-pennies. And given that Quebecers referred to half-pennies as sous, that gave rise to the ongoing practice of referring to 25 cents as 30 sous. When they use this term today, Quebecers are just referring to the archaic exchange rate between Spanish dollars and pence.

Source: La Maison nationale des Patriotes

This odd system of conversion really hits home when you work through the above scrip note emitted by Distillerie St-Denis, printed in 1837.  It is denominated in three different units. Trente-sous appears twice in French and once as XXX, while in the English paragraph near the bottom the £/s/d equivalent of one shilling and three pence, or fifteen English pennies, appears. Finally, a two-real coin, or quarter dollar—the pillars of Hercules side showing—has been emblazoned smack in the centre.

To end things off, you can also see a ghost of the old Spanish dollar in Venezuela's 12½ centimos coin. This coin is an eight of a bolivar—reckoning in terms of eights and sixteenths is a hallmark of the days of the old pillar coin.
Given Venezuela's ongoing hyperinflation, the likely destiny of the 12½ centimos coin is to be nothing more than another two-bit dead coin.


Sources:
George Selgin, Good Money
A. Piatt Andrew, The End of the Mexican Dollar (link)
J.B. Caldecott. The Spanish Dollar as Adapted for Currency in Our West Indian Colonies (link)
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Tuesday, April 25, 2017

Leaving a monetary union is difficult, but Hawaii pulled it off


In campaigning for a departure from the Euro, both France's Marine Le Pen and Italy's Beppe Grillo,  make the process sound easy. But one does not simply walk out of a monetary union. There are all sorts of messy problems to deal with, including harmful bank runs, massive banknote shortages, and long legal battles with investors over wealth confiscation and the redenomination of debts.

I recently stumbled on a successful and rarely-discussed exit from a monetary union: Hawaii in 1942. Hawaii's was a different sort of exit than a potential French or Italian euro exit. Whereas the latter are reactions to being straitjacketed in the face of a slow and grinding recovery from financial crisis, Hawaii's exit was executed in anticipation of a potential military invasion. Despite differing motivations, it's worth investigating the Hawaiian episode to see what it takes to pull off a successful exit.

To understand the course of events, I drew on several Fed bulletins from 1942 (including this one),  but for the most part relied on Martial Law in Hawaii, written by Brigadier General Thomas H. Green, the man who designed Hawaii's exit from the U.S. monetary union (PDF here). As everyone knows, Pearl Harbor was bombed by the Japanese on December 7, 1941. Hawaiian residents soon began to fear that a full scale invasion was imminent, and a bank run of sorts developed on the island. Here is Green describing the run:
"From the time of the Blitz, everyone realized the possibility of the return of the Japs and naturally gave consideration to the safety of their money. Those who had bank deposits began to worry about the security of their deposits and as a result many withdrew their savings and secreted them in various places considered safe...The result was that the banks were gradually running out of cash."

In the light of what the Japanese invasion forces were doing in the Pacific theatre, fleeing one's bank made good sense. According to Green, when the Japanese surprised the British forces in Singapore, they confiscated all hard currency, both from banks and and individuals' wallets. For the recalcitrant, Japanese troops had "special procedures" for getting prisoners to give up their possessions. Later on, the territories occupied by the Japanese would be forced onto a scrip-based monetary standard which quickly succumbed to inflation. Given such a fate, better for Hawaiians to withdraw U.S. banknotes ahead of an anticipated Japanese invasion rather than during or after one. That way they'd have enough time to find a good hiding spot for their notes on Hawaii, or ship them to the mainland for safekeeping.

The same sort of defensive run that occurred in Hawaii also happened several years ago in Greece. Greek fears that they would be cut off from the euro, their deposits suddenly frozen only to be redenominated into a much less valuable unit of account, led them to cash out before the anticipated event. In both cases, premonitions of confiscation motivated the run.

Brigadier General Green put an end to Hawaii's bank run on January 9, 1942 by prohibiting the withdrawal of more than $200 per month from banks and forbidding anyone from holding more than $200 in cash. Although he doesn't specify, I'm going to assume that this $200 limit applied not only to cash withdrawals but also bank wires from Hawaii to mainland banks. By putting an end to the convertibility of local bank deposits, Hawaii now had one foot out of the dollar zone. A dollar held in a Hawaiian bank was no longer quite like a dollar in the rest of the U.S.

For those with long memories, the same thing happened in Greece in 2015 when capital controls and cash withdrawal limits were imposed. Frozen Greek euros held in banks were no longer fungible with the rest of Europe's money. 

In principle it should be very difficult to enforce limits on cash holdings. Yet Brigadier General Green described the effect of his prohibition as "astonishing." Where before banks only had $1.5 million on deposit, over the next several days long lines developed to deposit funds so that after the order, banks found themselves with more than $20 million on deposit. Much of the banknotes were "moist and even wet," noted Green, indicating that they had been recently unearthed from hidden caches. 

While Green's prohibition stopped Hawaii's bank run, it didn't solve the problem of how to prevent notes from being seized should the Japanese invade. Green's initial solution to the confiscation problem was clumsy one. On the first sign of an invasion, Treasury employees toting burlap bags were to run to important intersections in Honolulu where they would collect bundles of banknotes from citizens, providing a receipt in return. The burlap bags containing the money would then be delivered to the city incinerator where they would be burned. The receipts, which would be redeemable for currency after the war, would be worthless to the Japanese, who wouldn't be able to collect on them.

Luckily, Green soon came up with a more elegant approach: create a new currency, or scrip, ahead of time. In the event of an invasion, this scrip would be immediately outlawed by a simple proclamation, thus preventing its use by the Japanese. Far easier to solve the confiscation problem by mere proclamation than have employees standing at intersections with burlap bags. Agreeing to the idea, the U.S. Treasury had a special issue of banknotes printed up. The new bills were similar to ordinary U.S. banknotes except that the seals and the numbers were printed in brown ink instead of green and the bills bore the word "Hawaii" overprinted in black on both sides (see top image).

On July 7, 1942 the Governor announced that anyone in Hawaii holding U.S. currency had until July 15 to visit a bank and turn the notes in for special Hawaii overprints. After the 15th, it would be illegal to hold regular banknotes. Henceforth, all notes imported from the mainland had to be immediately turned over to the authorities for conversion. Exports of overprints was prohibited. Anyone who wanted to transfer wealth to the mainland had to exchange it with authorities for regular currency. The punishment for evading these rules was harsh:
"Whoever is found guilty of violating any of the provisions of such regulations, shall, upon conviction be fined not more than five thousand dollars ($5,000), or, if a natural person, may be imprisoned for not more than five (5) years, or both." (source)

Over the 7-day exchange window, U.S. banknotes that were brought into banks for conversion were collected and burned. According to the New York Times, more than $200 million was taken to a crematorium in Oahu that soon ran out of capacity, the rest subsequently being hauled to furnaces at a a local sugar mill. Among the officer ranks, the task of serving on the crew that burnt notes was much sought after. Here is Green:
"Applications for the last named post were numerous and it was not until I learned of the practice of lighting cigarettes from bills of large denominations that I understood the desirability of such duty. This ritual was enjoyed, especially by young officers who had little prospect of handling, much less burning, bills of large denominations."
So by July 15, 1942, Hawaii had effectively left the dollar zone. Gone were regular greenbacks. The sole media of exchange were Hawaiian overprints and overprint-denominated deposits. In practice, the authorities maintained a policy of pegging Hawaiian dollars to U.S. dollars at a rate of 1:1. But if they wanted, they could have easily ratcheted that peg down or up. Alternatively, in the event of an invasion, the authorities could completely unpeg the Hawaiian dollar and let its exchange rate float. Without a strong central bank to back it, the exchange rate would probably have plunged to zero, or at least close to it. Which was exactly the point of Green's scheme... to take all the difficult steps of leaving the U.S. monetary union ahead of time so that, come an invasion, only the last (and easiest) step remained, floating the currency. Very clever.

The era of the Hawaiian dollar was a short one. With the Japanese threat now much diminished, Hawaii would be reabsorbed into the dollar zone in 1944. Regular U.S. dollars were once again allowed to circulate in Hawaii while the issuance of overprints was halted. In 1946 all overprints were recalled and destroyed.

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Could Le Pen or Grillo follow the Hawaii scrip script (pardon the pun) and leave the eurozone by declaring capital controls and then printing out new paper money? Greece went half way when capital controls were instituted in 2015... could it not have gone all the way?

There were probably a few factors working in Major General Green's favor that Le Pen and Grillo lack. To begin with, Hawaii is an isolated set of islands. Avoiding the note exchange window and sneaking dollars to the mainland would have been tricky. European borders are quite porous. I don't see why French or Italian citizens would submit to bringing their euro banknotes in for conversion to an inferior currency  when they could easily sneak them across the border into Germany.

Second, martial law had been imposed in Hawaii whereas Italy and France are democratic nations at peace. It would be much harder for the likes of Le Pen and Grillo to pass the draconian set of laws (and associated punishments) necessary for exit.

In executing an exit from a monetary union, in the time that elapses between the limit on bank withdrawals and the issuance of a new currency, the economy will probably suffer from a deep note shortage. Because so many people remaining on Hawaii were enlisted men whose needs were taken care of by the army, monetary exchange was less crucial. Not so the economies of modern France and Italy, which would endure a crippling shortage of transactions media.

Finally, the attitudes of citizens are different in wartime. United against a common enemy and trusting of their leaders, Hawaiian residents by-and-large submitted to the monetary inconveniences that were seen as necessary to winning. Witness the long lines described by Green for depositing notes after the $200 holding limit was established in January 1942, despite the impossibility of authorities actually enforcing such a rule. Le Pen and Grillo, on the other hand, govern divided populations. The requisite society-wide eagerness to leave the euro, one that would emerge in the face of a strong invading force, just isn't there.
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Sunday, April 9, 2017

C-day and military money


 Did Indian PM Narendra Modi get the idea for the recently-executed demonetization by watching old episodes of M*A*S*H, a 1970s hit TV show set in the Korean War?

In the clip below, M*A*S*H's Colonel Potter is alerted to an imminent phasing out old "blue" military money with red, the idea behind the switch to punish counterfeiters and black marketers. As the conversion is happening, Colonel Potter is ordered to make sure that the gates to the base are closed so as to prevent illegitimate blue money from being smuggled in for changing. Sounds a bit like Modi's November 8, 2016 sudden phasing out of ₹1000 and ₹500 notes, no?



The money switch depicted in the M*A*S*H episode isn't just fiction. During the Vietnam War, mass demonetizations were a fairly common event on military bases. To isolate dollar-using U.S. troops and civilian contractors from the regular Vietnamese monetary system, U.S. military authorities fashioned a parallel scrip-based system in which Military Payment Certificates, or MPCs, displaced regular dollars as the medium of exchange on U.S. bases (see top for an example).

All troops arriving in Vietnam were required to convert their U.S. cash into MPCs at a 1:1 rate. Over the course of a tour, troops received a monthly MPC stipend which could be spent at the army store on things like cigarettes or Pentax cameras. Usage of certificates by local Vietnamese or by troops off-base was prohibited. At the end of their tour, troops would reconvert all MPCs back in to dollars at the 1:1 rate, since any MPCs brought back to the U.S. were useless.

Unsurprisingly, the rule prohibiting non-American usage of MPCs was ignored as Vietnamese retailers began accepting MPCs from American GIs in payment. This was seen as a bad thing by the U.S. military and Vietnamese government, since any spread of MPCs into the domestic economy would displace local currency (in Vietnam's case the piastre), hindering the goal of rebuilding the local economy. To counter dollarization, U.S. authorities would periodically carry out sudden cancellations of existing MPC, replacing them with a new issue of scrip so as to strand Vietnamese users. With all Americans being confined to base on conversion day , or "C-day", there was no way for locals to get U.S. soldiers to act as go-betweens for conversion. This ever-present threat of C-day should, in theory at least, slow down the dollarization of the Vietnamese economy.

The other reason for regularly cancelling and reissuing MPCs was to flush out U.S. troops engaged in black market activity.  All GIs were allowed to convert a fixed amount of old MPC on C-day, no questions asked. Unusually large conversion requests above that amount would be investigated by military police to ensure that this wealth hadn't been dubiously acquired. To avoid being investigated, a would-be black marketeer might choose to sacrifice their MPCs, thus losing a large amount of wealth. These periodic losses would drive up the costs, and attractiveness, of engaging in black market activity.

The success of these conversions depended on secrecy, since any leakage of an imminent C-day would cause unauthorized users of MPC to quickly convert their hoard into goods at the military store, or exchange them on the black market into piastre or regular dollars. According to Prugh, the first C-day on October 21, 1968 resulted in $276.9 million in certificates being converted, with $6.2 million going unaccounted for, presumably because they were in the hands of unauthorized persons. The next C-day occurred less than a year later, on August 11, 1969. In the next conversion on October 7, 1970, about 25% of recalled MPCs were not accounted for, according to this GAO document. The final C-day took place almost three years later on March 15, 1973.

There were all sorts of ways to game the scrip system. During their tour of duty, troops were allowed to exchange MPC into dollars and transfer that value home by money order, as long as this amount did not exceed the soldier's monthly stipend. To get around these limits, those holding excessive amounts of MPC could recruit others with spare sending capacity as 'straw men' to transfer money on their behalf. We saw this happening in India too. During the recent demonetization, each Indian was allowed to deposit ₹250,000 worth of demonetized notes during the 50-day conversion period, no questions asked. Those holding large amounts of rupees paid others under the table to make use of their shelter.

Another trick used by GIs was to have regular $100 bills mailed to Vietnam. A GI could sell these dollars to a local for MPC at a premium, says $110. Locals were willing to pay this premium because regular dollars, which couldn't be demonetized, offered them protection . The GI could then convert this $110 in MPC into $110 dollars upon departure (or by money order), thus earning $10 round-trip.

Modi's reasons for embarking on demonetization mirrors those of the Vietnam-era C-day. The U.S. military used conversions to encourage use of piastre among locals; Modi used it to encourage use of digital money. And both want to attack the black market. It is somewhat worrying, however, that the best historical analogue for Modi's demonetization comes from wartime. I do realize that the army has developed a number of technologies now in wide civilian use, including the internet, but as a general rule the mechanisms adopted to cope during wartime are probably not ideal for peacetime.

The MPC program died decades ago. Nowadays, regular cash circulates freely on U.S. army bases overseas. Interestingly, the military is making an effort to go cashless, due in part to the high cost of shipping banknotes and coin to distant war theaters. To help cut these costs, the Department of Defence used cardboard tokens, or "pogs", rather than metal coins in the recent wars in Iraq and Afghanistan.
The Department of Defence has also encouraged usage of the EagleCash card, a stored-value card. One thing is for sure: closed-loop digital money is a far more effective way than paper-based scrip for isolating an army from the domestic monetary system of the nation it is occupying.
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