The State(s) Theory of Money: California and Canadian Tire

I learn via Mark Thoma that there is a distinct chance that California will allow taxes to be paid in the new scrip it issued when it ran out of funds. I have no idea whether this will happen, or whether the Federal government will stop it. Let me just assume that it does happen, and that the Federal government does not stop it. I'm (almost) hoping that it does happen, and that the Fed doesn't stop it, because it would be such a fascinating experiment in monetary theory.

Assuming this experiment does go ahead, what are the chances that California scrip will circulate as a medium of exchange, and be generally acceptable, not just at banks, but in exchange for all or most goods and services?

Another way to ask this question: what's the difference between California and Canadian Tire?

For non-Canadian readers let me explain that Canadian Tire corporation is a large chain of stores selling a wide range of automotive supplies, hardware, sports and camping equipment, gasoline, etc., that has many outlets across Canada. And it issues Canadian Tire "Money". CT money consists of small paper notes, about the same size as US dollar bills, in denominations ranging from a few cents up to a couple of dollars. When you buy something at Canadian Tire, you get CT money with a face value of a couple of percent of the purchase price. Canadian Tire money is redeemable for merchandise, at par with Canadian dollars, at all Canadian Tire stores.

That last sentence is crucial. If the State of California accepts California scrip for payment of taxes, at par with US dollars, it is just like Canadian Tire. Sure, you have to pay taxes, and you don't have to shop at Canadian Tire, but most Canadians do shop at Canadian Tire, and do so more times a year than most Californians pay taxes (if we are talking about annual income taxes, at least). So the frequency with which Canadian Tire money can be redeemed at its issuer will exceed that of California scrip.

But Canadian Tire "Money" does not normally circulate as a generally accepted medium of exchange. In special circumstances, someone (other than Canadian Tire) might accept Canadian Tire money in payment for goods, but only as a favour if you have run out of "real" money, or at a discount. It is not generally used outside of Canadian Tire stores. People generally redeem it as soon as they next visit a Canadian Tire store (or just leave it stashed away until they remember to do so).

And we can understand why Canadian Tire money does not circulate as a medium of exchange. This is a case where, contrary to Gresham's Law, good money drives out bad. (Gresham's Law does not apply because there is no legal tender law saying that merchants have to accept Canadian Tire money at par, and only Canadian Tire does so).

We have known since Carl Menger that money, like language, has network effects. If the people with whom you interact are already speaking a particular language, or using a particular medium of exchange, that increases your incentive to adopt that same language or medium of exchange. Conventions can arise spontaneously, and have the force of custom. Canadian Tire money would have to be, not just as good as, but significantly better than the Loonie, in order to compete with the Loonie as a medium of exchange.It isn't. You can redeem Canadian Tire money at par in Canadian Tire stores, and below par elsewhere, so everybody just redeems it at Canadian Tire stores. It doesn't circulate.

So California scrip would end up like Canadian Tire money - being kept in the glove box until your next visit to the issuing store - except for one thing: California scrip pays 3.5% interest; Canadian Tire money pays none. In that one respect at least, California scrip is better than US dollars.

Suppose California scrip does end up circulating as a medium of exchange, being generally acceptable at par to US dollars. Is that possible? I don't think it is, because then Gresham's Law would kick in. If I hold both in my pocket, and merchants will accept both, at par, I would pay with US dollars, and hoard the California scrip, to collect the interest.

It's hard to model a stable equilibrium in which two different monies could circulate side-by-side. If one money gains any slight advantage over the other, and becomes more widely accepted, that makes people even more willing to use it, and less willing to use the other, until one money dominates. And that's what we normally see, except in "bilingual" border zones.

And I just find it hard to imagine that California scrip could ever displace the US dollar as the preferred medium of exchange, even in California. The 3.5% interest might offset any risk of default or depreciation, but the sheer force of custom should outweigh both.

Comments

[JP Koning]

Interesting analogy Nick.

I don't agree with your point though that good Canadian currency has driven out bad Canadian Tire money as a medium of exchange, or that legal tender laws don't apply.

Canadian law makes money creation illegal by anyone but the state:

"Every bank or other person who issues or reissues, makes, draws or endorses any bill, bond, note, cheque or other instrument, intended to circulate as money, or to be used as a substitute for money, is guilty of an offence against this Act." Banking Law Revision Act

Acceptance of private money is illegal too:

"Every contract, sale, payment, bill, note, instrument and security for money and every transaction, dealing, matter and thing relating to money or involving the payment of or the liability to pay money shall be made, executed, entered into, done or carried out in the currency of Canada, unless it is made, executed, entered into, done or carried out in (a) the currency of a country other than Canada; or (b) a unit of account that is defined in terms of the currencies of two or more countries." Currency Act

Wallace and Eichenbaum (http://www.minneapolisfed.org/research/QR/QR911.pdf) explain how the decision by Rona to accept Canadian Tire money at face value as payment in 1983 forced Canadian Tire to go to court. After all, had Rona continued to accept Canadian Tire money (and been copied by others in a Mengerian manner), it might be interpreted that Canadian Tire was creating a circulating generally accepted currency, and would have put the company in contravention of the law.

In sum, the reason Canadian dollars circulate rather than CT money could be largely due to the legal restrictions that subsidize trades in C-dollars but prevent CT money from being accepted, and not any intrinsic advantage of C-dollars. No large company will accept CT money as payment, for were they to do so they might be pursued by Canadian Tire in court. Without these laws, it might be that CT money would have displaced C-dollars years ago.

[Nick Rowe]

And very interesting comment JP. I hadn't known about the Rona case. That second clause in the currency act sounds positively draconian. On my reading, it sounds like it could prohibit a lot of contracts like swaps (in both the financial market and ordinary sense). Sounds like it is so broadly worded that they can just prohibit what they please. The "substitute for money" bit would seem to prohibit almost any asset!

But then I think of Cuba, where possession of US dollars was illegal for many years, with much more serious penalties, and yet US dollars were used as money.

[Jon]

The 3.5% interest might offset any risk of default or depreciation, but the sheer force of custom should outweigh both.

But the interest-rate is precisely why it wouldn't trade as a medium of exchange--because it holds its value.

[Nick Rowe]

Jon: yes, that was what I was trying to get my head around in my second mention of Gresham's Law: "Suppose California scrip does end up circulating as a medium of exchange, being generally acceptable at par to US dollars. Is that possible? I don't think it is, because then Gresham's Law would kick in. If I hold both in my pocket, and merchants will accept both, at par, I would pay with US dollars, and hoard the California scrip, to collect the interest."

But what I didn't/couldn't work out is whether it might trade at above par.

In other words, can we imagine an equilibrium in which scrip depreciates over time, relative to the US dollar, but the 3.5% interest offsets a 3.5% expected depreciation?

If we drop the assumption (implicit in Gresham's Law), that two monies trade at the same exchange rate over time, then we seem to get the opposite result: good money drives out bad, because people will not want to accept the bad money. (By "good" I mean the one with a higher expected return, including both interest and depreciation/appreciation.) If something like this weren't true, then we would all be using Zimbabwe dollars, which would have driven all other monies out of circulation.

[Nick Rowe]

Thinking back to JP's comment: I was in Renfrew (small town outside of Ottawa) the other day. The local restaurant was advertising that it would accept one of those "local monies". "LETS"?

Those Currency Act laws he cites are much stronger than the so-called "legal tender" laws (which to my mind are just a legal dictionary to define what "dollar" means). But they don't seem to be enforced very systematically.

[anon]

A couple of additional wrinkles re Canadian Tire Money:

a) CT money is ISSUED only when a customer pays in cash; not when he pays by credit card. Presumably this is due to the cost to CT of credit card merchant transaction fees.

b) I recently bought a lawn mower for about $ 300 at CT. I was carrying enough cash to pay in cash. At the checkout, I asked how much CT money I would get if I paid in cash. I don’t remember the exact amount, but I was surprised and appalled at how low it was. I immediately decided to pay by credit card and forgo the CT money benefit. This had something to do with an instinct to protest, as well as my own liquidity preference function. Carrying cash makes me feel more like Donald Trump, at least when he’s not filing for bankruptcy. Carrying on the conversation with the cashier, I was told that CT has reduced the CT money payout ratio and is planning on doing away with the idea altogether. Given this, CT money at some point in the future may have value for a different reason. Coincidentally, I tend to hoard mine anyway, because my CT purchases tend to be more spontaneous than my contingency planning for CT money deployment, or I've forgotten where I've stored it.

[Greg]

Of course, it's not uncommon for bars occasionally to hold small-scale promotions where they accept Cdn Tire money. One way of looking at this is that what they're really doing is offering a way to clients to use their store of funny money (increase the velocity) while not offering discounts/promotions they would otherwise have to offer to get the same crowds in.

Which hints at another reason Crappy Tire (semi-official slang name) might occasionally bring the force of law to bear, while allowing some events that are effectively free publicity. The more events like this, the more their private money gets circulated, the less likely it may be lost or redeemed early, reducing their free carry.

If you're going to address private currency, though, how can we ignore traveller's cheques? They used to be accepted like money, and in many respects are very similar.

[Greg]

Whoops, should have said "the more likely it will be redeemed early."

[Nick Rowe]

Aha! I have now figured out how to approve comments, at least on the posts I authored, so that will take some of the load off Stephen during this spam attack.

anon: I was going to say "You're wrong; you DO get CT money when you pay using the CT credit card!", but then I remembered that the CT money goes directly on your CT card account, so you can't use it to buy anything somewhere else other than at CT, so you are basically right.

But I vaguely remember reading that different CT stores give different % amounts of CT money. Is that right? If so, it's just a way for CT to vary prices across stores and regions.

Greg: If CT money gets lost, then CT never has to redeem it. Same if people store it permanently, or if it circulates permanently. This creates seigniorage revenue for Canadian Tire. Similarly, if California scrip does circulate as money, and doesn't get redeemed, this would create extra revenue for California. Except they pay that 3.5% interest.

We can express the flow of revenue from seigniorage in a couple of ways. One way is money issued minus money redeemed minus interest payments (if any) on the stock of money outstanding. A second way is stock of money outstanding times difference between interest on bonds minus interest on money. Let's use that second way to think about California.

If that 3.5% interest on scrip is approximately equal to the interest rate on California State bonds, then it makes no difference to the California long run budget constraint whether the scrip is issued and circulates as money, or if they issue bonds instead. In the short run it only makes a difference because scrip is a way for California to evade their own legislative ceiling on issuing bonds. Being able to print money is only a source of income if the interest you pay on money (if any) is less than the interest you would pay on bonds. This can only happen if people are willing to accept your scrip, even at a lower rate of interest, because it is more liquid, being acceptable as a medium of exchange.

[jp]

I agree, the Currency Act sounds draconian. It would take a lawyer to extract the exact meaning of that phrase. Perhaps it means the unit of account must be in Canadian dollars?

Also, the Bank of Canada Act has a section limiting private note issue.

Section 25: "The Bank has the sole right to issue notes..."

Where 'notes' refers to "notes intended for circulation in Canada."

[Patrick]

The law is an ass.

Keep in mind that economist's (or even common sense) definitions and interpretations of the various Acts quoted above are quite likely incorrect. The legal interpretation of the language of the laws, as well as the jurisprudence, may give them very different meanings from what you might suppose on first reading.

[Anna]

California has put up a major roadblock to circulation; to redeem the scrip, you must either be the person it was issued to, or have a notarized letter of transfer from the person it was issued to. (This probably keeps it from running afoul of the U.S. Constitution's prohibition on any state "emit[ting] bills of credit", which is defined in the lawbooks as "paper issued and intended to circulate through the community for its ordinary purposes as money redeemable at a future day.")

[Nick Rowe]

Anna: Oh well. That sounds like the experiment has been called off. The transactions costs of having a notarised letter of transfer are so high that I see no way now that the scrip could circulate as money. Money is typically like a bearer bond, where physical possession is treated as prime facie evidence of ownership.

[David]

"It's hard to model a stable equilibrium in which two different monies could circulate side-by-side. If one money gains any slight advantage over the other, and becomes more widely accepted, that makes people even more willing to use it, and less willing to use the other, until one money dominates."

Saltspring Island dollars (see www.saltspringdollars.com) are a real-world example that defies this theory I think. You can get them at banks and bank machines on Saltspring Island (an island with about 10,000 inhabitants and countless more summer tourists in B.C.), and almost all businesses on the island accept them at par with the Canadian dollar. The Chamber of Commerce essentially trades the money at par for Canadian dollars with anyone that wants to; the Chamber earns interest on the Canadian dollars it receives in exchange for Saltspring Island dollars.

Saltspring Island dollars are widely used on Saltspring, but so are Canadian dollars. Saltspring Island currency has intrinsic value, especially for tourists, because it's unique, has nice local artwork and makes for a fun souvenir (at least the lower denominations). But Canadian currency has extra value in that you can use it off-island. So there's a tradeoff, and depending on your preferences, you'll choose to hold a different type of money.

The Saltspring Island economy thus appears to be a stable equilibrium where two different monies circulate side-by-side.

You can learn more at www.saltspringdollars.com.

[Nick Rowe]

David: Yes, that's an interesting counterexample. And I think your explanation ("So there's a tradeoff, and depending on your preferences, you'll choose to hold a different type of money.") may be the key to understanding why, in this special case, we might get this equilibrium. It's because people, or at least some people, care about the physical properties (artwork, etc.) of the medium itself. So we are into numismatics(?), as well as monetary theory. Normally in monetary theory we assume that people don't care about those qualities of money, only about it's value in exchange.

But what I find even more interesting is that it's a counterexample that appears to clearly violate the law, as jp notes above. There seems to be rather selective enforcement, or none at all, of the Currency Act. I'm almost tempted to say that "left-wing" private monies can get away with it, but "right-wing" private monies can't. Just say "community" often enough, and you can get away with anything;).

[Jim Rootham]

Hmm, perhaps the key issue on the Currency Act issue is whether the currency circulates throughout Canada.

I tempted to think that this is a law originally put in place to stop private banks from issuing notes when the government got into the game. The banks don't want to do this any more but the law hangs around.

[Nick Rowe]

Jim: that's a plausible (to me) interpretation of the original intent of the law.

But I can't see why it would make sense to ban currencies which circulate across Canada but allow local currencies. Unless the idea is that Canada is not an optimal currency area, so that each province (say) would have its own currency which traded at a flexible exchange rate with the Loonie? But if they trade at par with the Loonie (as in David's example above) that doesn't make sense either.

[JP Koning]

You're probably right on the left vs right thing, Nick. See the Toronto Dollar too (torontodollar.com), and the Calgary Dollar (calgarydollars.ca), both private currencies run by community organizations which I'd never heard of till now. Yikes, the latter is unbacked!

My guess is that the moment Salt Spring dollars, Calgary dollars, or Toronto dollars start being accepted in other parts of Canada, the authorities would jump in. The law seemes to be pretty fluid.

"Normally in monetary theory we assume that people don't care about those qualities of money, only about it's value in exchange."

What does monetary theory have to say about economies that use gold bars as money, since in this situation people do care about its nonmonetary qualities (jewellery, industrial) as well as its value in exchange.

"The banks don't want to do this any more but the law hangs around."

Dunno about that. I think Royal Bank would jump at the chance to fund itself with some non-interest bearing debt.

[David]

Interesting point about the law. I guess the government figured it wasn't a battle worth fighting. You'd lose at least 10,000 votes (maybe additional ones from other Gulf Islands nearby Saltspring and others who sympathize with their case) in the Saanich-Gulf Islands riding, which is usually a fairly hotly contest four-way (yes, it's one of the Greens' strongest ridings in the country) battle federally.

The upside to killing the currency doesn't seem to be that big, so it's probably offset by the political risk. Public choice economics all the way.

[Marc]

Interesting post, Nick. A couple interesting comparators are social credit and airmiles.

In the case of social credit, a new Alberta government in 1933 under William Aberhart had proposed to issue scrip or "social credit" to alleviate the effects of the Depression. This was fought vigorously by the feds, who have jurisdiction over money creation and banking, and this doctrine was abandoned in 1944 by Ernest Manning.

Airmiles are a more recent case. People make lots of purchasing decision (specific to air travel and otherwise) in order to get airmiles. A couple years ago, Aeroplan unilaterally decided to delete accumlated points from members who had not been recently active. I did a blog post about it back then and still get a few comments a week from outraged consumers who have lost points. But non-legal tender alternative money can be arbitrarily taken out of circulation just as easily as it can be put in.

[Nick Rowe]

JP: "What does monetary theory have to say about economies that use gold bars as money, since in this situation people do care about its nonmonetary qualities (jewellery, industrial) as well as its value in exchange."

The normal assumption is that the demand for money is a demand for *real* money, i.e. M/P, so that if you double M, and double P, nothing changes. This insight is what creates the quantity theory of money, and the neutrality of money. When you have gold bars as money, on the other hand, theory implicitly or explicitly distinguishes between the "monetary" demand for gold, and the "industrial" (non-monetary) demand. The assumption is that a given bit of gold can either be used as money, or be used as (say) jewelry, but cannot be used as both money and jewelry at the same time. So the quantity theory and neutrality only refer to the stock of monetary gold, not the total stock.

But if you cannot separate the two uses, it can't work exactly. Take a simple example. If money is heavy, then if you double M and double P, you cannot expect all real things to stay the same. Because you are carrying twice the weight of the damned stuff around in your pockets. (That's what killed the cowrie shell as money, ultimately.

I've never worried about money being "unbacked". The ultimate backing is the custom, created by network externalities, that people do and so will continue to accept it in exchange for goods and services. Languages are unbacked too. The meaning of words is enforced by custom. But backing and redeemability may be important in getting the ball rolling in the first place.

Marc: Given my view that recessions (general gluts) are always and everywhere a monetary (medium of exchange) phenomenon, I am pleased to see funny monies springing up and expanding during a recession. Both because it will help to solve (or at least ameliorate) the problem; and because it confirms my theory empirically! Social credit were right (but for the wrong reasons; their theory does not make sense).

Air Miles can't work as money (I think), because it's hard (impossible?) to exchange them with someone else, unlike CT money. I hate Air Miles. They seem to be just a costly rent-seeking exercise. I legal kickback, if your employer pays for your ticket, but you keep the Air Miles.

[Jim Rootham]

Air Miles are actually a consumer tracking exercise. Using your Air Miles (or any other similar card) produces a spending database so you can be an advertising target.

I suppose the banks would jump into currency if it was easy. The presence of the law puts a quick spike into them trying it.

[JP Koning]

I see. So to paraphrase the latter part of what you said Nick, if you can't distinguish money's monetary and non-monetary properties, then the demand for money is simultaneously a demand for M and a demand for M/P. ie. it is a demand for real and nominal balances. Am I on the right track?

[Nick Rowe]

JP: yes, exactly. (Or, you are on the same track I am on, though whether that's the right track is a separate question, I suppose ;) )

Or, it might even be a negative demand for M, if you don't like dragging a lot of heavy stuff around with you.

The key point is, we normally assume that the demand for M is homogenous of degree one in nominal variables (start in equilibrium, double all nominal variables, including M, and you are still in equilibrium). But if the physical properties matter too, then it won't be.