When we first learn about money and banking in high school or university, we are all taught that money has three functions: medium of exchange, unit of account, and store of value. Maybe it’s time for educators to throw out this triumvirate. It’s not very accurate. 

We need a simple and teachable device to take the triumvirate’s place. I propose the money Venn diagram.

Before I explain the money Venn diagram, let’s revisit the textbook triumvirate.

When something is a medium of exchange, what is meant is that it is generally acceptable in trade. You can use it to buy stuff at the grocery store, or purchase stocks on the stock market, or get things online. 

The quality of being a medium of exchange is really more of a gradient than a matter of either/or. Banknotes, for instance, are good at brick and mortar shops, but useless online. Your debit card works great at shops, but forget trying to buy shares with it. But both are sufficiently widely accepted to qualify as a medium of exchange.

Because cryptocurrencies like Bitcoin and Litecoin aren’t widely accepted, they don’t make it across the line to qualify as a medium of exchange. Neither do Walmart or Target gift cards. Cigarettes don’t qualify either, but that wasn’t the case in 1950 when Milton Friedman used them to buy gas:

Milton Friedman describes the time he used cigarettes as money. (I get this from his book "Money Mischief".) pic.twitter.com/1NSjY9vZNX

— John Paul Koning (@jp_koning) November 6, 2020

The unit of account function of money refers to the fact that our economic conversations and calculations are couched in terms of a given monetary unit, whether that be the $, ¥, or £. In Canada and the US, prices are expressed in grocery aisles with dollars, our salaries use dollar units, and our debts are denominated in dollars. We don’t express prices in terms of government bonds, or Microsoft shares, or cigarettes or bitcoins. These things don’t function as a unit of account.

Thirdly, when money acts as a store of value we mean that it preserves value over time and space. Whereas the first two functions are quite useful, the store of value isn’t. Every asset functions as a store of value: houses, diamonds, banknotes, deposits, bitcoins, LSD tabs, lentils, cars, spices. And so it is meaningless to cast store of value as a unique function of money. Monetary economists such as Nick Rowe and George Selgin have proposed, and I concur, that we just chuck store of value from the definition of money.

But we are still left with two useful definitions for money, unit of account and medium of exchange. Which gets us to the money circle.

Note that the two circles in the diagram, medium of exchange and unit of account, don’t perfectly overlap. About 99% of the time the things we use as media of exchange are also the things we use as a unit of account. So the contents of our wallets or our bank accounts, dollar banknotes and dollar deposits are functionally equivalent to the $ units displayed in signs in grocery aisles.

But for the remaining 1% of the time, the unit of account and medium of exchange are separated. The idea of a separation is tough to get one’s head around. Luckily we’ve got a nice example. In Chile the prices of many things, particularly real estate, are expressed in terms of the Unidad de Fomento. But no Unidad de Fomento notes or coins circulate in Chile. It is a purely abstract unit of account.

Apartments for sale in Chile, priced in Unidad de Fomento

If a Chilean wants to buy an apartment that is priced at 840 Unidad de Fomento, she must use a separate medium of exchange, the Chilean peso, to make the payment. The peso is issued by Chile’s central bank, the Banco Central de Chile, in both paper and account form.

How many pesos must she pay? Every day the Banco Central de Chile publishes the exchange rate between the Unidad de Fomento and the peso. Right now one Unidad de Fomento is equal to 28,969 pesos. If an apartment were priced at 840 Unidad de Fomento, a Chilean would have to hand over 24 million Chilean pesos today.

Why has Chile separated its unit of account from its medium of exchange? I have discussed the issue at length. But the short answer is that it was a trick the government used to help cope with high inflation in the 1960s. Chilean inflation has been well under control for decades now. The practice of using the Unidad de Fomento as a unit-of-account has continued nonetheless.

You can see why it’s rare for these two functions to be separated. It’s awkward to do conversions every time one wants to pay for something. For the sake of ease, we tend to evolve towards systems where the medium of exchange and unit of account are united. But these exceptions are still important enough that we need a Venn diagram.

To sum up, money isn’t best thought of as a medium of exchange, unit of account, and store of value. Let’s just think of it as just a medium of exchange and a unit of account. For the most part these circles overlap, and the two functions are united. But this isn’t always the case. 

[My article was originally published at AIER's Sound Money Project in 2020 under the title A Simpler and More Accurate Way to Teach Money to Students]

What do I like about Byzantine coinage?

Most people probably admire the Byzantine solidus, a gold coin that maintained its weight and purity for over 600 years, which is quite remarkable for a coin. The solidus was exported all over the world, including to Europe, which lacked gold coinage at the time, making it the U.S. dollar of its day.

That's neat, but it's not the solidus that impresses me. It's Byzantium's small change that I like.

The availability of small change is vital to day-to-day commercial life. Alas, the minting of low-value coins has often been neglected by the state. Small change isn't sexy. And it has often been unprofitable to produce. But that didn't stop the Byzantines. After a monetary reform carried out by Emperor Anastatius in 498 AD, Byzantium began to issue a number of well-marked and differently-sized bronze coins of low value. Anastatius, who had been an administrator in the department of finance prior to becoming an Emperor, appears to have had a fine eye for monetary details.

Let's start with the follis, worth 40 nummi. (The nummus was the Byzantine unit of account.)

The follis in the above video was minted in 540 AD by Justinian I, some forty years after Anastatius's monetary reform. At 23 grams, it contains an almost comically-large amount of material. For comparison's sake, that's the same heft as four modern quarters. Allocating so much base metal to a single coin illustrates the Byzantine's dogged commitment to producing a usable set of low denomination coins for the population.

The decision to go with the hulking follis was better than the small change strategy that the English would pursue hundreds of years later. English monarchs either neglected small change altogether, forcing the public to hack up silver pennies into smaller chunks by hand. Or, if they did produce low value coins, did so in the form of silver halfpennies and farthings, the smallest English denominations. Which was not a good idea. Silver has a much higher value-to-weight ratio than bronze, so the half-penny and farthing ended up being absurdly tiny, as illustrated in the video below from the Suffolk Detectorist.  



"Weighing only three troy grains each, these were 'lost almost as fast as they were coined,'" writes monetary economist George Selgin of the farthing. And because the two coins were so small, almost no information could be conveyed on their face. No, as far as small change goes, the Byzantine's bronze coins were the way to go.

Anastatius had another theoretical option available to him, one which wouldn't have tied up so much raw material. He could have made a token coin. With a token coin (say like James II's tin halfpennies, which came almost a thousand years later, and which I wrote about here), the value of the coin doesn't rely on the metal in it, but on the ability of the issuer to repurchase it at the stipulated weight. By issuing the follis as a token, the Byzantines could have been able to make it smaller, say half the size, yet still rate it at 40 nummi, thus saving large amounts of bronze for alternative uses.

But the Byzantines appear to have been committed metallists, abiding by the principle that the value of money comes from the value of the metal in it. And so they bequeathed the world the monster-sized follis.

In additions to the follis, Anastatius introduced lower denomination bronze coins, including the half-follis (20 nummi), quarter-follis (10 nummi), and pentanummium (five nummi). They are illustrated below. Later emperors would add a three-quarter follis, or 30 nummi coin, to the mix. At times, a tiny 1 nummus coin was issued too.

Follis (40 nummi), half-follis (20 nummi), quarter-follis (10 nummi), and pentanummium (five nummi). Source: Cointalk

The decision to produce a full array of base coins illustrates Anastatius's sensibility to the transactional needs of the common person, for whom the gold solidus would have been far too valuable to be relevant to their economic lives, almost like a $1,000 bill. Oddly, Anastatius chose not to mint any silver coins. But as the English farthing example illustrates, silver was too valuable to be useful for the lower end of day-to-day commercial life, better destined to act like a modern $50 bill than a humble $1 or $5 bill.

Another neat feature of Byzantine coinage is how Anastatius and his successors used each coin's surface area to convey useful information rather than to aggrandize god & state. The obverse of each coin bore the obligatory image of the Emperor, but the reverse side provides loads of monetary data: the denomination, the date of the Emperor's reign in which the coin was minted, the name of the mint, the number of the workshop of the mint. Compare this to Roman coinage, for instance, which often bore expressive portraits on either side of the coin, but next to no data.

If you're interested in getting a longer description of how to read Byzantine coins, check out Augustus Coins.  

I'm new to Byzantine coinage, but I'm impressed by how much information they managed to pack into such a small area. Here's a great introduction on how to read Byzantine coins: https://t.co/46sVeROIKx

The example below shows how to read a follis issued during Justin II's reign: pic.twitter.com/OSsH930c2g

— John Paul Koning (@jp_koning) March 14, 2022

A particularly unique feature of Anastatius's monetary reform was his decision to inscribe the unit of account directly onto his coins. As you can see, the follis has a big "M" on its reverse side, which is Greek for 40. The half follis has a "K", which means 20, and the quarter follis an "I", which is 10. Finally, the pentanummium displays an "Є", equal to 5. All of these numbers indicate the value of the coin in terms of the Byzantine unit of account, the nummus.

Nowadays, we take this format for granted. The coins in your pocket all include the coin's value on their face, just like Anastatius's coins did. But what you need to realize is that the coinage of most civilizations, both before and after the Byzantines, rarely displayed how many pounds or shekels or dinars that coin was worth. Take a look at Rome's Imperial era coinage. There's plenty of religious symbolism to be found on the sestertius, as, and dupondius. The monarch's face appears, as do dates and names. But there's not a single digit to indicate how many units of account the coin is worth. The same goes for most medieval European coinage. (A lone exception is Roman coinage from the Republican period beginning around 211 BC).

Anastatius's decision to stamp the denomination directly on the coin represents a big improvement in usability. No need for transactors to seek an external source to determine how many nummi a follis was worth. It was right there for everyone to see.

Some of you may be wondering: why did so many civilizations avoid numbering their coins? 

Ernst Weber, an economist, has put forward one possibility. A lack of "value marks" may suggest that coins were intended to circulate at "market determined exchange rates" according to their metal content. Coins might have had varying amounts of metal due to inadequate manufacturing technology, people preferring to weigh them prior to payment so as to assess their market value. In this context of non-fungibility, striking a universal unit of account on each coin would be a nuissance, or at least a waste of time.

According to Weber's theory, Anastatius may have had so much confidence in the ability of his mints to produce durable and homogeneous bronze coins that he dared to affix the nummi unit-of-account onto them.

Another reason for not numbering coins may be that a blank slate gave authorities a degree of flexibility to set monetary policy. If a coin isn't indelibly etched with a value, a monarch can alter a coin's purchasing power, or rating, by mere proclamation. This was known as a crying up or a crying down of a coin's value. For instance, an English king might wake up one day and declare a certain type of already-circulating coin that had been worth £0.10 the day before to be worth £0.09 today, thus decreasing its purchasing power. This sort of abrupt change in value would be awkward to implement if said coin already had £0.10 struck on its face.

A ruler might have good monetary policy reasons for wanting this flexibility. But this same malleability could be abused, too, in order to profit some at the expense of others. Anastatius decided to forfeit this flexibility by freezing his coin's value in time. The Byzantine public no longer had to deal with the uncertainty of coins being suddenly revalued.

Unfortunately, the full array of Byzantium small change introduced by Anastatius would only survive for two or three centuries. As time passed, weights would be reduced and workmanship would become "increasingly slovenly," according to numismatist Philip Grierson. The quarter follis and pentanummia would be discontinued by Constantine V (741–775). The half-follis ceased under Leo IV (775–780).

As for the follis, it would stick around for a few more centuries, but around 850 AD, Theophilus would drop the emblematic M in favor of the unhelpful inscription "Emperor Theofilos, may you conquer," writes Grierson. Thus ended the great period of Byzantine low-value coinage. But during the brief period of time after Anastatius, Byzantine produced one of the best examples we have of good small change, presaging the coins we carry in our pockets today.

I'll start with the conclusion. I don't think flatcoins are a good idea.

The idea for flatcoins has been around for a while, but it got a wider airing when it popped up in a Coinbase marketing piece from earlier this year. Now, arch-crypto hater Nouriel Roubini has undergone a Damascene conversion and is about to introduce a crypto flatcoin, suggesting that these novel instruments are "the way forward."  

What is a flatcoin?

If you own one dollar's worth of stablecoins or one dollar's worth of Wells Fargo deposits, both stay locked at $1 dollar indefinitely. A flatcoin, by contrast, slowly rises in value over time to compensate the holder for inflation. So if you own a single flatcoin worth $1 today, it will be worth $1.0001 tomorrow, and $1.0002 the next day, and so on. Twelve months later its value will have arrived at $1.05. This 5% appreciation protects you from 5% inflation, leaving your purchasing power unchanged.

Roubini and Coinbase are marketing flatcoins as a blockchain-specific thing, but there's no reason the concept couldn't by packaged up as a traditional financial product, one without a blockchain. Imagine a Wells Fargo account that holds 100 in Wells flatbalances which rise by 3-4% a year. Or imagine a flatnote, the issuer indexing the purchasing power of its paper banknotes to inflation by promising to buy them back at progressively higher prices.

Roubini stakes out a role for flatcoins as a potential "global means of payment." As far as monetary/payments technology goes, I disagree. I think flatcoins are an evolutionary dead-end.

One of the key features of money that makes it so popular is that it is directly fused to the dominant commercial language that we all use in our day-to-day economic lives.

What do I mean when I say commercial language? We converse and haggle with each other in terms of the dollar, we think and plan in terms of dollars, we dream in dollars, and we remember in dollars. Every facet of our day-to-day commercial lives revolves around this very basic measuring unit. (In Europe, the euro serves as the basis of Europe's commercial language, and in Japan it's the yen.)

The dollars that we own in our pockets (and in our bank accounts, as well as the stablecoins in our Metamask wallets) have been conveniently designed to be fully compatible with the dollar measuring unit that we refer to in language. That is, our media of exchange are pegged, or wed, to $1. For instance, if I've got to make a $1500 rent payment next week, I know that the 1500 units sitting in my bank checking account are a precise fit for meeting that obligation. I don't know the same about my other assets, say my S&P 500 ETF, my gold, my government bonds, or my dogecoins.

This standardization is a convenient feature. It takes a lot of hassle out of day-to-day commercial life. It means that when we buy things or make plans to buy things, it's not necessary to engage in constant translations between the dollar media in our pocket and the dollars in our speech and thoughts and plans. As Larry White once put it, harmonizing the unit we use in our speech with the units we transact with "economizes on the information necessary for the buyer's and the seller's economic calculation."

Since everyone tends to converge on these very useful standardized units for making payments (i.e. deposits, stablecoins, and banknotes), the markets for them have become highly developed and liquid. This only makes them more useful for payments, in effect locking in their dominance.

A flatcoin, by contrast, has been rendered incompatible with the dollars that we use in our speech. One unit might be worth 1.1145 times the dollars we use in our speech today, and 1.1147 tomorrow, and 1.1205 next month. This erases one of the most user-friendly features of money, its concordance with the commercial vernacular, alienating anyone who might use it for their day-to-day spending. Flatcoins will thus be less liquid than standardized 1:1 dollars, and this lack of liquidity will render them even less useful for making payments.

There's the secondary problem with flatcoins that stems from taxes. Since a flatcoin rises in value over time, all purchases made with flatcoins will generate a small taxable capital gain. This introduces an administrative burden which makes it even less likely that people will use flatcoins as an everyday medium of exchange.

This incongruity between linguistic dollars and flatcoins doesn't mean that people won't hold them. They might be useful as a type of long-term savings vehicle, much like how one might buy and hold a fixed income ETF. But unlike Nouriel Roubini, I don't think they are "the way forward" when it comes to acting as a medium of exchange. No one is going to be buying a coffee with a flatcoin.

Tether, a stablecoin, has been in the news for offering sanctioned actors such as Hamas a means to participate in the global payments ecosystem.

In this post I want to explore in more depth how Tether is being used to dodge sanctions. I'm going to avoid drawing on the Hamas example, which has been controversial, and will instead dissect the U.S. Department of Justice's recent indictment of group of business people who brokered oil purchases from PDVSA, Venezuela's sanctioned state-owned oil company.

Let's get right into things. In this particular case, the buyers – who indirectly represented a sanctioned Russian aluminum company – seem to have used two methods for settling payments with Venezuela: bank wires and cash. (Tether makes an appearance in the second.)  

Before we get to Tether, we need to understand how the bank wires worked.

The Russian buyers operated through a network of shell companies, or fronts, set up in places like Dubai. "Because of [sanctions] we are using 'fronting'" the Russians admit. The Russians' Dubai-based shell companies had accounts at an Egyptian bank with a branch in Dubai. In a lovely line, one of the Russians, Orekhov, describes this bank as the "shittiest bank in the Emirates ... They have no issues, they pay to everything."

...the shittiest bank in the Emirates [link]

The more reputable Dubai banks probably didn't want to risk enabling the potentially sanctioned transactions of a Russian shell company, but here was a bank that had no qualms.

The Russian front companies couldn't wire U.S. dollars directly to the PDVSA; it was sanctioned. Instead, the payments were sent via the Egyptian bank to a number of foreign shell companies owned by the PDVSA, located in places like Australia, Hong Kong, and the UK. With the payments sent, the Russian's boats could be loaded with Venezuelan oil.

The second payment method was U.S. banknotes. In fact, the PDVSA seemed to have preferred cash. In the excerpt below, the Venezuelan contact, Serrano, says that the Russian middleman, Orekhov, lost out on a previous oil shipment because a competing buyer offered to pay 100% in U.S. banknotes. "The key is cash," says Serrano. Venezuela is mostly dollarized, and with the PDVSA cut off from U.S. banks, you can understand why U.S. paper money would be quite valuable to the PDVSA.

"The key is cash" [source]

In response, the Russians suggest two cash-based payments options. In the first, they will send a bank wire to a Panamanian bank, and the Panamanian bank will pay the PDVSA cash in Venezuela. "This is simply a service that they do," says Orekhov. The second option that he suggests is to bring paper money to Evrofinance in Moscow. Evrofinance is a bank that is controlled by the PDVSA and has been sanctioned by the U.S.

The indictment doesn't detail whether either of these two solutions was chosen, but instead focuses on a third cash-based solution, one that involves using Tether, or USDt, as a switch.

The indictment documents this transaction particularly well. It's November 2021 and the Russians' ship is about to berth in Venezuela for loading. The Venezuelan contact, Serrano, notifies the Russian, Orekhov, that he needs to get ready to pay for 500,000 barrels of PDVSA oil. Orekhov responds by sending $17 million worth of USDt to a broker in Venezuela, who converts the USDt to cash. "No worries, no stress," says the Russian to his Venezuelan contact. "USDT works quick like SMS."

"...quick like SMS" [link]

Once the broker receives the $17 million USDt, the cash is placed in a bank where PDVSA officials can collect it. Now the boat can be loaded.

So in this case Tether is being used as third-party rail for buying cash in Venezuela. It is serving as an alternative to a set of bank wires made through shell companies, a notably speedier one. "It's quicker than telegraphic transfer," says Orekhov. "That why everyone does it now. It's convenient, it's quick."

Going the Tether route also has the benefit of not requiring a single know-your-customer (KYC) check. Orekhov could have bought $17 million USDt, and sent it to the Venezuelan broker, and neither of the two would have had to show the owner of the platform, Tether, their ID or fill out any forms. It's like using the "shittiest bank in the Emirates," except with even fewer hassles.

Delving further into the indictment, we learn that another key benefit of Tether is that it provides a degree of protection from the legal hazards of a traditional bank wire transfer. If you scroll down to the part of the indictment where charges are being laid, particularly Count Two, it is the bank wires that are at the root of Orekhov and Serrano's legal woes, not the Tether transactions.

Among many other crimes, Orekhov and his Venezuelan counterpart, Serrano, are accused of sanctions evasion, more specifically conspiring to violate the International Emergency Economic Powers Act (IEEPA). The IEEPA is the bit of legislation that contains U.S. sanctions law.

What specific actions incriminated them? This is a good question, because on first glance the defendants seem to be beyond the pale of U.S. jurisdiction. Both men were foreign nationals operating outside of the U.S. They connected a non-US buyer to a non-US seller. The product is not made in the America. Without a U.S. nexus, it would appear that Serrano and Orekhov are safe from the long reach of U.S. law enforcement.

The ultimate hook that catches Orekhov and Serrano is that part of their dealings were deemed to have occurred on U.S. soil. They made wire transfers using the "shittiest bank in the Emirates," and those wire transfers were ultimately processed through correspondent banks based in the New York metropolitan area.

To understand how New York-based banks touched the transaction, you need to know a little bit about how wire transfers work. To be capable of making a U.S. dollar wire transfer, the "shittiest bank in the Emirates" needed to have an account with a large U.S.-based correspondent bank, like JP Morgan. Likewise, the bank that the PDVSA shell companies were using would have also had accounts at a U.S. correspondent bank in order to accept U.S. dollar wires. A correspondent bank is a bank that, in addition to conducting regular banking business, specializes in serving foreign financial institutions.

So long story short, when U.S dollar funds moved from the Egyptian bank to the PDVSA shell accounts, much of the underlying activity to support this fund transfer occurred back in the U.S. the on the books of a bank such as JP Morgan.

That's the Department of Justice's smoking gun. Serrano and Orekhov are accused of having "caused" a U.S.-based financial institution to process tens of millions in U.S. dollar-denominated payments in violation of the IEEPA.

The Tether transactions, by contrast, do not provide the Department of Justice with anything incriminating. USDt transfer occurs on the books of Tether (which is registered in the British Virgin Islands), completely bypassing the New York correspondent banking system. So when they paid with USDt, Serrano and Orekhov didn't "cause" a U.S-based actor to do anything wrong.

Put differently, if the Russians and Venezuelans had conducted all their transactions with Tether and cash, and avoided bank wires altogether, it would have been impossible for the U.S. to indict them for violating the IEEPA. Thus, not only is Tether "quick like SMS," it also provides a degree of safe harbour from sanctions law.

But not for long?

In a recent letter to Congress, the U.S. Treasury says that stablecoins such as Tether pose a sanctions risk, and requests legislation to close this loophole. The Treasury notes that while it already has jurisdiction over offshore wires transfers because they "transit intermediary U.S. financial institutions," or correspondent banks, it does not have the same authority over "equivalent-value stablecoin transactions, because certain stablecoin transactions involve no U.S. touchpoints." (That's the core of what we were talking about in the previous paragraphs.)

"...stablecoin transactions involve no U.S. touchpoints"

To remedy this, the Treasury wants Congress to update its sanctions toolbox to give it "extraterritorial jurisdiction" over U.S. dollar-pegged stablecoin transactions. In brackets, it also adds "other U.S dollar-denominated transactions" to its wish list. What this appears to be conveying, and I could be wrong, is that the Treasury wants the ability to leverage the U.S. dollar symbol, more specifically the dollar's role as the dominant unit-of-account, as a new nexus for controlling transactions made by foreigners. 

If such a law were to pass, folks like Serrano and Orekhov could now be indicted not only for the traditional crime of making offshore U.S. dollar wire transfers that "cause" New York banks to violate sanctions law, but also for paying with Tether, because the latter invokes the U.S. dollar trademark. 

Leveraging the unit-of-account role of the U.S. dollar to get authority over foreign transactions is a huge step to take, certainly much broader than relying on correspondent banking as authority. Doing so would extend U.S. sanctioning power to a much wider set of foreign economic activity, not just U.S. dollar stablecoin-based transactions, but also potentially to U.S. cash payments, since those too make use of the U.S. dollar accounting unit. Congress will have to think hard before it grants the Treasury's request.

An Islamic gold dinar minted by Offa, a Christian king of Mercia [source]

If you follow me on Twitter, you may have noticed that I've been more excited about ancient coins than I usually am. The gold coin pictured above, for instance, was minted by Offa, an Anglo-Saxon king of Mercia, in the late 700s. Offa was a Christian, but his coin contains the words "there is no God but Allah alone." In this blog post I'm going to bring together a bunch of my tweets and explore why rulers sometimes produced coins that contained icons and text dramatically at odds with the culture to which they belonged.

Money is like language. Both are characterized by network effects, or lock-in. People living in a geographical location grow up speaking a certain language, and since all their friends, family, neighbours, and colleagues also speak it, it's almost impossible for a new language to get any sort of traction.

That's why the artificial language Esperanto has never taken off. Designed in the 1800s by L.L. Zamenhof to be easy to learn, only 2 million or so people speak Esperanto. Why bother learning a new language, even an easy one, if everyone you know is already speaking English, or Chinese, or Swahili?

The same goes for money. People grow up 'speaking' a certain monetary language: dollars, yen, pounds, hryvnia, whatever. Every Canadian, for instance, internalizes a full array of Canadian dollar prices in their minds: it costs $50 to fill up with a tank of gas, $1 to buy a chocolate bar, $150 to renew a driver's license, etc. And that's why it's difficult for new monetary units to intrude where an old one already dominates. Why adopt a monetary version of Esperanto when speaking in Canadian dollars comes so naturally?

Ancient coins are a good way to illustrate the idea of money as a locked-in language.

Islam emerged in the 7th century A.D., quickly moving from the Arabian peninsula into Africa and Spain. The heretofore dominant Byzantine Empire, with its base in Constantinople, lost Syria and Egypt to the emerging Islamic caliphate.

The Byzantines and the Romans before them had a long history of issuing the solidus, a high-quality gold coin. The solidus was a bit like the U.S. dollar of its day, circulating widely across Europe and the Middle East. Below is a Byzantine solidus from 638 AD, issued by Heraclius, who is pictured with his two sons. Their crowns and staffs have crosses on them, and the reverse side displays a large cross on top of a set of steps.

Byzantine solidus issued by Heraclius, 638 AD [link]

Having conquered such a huge territory in just a few years, the Muslims may have tinkered with the idea of issuing their own entirely new coins replete with Arab text and imagery. But they chose not to, at least not at first. Bowing to pragmatism, their first gold coins (below) were replicas of Heraclius' solidus dated to around 680 AD. That is, a Muslim ruler took the strange step of minting coins that portrayed three Christian emperors. The major difference between the 638 AD Byzantine solidus and the 680 AD Islamic imitation is that it has been "de-christianized" – the crosses had been removed.

Islamic imitation solidi, est 680 AD [link]

You can imagine the tradeoffs that the Muslim invaders may have been making when they designed the coin. By creating a near replica of the Byzantine solidus, they were probably trying to harness its network effects and get the first Islamic gold coin into circulation; and by making only a few small changes – removing the crosses – they wouldn't be compromising too much on their religious values. According to numismatist Clive Foss, these changes may have been too much. Opposition to the crossless coins among the local population was strong enough that the authorities stopped minting them soon after. Foss speculates that's why archaeologists have only found a handful of crossless dinars.

It wasn't until 697 AD that the first fully Islamized gold coins were finally issued, pictured below:

Umayyad gold dinar minted in  Syria in 697 AD [source]

Like the Byzantine solidus that preceded it, the gold dinar circulated outside the Islamic world. Examples have been found as far as Scandinavia, Russia, and England. And like the Byzantine coinage before it, Islamic coinage was copied. Caitlin Green has a very good blog post showing how Anglo-Saxon Mercia (see image at top) and the Carolingian Empire issued their own imitation gold dinars.

The caliphate's silver dirhams were copied, too. According to Green, the first coins issued by Kievan Rus (below) were probably imitation silver dirhams to which a cross and bird were added. "The fact that the first Rus' coinage imitated an Islamic dirham is interesting, although perhaps unsurprising, given that many millions of dirhams appear to have been imported into northern and eastern Europe by the Vikings/Rus' as a result of their trade with the Islamic world (perhaps primarily involving slaves)," writes Green. 

Put differently, don't fool around with a good thing. Copy it with just a few modifications.

A 'Christian falcon' imitation dirham issued by the Kievan Rus' in c. 950 [source 1][source 2]

One reason that European kings may have been particularly eager to copy Islamic gold coins is that while silver coins were common the continent didn't have a long history of minting their own gold coinage. By imitating already-dominant gold dinars, Europeans could coast on the network effect of those coins. In the case of Offa's gold dinar, pictured at top, it may have been designed as a trade coin, similar enough to the original that it would be accepted in southern Europe.

Another example comes from Spain. By the 13th century the Almohads – the last Muslim empire to rule Spain – had been driven back to North Africa. The monetary influence of Islamic coins was such that the Christian conquerors continued to issue dinar-style gold coins, or maravedis. Around 1180 AD, Alfonso VIII of Castile, a Christian, minted maravedis with Arabic script rather than Latin, "Christianizing" them by inserting a small cross and changing the Arabic message to a Christian one:

Spanish maravedi, 1180-1214 AD: https://t.co/cCyQ91Unw5

Alfonso VIII of Castile, a Christian, issued gold coins with Arabic script rather than Latin. Probably a wise compromise given the Islamic dinar's dominance in Spain up till then. pic.twitter.com/Ijp2GttnEs

— John Paul Koning (@jp_koning) February 2, 2022

Notice that in the previous examples, the new coin issuer used the incumbent coin's style while dropping its religious motifs. But the desire to latch on to the strong network effects of existing coinage sometimes trumped even the demands of religion.

As an example of this, when the Crusaders took over Jerusalem they issued dinar-style gold coins without even bothering to add Christian embellishments (see below). Initially minted in the late 1100s, the Crusader dinars only gained crosses in 1250 when an angry pope pressured the local princes to eliminate coinage which was "not well-formed enough to conceal the scandalous fact that its inscriptions praised Mohammed and bore dates of the Muslim era." Against the pope’s objections, the text on the new Christian design was still written in Arabic.

Coin of the day: a Crusader imitation dinar from 1187 AD.

When the Crusaders took over Jerusalem, they very pragmatically minted imitation Islamic gold dinars rather than Christian-themed coins. Until the pope heard and threatened excommunication.https://t.co/klocGcCMmx pic.twitter.com/CvOk2BROwL

— John Paul Koning (@jp_koning) January 27, 2022

So the idea that money is sticky and locked-in like language may explain some of the strange coins pictured above. It may also explain some of the phenomenon around us today, like:

1) why stablecoins have come to dominate the cryptocurrency space, and why the dominant stablecoins are U.S. dollar stablecoins and not, say, Turkish lira stablecoins. (Bitcoin and other volcoins are awful candidates as unit of account, whereas stablecoins are not only stable, but also benefit from the network effect of existing currencies, none of which is stronger than the U.S. dollar.)

2) why Facebook's original idea to create a new Libra unit of account was crazy overambitious.

3) why Canadians still use the Canadian dollar despite being right next door to the world's mightiest monetary power. We grow up speaking in loonies and toonies, and that's not something that is easily changed. It also explains why Quebecers sometimes refer to the dollar as a 'piasse,' which derives from the piastre or peso, and old coin that once dominated North American trade. The network effects of the long departed Spanish peso were so strong that shades of it still exist.

As crypto continues to move into the public's consciousness, curious people who aren't familiar with it often ask me if central bankers at the Bank of Canada or the Federal Reserve should be worried that crypto may replace the dollar. 

In this short blog post I'll suggest that they should not be worried.

For central bankers like the Fed's Jay Powell or the Bank of Canada's Tiff Macklem, controlling national monetary policy is probably their most important task. By altering the money supply or shifting interest rates, Powell influences the value of U.S. dollar. These policy changes get transmitted across the entire country thanks to the ubiquity of the U.S. dollar as a unit for expressing prices. (For his part, Macklem relies on the Canadian dollar's dominance as a unit-of-account in Canada to exercise monetary policy). 

Monetary policy is important. First, it keeps the dollar's purchasing power stable. Since our wages and contracts are denominated in dollars, a degree of sameness and consistency is important. Second, monetary policy is an important tool for offsetting broader economic shocks, say the pandemic or the '08 financial crisis.

Given that crypto is often marketed as a dollar replacement, might Powell and Macklem be losing some sleep? After all, if crypto starts to replace the dollar as America or Canada's unit-of-account then neither central banker can carry out national monetary policy.

Luckily for Powell and Macklem, crypto is not a threat to the dollar.

Crypto is no longer a very useful term, since it encompasses so many different types of phenomena. There is bitcoin, programmable blockchains like Ethereum, stablecoins, non-fungible tokens (NFTs), decentralized finance (DeFi), and more.

Let's start with Bitcoin. In this category I've included other volcoins like Dogecoin, Shiba Inu, Bitcoin Cash, and Litecoin. I call them volcoins because they are incredibly volatile.

In the early days, many of us thought it possible that Bitcoin might develop into a legitimate threat to the dollar. But enough time has passed now that we know this isn't case. The dominant reason people have for owning volcoins is to get exposure to their exciting price moves. That is, volcoins are a gambling technology, not a monetary technology. Rather than competing for dominance with the relatively stable payments instruments issued by central banks, volcoins serve as substitutes for casinos, meme stocks, lotteries, poker, and OTM options. None of these bets will ever be a credible threat to Fed or Bank of Canada dollars.

Let's move onto stablecoins. Whereas volcoins are wildly unstable, stablecoins are the tamer version of crypto. The stability of stablecoins means that they could credibly replace banknotes issued by the Fed and Bank of Canada.

Even if stablecoins become widely used, they won't subvert Powell and Macklem's ability to conduct monetary policy. Because they are pegged to central bank money, stablecoins effectively do the opposite: they extend central bank monetary policy power into blockchain environments. Stablecoins are therefore allies of the Fed and Bank of Canada policy makers, not enemies, in the same way that regular banks such as TD Bank or Wells Fargo are allies because they extend the range of central bank monetary policy into the regular economy.

[Yes, stablecoins involve financial stability issues. But this post is about monetary policy, not financial stability.]

Nor is decentralized finance, or DeFi, a threat to monetary policy. DeFi is just another component of a nation's financial edifice, albeit more decentralized than the other bits. If a stock exchange like the NYSE or Toronto Stock Exchange is no threat to monetary policy, then neither does a decentralized exchange such as Uniswap pose a threat.

Finally, NFTs are a hyperfinancialized claims on underlying digital art. Art never has been a threat to monetary policy and never will be.

In sum, Jay Powell and Tiff Macklem may have reasons to worry about crypto, but concerns of monetary policy impotence should not be one of those worries. Crypto is not going to replace the dollar anytime soon.

How would I feel if Judy Shelton was a candidate for Governor of the Bank of Canada? Here are my thoughts.

A bit of background first. Judy Shelton was a Trump appointee to a key spot on the Federal Reserve board, the U.S.'s central bank. A President's appointees must be confirmed by Congress, and this was probably the most heated confirmation process I've ever followed. Shelton has espoused several controversial view points, including a return to the gold standard. 

The reason this appointment is so important is because Federal Reserve board members determine American monetary policy. That is, they decide whether to pluck interest rates up or down in order to ensure that the central bank is hitting its mandated targets.

That's a pretty important job! Not only would Shelton have been in the monetary policy hot-seat, she would have been on track to become the next head of the Federal Reserve. But it was all for naught. Shelton narrowly lost the spot as several Republican senators, including Mitt Romney, dissented.

So Shelton for Bank of Canada? Here's a simple set of guidelines I'd suggest Canadian voters adopt when they consider what sorts of people should be at the helm of the Bank of Canada. 

First, I'd suggest that anyone being considered for the Canadian monetary policy cockpit have a PhD in economics, preferably one in macroeconomics. And second, they should have administrative experience. (I'd be willing to accept a master's degree in economics as a substitute, with sufficient time spent working up the rungs of a central bank. The administrative experience is important because candidates will be in a management position.) Once they've passed those two hurdles, the finer points of their candidacy can be discussed.

A quick scan of Shelton's background reveals that she has a PhD in an unrelated discipline and no prior central banking experience. So if she was being floated for the job of Bank of Canada governor she wouldn't have passed through my filter. (Current Fed governor Jerome Powell, who is a lawyer, wouldn't have got through either.) 

Some readers may think I'm only stating the obvious. "Of course the most important people at a nation's central bank should have high-level economics degrees." But other readers will be disappointed in my criteria. I mean, here I am, an independent blogger—one who doesn't have a graduate degree—advocating an elitist sclerotic filtering mechanism.

Note that I'm not criticizing Shelton for her controversial stance on the gold standard. If she was a trained economist whose gold standard views had survived through years of rigorous training, she'd pass through my basic filter. Nor am I criticizing Shelton because she was a Trump appointee. Christopher Waller, another recent Trump appointee, would have easily passed through my filter.

Here's why I think my filter makes sense for Canadian voters. Monetary policy is complicated. Luckily we have an institution that teaches it: economics departments. Once someone has attained a PhD (or Masters + experience) in macroeconomics, odds are they'll be better than most at understanding how to operate the levers of a central bank. 

Why not draw central banking talent from other venues like the media, activism, think tanks, law, finance, business, or the blogosphere (ahem)? These venues don't attack the problems of central banking in as disciplined a manner as an economics department does. And so the average quality of these talent pools will not be as high.

In particular, I want to comment on the idea of drawing central bankers from the business/finance community. Many voters may think that Canadian business personalities like Kevin O'Leary, investor Prem Watsa, or banker David McKay would be uniquely qualified to run the Bank of Canada. I disagree. Sure, these titans of business will have good administrative experience (although no better than anyone else at the top of their field). 

But running monetary policy has little in common with running a business. Like the litre, second, and meter, the Canadian dollar is one of Canada's most important weights & measures. We put well-trained physicists at the National Research Council (NRC) in charge of maintaining our key physical measurements, not business people. (In fact, NRC scientists recently guided us onto a new standard for the kilogram.) Likewise, we need people with proper scientific training to manage our key economic measuring unit, the $.

Will my filtering system leave out a lot of good candidates? Yes. Will it bring in some bad ones? Certainly. Economics departments have tons of problems. Trust me, I've heard stories from insiders.

But even if it's not a great filtering system, it's still the best filtering systems we've got. Imagine that the plane you're on has lost its pilot in mid-air and needs a replacement. If one of the passengers has been to flight school, that person is probably going to be the best pick for flying the plane.

The WSJ marketed Shelton's candidacy on the basis of diversity. Yes, diversity of opinion is important. We want the co-pilot on our plane to criticize the pilot when one sees him/her make a mistake. But we still want both to be trained pilots with solid skills. They need to know exactly what that little red button above and to the left of their heads does when pressed. We wouldn't put a cake decorator, a plumber, and psychologist in the cockpit, just for the sake of diversity.

It's interesting to contrast U.S. and Canadian central banks on my very simple filter. Going back to 1970 the U.S. has missed twice: Jerome Powell and William Miller. The hits include Janet Yellen, Ben Bernanke, Alan Greenspan, Arthur Burns, and Paul Volcker.

Canada hasn't missed once. Everyone from Louis Rasminsky and James Coyne to Mark Carney, Stephen Poloz, and Tiff Macklem qualify.  

Scale & weights | Aylmer, Quebec | Canadian Museum of History

 

This post is for my dad, who says he doesn't understand my writing but remains a loyal reader nonetheless.

I am going to try and explain one of the most important things that central banks do: monetary policy. We often see news clips in which bespectacled central bankers discuss their "inflation targets," or tell us that they are ratcheting interest rates up or down, or that they are engaging in "quantitative easing". The catch-all term that we use to describe what they are doing is monetary policy. But what does this mean? What is monetary policy?

Central banking is confusing, so here's what I propose. Let's find something simple, something we all intuitively understand. And then I'll show why monetary policy is like that simple thing. Hopefully that demystifies what is going on. I'm going to use a Canadian example, but it applies just as well to any nation.

K50, K75, and K106

People take their national system of weights & measures for granted. But we simply couldn't function as a society without a standard way of measuring things: kilograms, metres, seconds, or degrees Celsius.

A nation's system of weights & measures doesn't just manage itself. Take the kilogram. The Canadian Federal government had to push and prod for years to get the kg into popular usage. Canadians had historically relied on the imperial measurement system with its strange mix of ounces, drams and grains. In 1970, Pierre Trudeau passed the Weights and Measures Act, giving birth to the Metric Commission and its mandate to get Canada officially onto the metric system. Fifty years later we Canadians all reckon in terms of kilograms, grams, and a raft of other metric measures. (Ok, not entirely, I admit. I cook in Fahrenheit, not Celsius, and weigh myself in pounds, not kg. But I definitely don't drive in miles.)

The Canadian government's job didn't stop once the kilogram was widely accepted. It has continued to manage the kilogram ever since. The main thrust of this ongoing effort is to ensure that 1 kilogram is 1 kilogram all across Canada. No agency is more involved in this harmonization effort than the National Research Council of Canada, or NRC, the Federal government's research and development lab.

National Research Council building in Ottawa

The NRC's headquarters in Ottawa houses three individual physical kilogram weights. Known as K50, K75, and K106, these specimens represent Canada's official kilograms. Because Canadian manufacturers require incredible precision, they can periodically visit the NRC and calibrate their weights against K50, K75, or K106 to ensure accuracy. If the manufacturer's weights diverge by even a few micrograms from the NRC's official weights, they will have to be replaced with more accurate ones.

And so the definition of the kilogram diffuses across Canada, first from the National Research Council, then to industry, and finally to Canadians who consume carefully weighed products.  

The National Research Council's K50, K74, and K106 are in turn copies of the most important kilogram weight in the world, the International Prototype Kilogram. Manufactured in 1889, the IPK is stored at in the International Bureau of Weights and Measures (BIPM) in France. Scientists at the National Research Council used to periodically hop on a plane with K74 and fly to France to cross-check it against the IPK.

In 2018, the world stopped using physical artifacts to define the kilogram. The problem with using actual objects like the IPK and K50 is that over time they suffer from slight degradation. K50, for instance, began to display fluctuations of a few micrograms due to "tiny cracks in the surface which adsorbed and released water from the air." And so our standard for weight suffered. 

We now rely on a much superior non-physical standard for the kilogram, one that is defined in terms of Planck's constant. But even though the definition of the kilogram has changed, the National Research Council is still key in ensuring that the kilograms Canadians use are good kilograms.

The beginning of the long dash...

The National Research Council also maintains Canada's official time. Cesium atomic clocks are the world's most accurate method for recording the passage of time, of which the NRC's time standards office in Ottawa has several. The NRC broadcasts official time on the web, via short wave radio band, and by telephone. Faithful CBC radio listeners will all be familiar with the NRC's habitual: "The beginning of the long dash indicates exactly one o'clock..." For $7,500 per year, industrial customers can even get authenticated access to NRC time servers.

An NRC control room containing systems used to disseminate official time to the public, including the telephone talking clock, the CBC daily time broadcasts, and computer time clocks.

Precise timing is particularly important to the Canadian financial industry. Take the Investment Industry Regulatory Organization of Canada, or IIROC, which regulates the Toronto Stock Exchange and all the firms that deal on it. (IIROC is sort of like Canada's version of the SEC). To ensure that all market participants are on the same rhythm, IIROC sets its internal clock off of the NRC's clocks. All firms that trade in Canadian securities must in turn synchronize their clocks to IIROC's clock. And thus the NRC and its atomic clocks impose order on the chaos of the stock market. 

kg, s, and $

Now let's bring this back to monetary policy. 

The main suggestion in this article is that readers put the National Research Council and the Bank of Canada in the same bucket. Both institutions are responsible for upholding Canada's system of weights & measures. 

But whereas the NRC is in charge of managing physical measures, the Bank of Canada is responsible for managing the nation's key unit of economic measure, the $. So when you see news about the Bank of Canada and the dollar, and you start to get confused, consider reframing the news as if it was the National Research Council making policy changes to the way it manages the kilogram. Hopefully that will make the news more relatable.

The dollar is the universal sign we Canadians use to express economic value. It shows up in grocery aisles, at online stores, in our bank statements, and is used in our heads to calculate bills.

But like the kg, the $ must be managed. As I wrote earlier, the NRC originally defined the kilogram in terms of a physical artifact before switching to a non-physical construct. Likewise, a long time ago the Canadian dollar was set at 23.22 grains of gold. But these days the Bank of Canada (much like the NRC) measures the dollar in terms of a theoretical construct, a basket of consumer goods.

What does it mean to measure the dollar in terms of a basket of consumer goods? 

Each month government statisticians canvas store aisles and websites for price data which they use to calculate the cost of purchasing a basket of consumer goods. This data compilation is known as the consumer price index, or CPI. It includes items like groceries, rent, gas, etc. 

In its definition of the dollar, the Bank of Canada promises citizens that the $ unit will be capable of buying the same amount of consumer baskets from one month to the next. (It's a little more complicated than that, but that's for another post).

So then what are interest rates for?

Sometimes the Bank of Canada will make the news because it is increasing or lowering interest rates. What is happening here? Recall that the National Research Council had a number of tools for diffusing official time across Canada, one of which is broadcasting across channels such as the CBC. The Bank of Canada also has tools for diffusing its definition of the dollar across Canada. Interest rates happen to be its favorite tool.

If the dollar falls in value such that it is no longer powerful enough to purchase the appropriate quantity of consumer baskets, the Bank of Canada will increase rates. In theory, this pushes the dollar's purchasing power back up to target. And if the dollar is too powerful and purchases more baskets than the Bank of Canada's target, the Bank will decrease rates. This should nudge the dollar's purchasing power back down.

Updating the definition of $

So when experts discuss standards bodies like the National Research Council or the Bank of Canada, they are likely having two sorts of discussions. Half of their conversations will be about the definitions that these institutions uphold (i.e. should we define the kilogram using K50 or Planck's constant? Should we define the dollar in terms of grains of gold or consumer goods?). And the other half will be about strategies and tools for diffusing the standard across Canada (i.e. should we provide the public with more channels for accessing official time? Should we increase interest rates or keep them unchanged?)

The Bank of Canada is currently in the thick of the first sort of discussion. Every five years the Bank of Canada and the government come to an agreement about how the Bank will define the dollar for the ensuing five years. The next agreement is scheduled to be inked in 2021. 

Some people involved in this discussion want to adopt new definitions for the dollar. Recall that the Bank of Canada already uses consumer basket to define the dollar. One group wants to redefine the dollar in terms of nominal gross domestic product. Others want to add a reference to employment. 

Much like discussions about whether to redefine the kilogram in terms of Planck's law, this is a complicated debate, one that non-experts cannot easily access. But whatever the decision, you can be sure it will have implications for all Canadians. After all, the $ is a measure that each on of us uses on a daily basis.

I often write about odd monetary phenomena on this blog. Here's a new contender, Yemen's dual banknote system.

Yemen uses the Yemeni rial as a unit of account. As one of the poorest countries in the world, Yemen still relies mostly on banknotes to make transactions, which are issued by the Central Bank of Yemen, or CBY.

One of the convenient features of banknotes is their fungibility. This means that one banknote is perfectly interchangeable with another. For a few months now, something strange has happened to Yemen's banknotes. Old rials and new rials have ceased to be fungible. Any rial note that was printed prior to 2016 is now worth around 10% more than newer rial notes.

More generally, the entire Yemeni monetary system has split on the basis of banknote age. From a Western perspective, it would be as if every single U.S. banknote issued with a Steve Mnuchin signature on it, the current Treasury Secretary, were worth 10% less than bills signed five years ago by his predecessor Jack Lew.

Conflicts are always complicated. What follows is a short but drastically simplified explanation of how Yemen's banknote problem began.


In 2014, the northwestern part of Yemen was taken over by rebel Houthis. They also managed to capture the capital, Sana'a. Meanwhile, an internationally-recognized government occupies the south, the port city of Aden being its capital. Very few people live in eastern Yemen.

Source: Aljazeera

The Central Bank of Yemen has always been located in the capital, Sana'a. It tried to be a neutral party between the two warring sides. This sounds like it must have been a very awkward role to play.

For instance, before the war started the central bank was responsible for paying government salaries, including the army. When the war kicked off some soldiers supported the rebels in the north while others joined the internationally-recognized government in the south. According to Mansour Rageh & coauthors, this meant that the central bank was simultaneously paying the salaries of both sides of the conflict. That's touchy.

This balancing act eventually broke down in 2016 when the internationally-recognized government forced the central bank to move to Aden. Rageh et al explain how this happened. In short, the government convinced the international community to block the Sana'a branch's access to foreign reserves. It also prevented the branch from getting new banknotes printed.
 
So by late 2016 we've got two different branches of the central bank, one controlled by the rebels and the other by the internationally-recognized government. The latter controls most monetary functions.

With the stage set, we can now start to get into the meat of why old rial notes are worth more than new ones. After the Aden branch of the CBY had established itself in 2016, one of the first things it did was order a bunch of new banknotes to be printed up by Russian note printer Goznak. These arrived in Aden in early 2017. They looked like this:

Source: Banknote News

You can see that there are some differences between the new 1000 rial note and the old one, pictured below:

Source: Banknote News

The rebels were not happy with the new notes. It's easy to guess why. Fresh money could be used to pay government fighters, not rebel fighters. This "blood money" would then cheekily flow north via trade. Since anyone who holds a banknote is by definition funding the government that issues it with a no-interest loan, the rebel north was financing its own enemies. (The technical term for this sort of financing is seigniorage).

In 2017, the rebels began to limit the ability of northern civilians to use the newly issued banknotes. This mostly affected banks and other large businesses in the northern Yemen, which were now required to avoid dealing in the new notes. Anthony Biswell of the Sana'a Center for Strategic Studies has a much weightier explanation of this transition. Do read his article if you want to learn more about this topic.

Anyways, on December 18, 2019 the rial spat crescendoed into a full out ban. The rebel government announced that everyone in the north had thirty days to turn over new notes at any of 300 agents located across the region. In return they would get an equivalent amount of old banknotes, if available, up to 100,000 rials per person. That's around US$170.

Anything above this 100,000 rial limit would have to be converted into a digital rials. These would be supplied by one of three privately provided electronic wallets. Unfortunately, Yemen has almost no digital payments infrastructure, so these balances wouldn't be of much use.

Thanks to the December 2019 ban, the price of old and new rial banknotes has completely diverged. Below is a chart from the World Bank.

Source: World Bank

We can surmise why a big gap has developed between the two types of notes. The stock of old pre-2016 banknotes is fixed. It can't grow. But the supply of new banknotes is not fixed. The Aden branch of the CBY can get Goznik to print as many notes as it wants. So the rare rials, the old ones, are worth more.

I'd expect Gresham's law to kick in, too. Gresham's law says that if a government stipulates that two payment instruments are to circulate at the same rate, but one is worth fundamentally more than the other, then the "bad" one drives out the "good". More specifically, the undervalued money will be hoarded (or exported), leaving only the overvalued one in circulation.

In Aden's case this is likely to translate into "bad" rials (the post-2016 ones) driving "good" rials (the pre-2016 notes) out of circulation. Since the Aden government treats both old and new banknotes as interchangeable, but old ones are worth more, the old ones will all be exported to the north.


Where might all this lead? With the Sana'a branch having declared war on new notes, the Aden branch may do the opposite and try to hurt the old ones. This would involve orphaning all of its pre-2016 banknotes. That is to say, the Aden branch will demonetize them; cease accepting old notes as its liability or obligation.

But even if they were to be demonetized, orphaned rials would still circulate.

The topic of "orphaned" currency has popped up before on this blog. The Somalian central bank ceased to exist in 1991. Yet even though the Somali shilling now lacked a central bank sponsor, they continued to be used in Somalia as a medium of exchange, as recounted by Will Luther here.

A new Somali central bank has stated that it will re-adopt these old shillings and replace them with new currency. To date, this hasn't happened.

Along these same lines, even though Saddam Hussein disowned Iraqi dinars that had been printed in Switzerland, these so-called "Swiss Dinars" continued to circulate in northern Iraq. After Saddam was deposed by the Americans in 2003, the new central bank re-adopted all of the orphaned Swiss dinars.

If the Aden government is going to disown old Yemeni rials, I wouldn't expect them to remain orphaned for long. The Sana'a branch of the Central Bank of Yemen would quickly adopt them as their own obligation. At which point Yemen's unofficial two-currency system would become official. The Sana'a branch might even try to get its own version of the rial printed up. If so, it would have to rely on printers other than Goznak.


Yemenis already face so many difficulties. The sudden emergence of a dual-currency regime only compounds their plight. Prices are a language. We become fluent in this language as we engage in our commercial habits of buying, selling, and appraising. The sudden rial split forces Yemenis to start "speaking" in two different price arrays (three if the U.S. dollar is included). It's terribly inconvenient.

There are also costs to renegotiating rial-denominated debts. If one Yemeni owes the other, are they to pay in old rials or new ones? Debtors will always prefer the debased currency, new rials, but creditors will ask for the stronger one, old rials. Somehow a decision will have to be made.

Finally, a dual currency regime means that Yemenis will be forced to convert from one type of currency to another to make payments. That means incurring fees, hassles, and waiting time.

In the west, we take fungibility for granted. To achieve monetary standardization, a big investment in technology and coordination is required. The fact that a dollar is worth the same in Los Angeles as it is in New York, or Vancouver as it is in Halifax, is worth celebrating.

---

P.S. Yemen's old rials are really old. See image below. Dilapidated banknotes are a major problem. They make trade harder and allow for easier counterfeiting.

ولا شي لا تفتجعش، بياس ابو خمسين pic.twitter.com/ljMmZuTxjY

— فرانز عبدالستّار النمساوي (@DerOsterreicher) May 20, 2020