#76 Base Layer Settlement

An important distinction we like to make, which I feel is often lost in confusion these days, is that the differences between a currency and money is mostly semantics. Allow me to explain…

The historical evolution of our banking system has seen a myriad of currencies and financial instruments built out on top of the base layer money. Traditionally, the base layer money has been specie in the form of gold or silver and layers built on top of that money have taken many forms. These forms can include a variety of instruments such as paper bank notes, gold and silver coinage, bonds, equities, and even fiat currencies. All layers built on top of the base layer money system have been intended to scale the functions of gold and silver specie…that is they function to facilitate more complicated financial interactions that may be difficult to conduct in gold and silver bullion.

For example, it is far easier to pay for a cup of coffee with paper bank notes (or fiat currencies) than with a gold bar. The divisibility and portability of a bar of metal is a limiting factor in the settlement of small exchanges, and even at a larger scale settlement in precious metals can be cumbersome and expensive. This is why financial instruments have evolved around the banking system to help cover some of the difficulties in finality of settlement (that is settling on the base layer: specie).

As we discussed in our panic series, a common thread throughout the 19th century US financial panics was the Federal governments suspension of redemption of specie. Said another way, the government was halting the process of settlement to the base layer. In more traditional economic terms you should think of settlement to the base layer (specie) as liquidation.

This is because bank notes were a financial instrument on top of the base layer money to solve problems of scale with settlement in specie. Individuals and businesses could conduct transactions on a higher layer of the money network (bank notes) and then banks could facilitate the cumbersome and cost prohibitive process of final settlement on the base layer.

Because banks existed in a pseudo free market, their issuance of banks notes was kept in check by the public’s faith in their ability to settle to the base layer, in the event of widespread liquidation of bank notes for specie. Likewise, liquidation of other, higher order financial instruments such as bonds or equities would as well require settlement on the base layer eventually. By intervening in the process by which the public liquidated bank notes, the integrity of the base layer money was compromised.

As I have written at the end of the panic series, Executive Order 6102, the creation of the Federal Reserve, the end of Bretton woods…all of these monetary policy changes are very akin to the suspension of redemption of specie throughout the 19th century, in the sense that they are a disruption in the process of liquidation during a financial downturn.

Essentially, when the tide goes out, liquidation allows the public to see who still has their shorts on. The reason the difference between a money and a currency is arbitrary, in my mind, is because higher order layers built on top of a base layer money (specie) only have integrity if they are allowed to fully liquidate as the market demands. The idea of a fiat currency (a far gone abstraction of the bank note) intentionally not being a store of value is a distortion of the fundamental order that evolved around what the markets once preferred to use as money.

Fiat currency is essentially a bank note with the option of settlement to the base layer removed. A currency is a higher order of a base layer money. They are one in the same…or at least, in an honest system, they should be.

We understand that many people take great offense when Ben and I say that gold failed as a money. But you must look at the complexity of the system in its greater context. Gold failed as a money in the sense that liquidation (or settlement to the base layer) was too easily corrupted and halted entirely following the series of monetary policy changes throughout the 20th century.

We understand that it was humans who brought about this disruption in the natural process of settlement to the base layer, however, we believe that forward looking solutions must seek to eliminate reliance on trusted third parties which facilitate the process of settlement.


Book of the Month:

Economics in One Lesson: The Shortest and Surest Way to Understand Basic Economics

-“This is perhaps as good a place as any to point out that what distinguishes many reformers from those who cannot accept their proposals is not their greater philanthropy, but their greater impatience. The question is not whether we wish to see everybody as well off as possible. Among men of good will such an aim can be taken for granted. The real question concerns the proper means of achieving it. And in trying to answer this we must never lose sight of a few elementary truisms. We cannot distribute more wealth than is created. We cannot in the long run pay labor as a whole more than it produces.”

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