January 15, 2004

Government Fiat Money without Government

Normally, "fiat" money--pieces of paper with little or no intrinsic use value as wallpaper or notepaper--has value only if three things hold:

  1. It's a convenient way to carry your cash.
  2. The government will punish you if you try to use anything else as cash.
  3. It's in short, limited supply.

Hal Varian considers the case of the "Swiss" dinar in northern Iraq, for which reason (2) failed, and yet it continued to have value:

Hal Varian: ...one can have currencies that have no government backing. Gold has been used for centuries as a medium of exchange; cigarettes were used for payment in prisoner-of-war camps in World War II; and countless other goods, including cowrie shells and peacock feathers, have functioned as money throughout history. They were money because people were willing to accept them as payment for debts, public and private. Gold, cigarettes, cowrie shells and peacock feathers all have "use value" in addition to their "exchange value." These items were originally valued for their utility or their beauty, and they became used as currency. It is rare to see a purely paper currency functioning as money without the backing of some government or financial institution.

Rare, perhaps, but not unheard of. Mervyn A. King, governor of the Bank of England, cited an interesting example - the Iraqi dinar - in the Ely Lecture delivered at the recent American Economics Association meeting in San Diego. (Mr. King's speech can be downloaded from http://www.bankofenglandco.uk/speeches/speech208.pdf.)

Here is the story Mr. King told:

After the gulf war of 1991, Iraq was divided in two: the south ruled by Saddam Hussein, the north governed by the local Kurds. Mr. Hussein needed money to finance government spending, and in the time-honored tradition of dictators, created it himself.

The government could not import more of the bank notes then in use, because of United Nations sanctions, so Mr. Hussein ordered the local printing of a new currency. In May 1993, the Central Bank of Iraq announced that citizens had three weeks to exchange their old 25-dinar notes for the new "Saddam dinars," which bore his portrait.

During the next few years, so many Saddam dinars were printed in southern Iraq that they became virtually worthless. The face value of cash in circulation rose from 22 billion dinars in 1991 to 584 billion in four years, and inflation averaged about 250 percent a year over that period. Residents of northern Iraq could not exchange their notes. The 25-dinar notes continued to circulate and became known as the "Swiss dinars," because they were printed with plates made in Switzerland.

The fact that the Swiss dinars continued to be used at all speaks to the power of social conventions. The Kurds in the north despised the Baghdad government, and would have much preferred to have their own currency. But there was no government in place powerful enough to mandate a currency change, so they kept using the old Swiss dinars by default. The Swiss dinar was in fixed supply, while the Saddam dinar was flying off the printing presses, so it is not surprising that the Swiss dinar quickly became more valuable. By spring 2003, it took 300 Saddam dinars to buy one Swiss dinar...

Posted by DeLong at January 15, 2004 05:37 PM | TrackBack

Comments


I think that, once people have gotten used to paper money, they don't go back. An even more extreme example of Fiat money without government backing was notgeld "emergency money" issued by when whoever during the German hyperinflation. It was issued especially in the Rhineland (then under French occupation).

Posted by: Robert Waldmann on January 15, 2004 11:34 PM

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In Bosnia, they still use the DM (Deutsche Mark) as currency. I do not know if and how they can ever change their DM bills into real Euros - but as long as everybody appears to believe that the defunct DM "is" a curreny, it seems to work as such. Possibly because they have no real government that forces them to believe differently. Maybe Marx got a point there: If currency is only a "sign" (a semiotic designant, Eco would say) standing in for "value", you can use anything - from cigarettes to banknotes, as long as evybody taking part in the transaction "believes" it "represents" value.

Usually you need governments to establish what is believable und what is not. In the absence of a credible government, apparently it is "conventional wisdom", or isn't it?

Or forget it and go back to Boris Godunow? (By the way, the scene where Boris, shortly before he dies, cries out "But I am still the Czar" - while somewhere our there they are already celebrating the coronation of his successor, is much more impressive than the coronation scene. And then, nobody beats Mozart's "Don Giovanni", anyway: Take the scene - the last but one - where Giovanni goes to hell and still defiantly sings "No, ch'io non mi pento" - I will never regret what I have done: Forget about all other operas including Turandot; if that doen't send chills down your spine, you have no ears. And no soul.)

Posted by: gerhard on January 16, 2004 02:36 AM

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Robert Waldmann,

they had that kind of "Notgeld" also in Austria, after world war I - it worked for years in the town of Woergl, in the Tyrol: it was "money" issued by the municipality, it "represented" x hours of work (Marx again!), and poeple "exchanged" goods and services by way of that municipal "currency" and forgot about hyper-inflation. It seems some (rather suspicious, really) Swiss and German economists then developed a whole theory from there: the "Freigeld" theory), "frei" (free) meaning "frei von Zinsknechtschaft", free from the yoke of interest rates: they thought of a kind of simple "market economy" without capital, profit and interest rates. Rather soon, they identified interest rates with Jewish capital, and we all know where that lead to...

And in Italy, in the 1980's, when there was a shortage of small change (because of the notorious inefficiency of the National Bank, they ran out of 50 and 100 Lire coins, which is something like nickels and dimes), municipalities printed 50- and 100-Lire-"promissory" notes (some kind of "Ersatz"-money), and they were accepted anywhere, in all shops, even outside the city territory. In the end, you bought your cigarettes in Milan spending Bologna 100-Lire-notes. Apparently, people "believed" that the piece of paper signed by the Mayor of wherever was "worth" 100 Lire.

The only inconvenience was, you could not use them in phone booths.

Posted by: gerhard on January 16, 2004 02:50 AM

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Gerhard, I think that DM can be exchanged at German branches of the German central bank. At least in Spain it is true for pesetas.

DSW

Posted by: Antoni Jaume on January 16, 2004 07:04 AM

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There's also a "labor-based" currency in use in Ithaca, NY.

"Ithaca Hours" were gradually introduced as an alternative currency. The notes have values of "Hours", nominally the value of 1 hr of labor.

Posted by: Troy on January 16, 2004 07:45 AM

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I can't cite anything, but during a economics course back in college the professor said that in Russia after the revolution, paper money with the czar's picture continued to be used and considered to have value. It at least had the advantage that no more was being printed.

Posted by: Captain Button on January 16, 2004 09:06 AM

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An identical situation occurred in Zaire (Congo) in the 1990's as President Mobutu printed a new version of the currency (known as Zaires, confusingly). When Mobutu introduced the new bills, there were riots by the military as opposition politicians spread the word that the new currency was not to be accepted. The military, paid in the new bills, didn't like the fact that no one was accepting their pay. The trashed every major city in the country.

The restive province of East Kasai, home of the leading opposition politician, simply used the old currency and faced no inflation.

Posted by: Peter on January 16, 2004 01:11 PM

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A point and a question.

#2 is clearly not necessary, unless I'm missing
something. In the Communist-ear Eastern Europe
the government would punish you, IF you used
dollars as exchange. None the less, the dollar
was used for any mid sized to large transactions
(circa 1983 my parents bought me a bicycle with
dollars, since no one would ever have sold one
for quickly inflating zlotys).
So EVEN IF the government punishes you for using
a particular currency, a fiat money can still be viable.

The question, is - and again, I might be missing
something here - whatever happened to Copernicus
Law (by Stigler's Law, generally known as
Gresham's Law)? Shoudln't the bad money drive out
the good?

Posted by: radek on January 16, 2004 01:52 PM

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Normally, "fiat" money ... has value only if three things hold...

2) The government will punish you if you try to use anything else as cash...
~~~~~~~~~

Not here in the US where "private money" other than dollars is perfectly legal. The Federal Reserve even has a publication on it in case you want to issue your own:

"Private Money: Everything Old is New Again"
http://www.clev.frb.org/Research/com98/

And yet the fiat dollar survives!

The legal tender law doesn't prohibit anyone from using "unofficial" money, it just says that an offer to pay in official dollars is a legally valid offer of payment and will be recognized as such in a court if it comes to that.

I think the key to a successful fiat currency is simply that people have to want to use it, that's #1+. If the supply of it is out of control, #3, that will make people not want to use it and be seen in #1. In what I've seen of countries that tried to impose currencies that the people didn't want to use, #2 wasn't real effective at making them do so. Hey, 2/3rds of all US currency is circulating abroad somewhere IIRC, no doubt a hefty part of it in countries with fiat currencies.

Posted by: Jim Glass on January 16, 2004 02:59 PM

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'Normally, "fiat" money--pieces of paper with little or no intrinsic use value as wallpaper or notepaper--has value only if three things hold...'

You left one out, if fiat money can be used in payment of taxes. It permits governments to install their own money without having to chase down and punish all other competitors. It's effectively what colonialists did to get subsistence economies moving in the development directions they needed; they used poll taxes and hut taxes, often payable in labour but commutable for cash with a discount. This trick worked quite well.

Posted by: P.M.Lawrence on January 16, 2004 04:06 PM

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