Once upon a time, there was a small kingdom with no money system. All trade had to be conducted by barter. This had a limiting effect on the economy. The king wanted to encourage trade. He could have decreed that some rare commodity be used as money, but being a wise king, he did nothing and waited to see what developed.
One day one of the wise men in the kingdom, who had a reputation for honesty, began to sit at the gate of the city. Things changed when a group of people who had been exchanging goods with each other fell into dispute. One person claimed that he had not received what he was entitled to. The wise man saw an opportunity and offered to investigate the situation. He tracked down and recorded all the trades that had taken place. Once his list was complete, it became obvious that one person had received more than he was entitled to and another had gone short. When the information was presented to the group, the person who had received too much agreed to give it up to the other.
The other thing that became evident was that some people had given up their goods to cheaply. Some people had gained much better deals than others. The clever man saw an opportunity and suggested that, for a small fee, he would begin recording all transactions. This would reduce the risk of fraud.
People could also see the benefit of having better information about the rates at which goods were exchanging. Better information would support better decisions, so his system was well received.
The clerk began to keep a book in which he recorded all transactions. When deals were being agreed, they would be expressed in terms of the units in which he kept his records (for example, beebles).
For example, if I sold some wool to another person for three beebles, the clerk would record +3 beside my name and -3 by that person's name. I could then go and buy a slab of butter from someone else for one beeble. One would be deducted from my account, and one would be added to theirs.
The clerk did not set prices. The price was always agreed between the two people trading. People would be able to look at the list of trades that have already taken place to determine what their goods or services are worth in terms of beebles. (If a money system already exists, this would not be a problem).
The first trades would have to be for commonly traded goods and services (like bread or a daily wage for a labourer), so that people would be able to estimate the price of their good or services in terms of the beeble. The person selling will be able to get an idea of what he will be able to buy with the price that he agrees to. At first, people may build in a margin for getting the price wrong, but this would be outweighed by the benefit of being able to go beyond barter. As people became more familiar with trading in beebles, this margin would reduce.
When a major food producer began to accept the wise man's records, his system really took off. People would be happy to trade using his recording system, because they knew they could always get value in food.
I might buy a handloom for 2 beebles from someone else. Two beebles would be deducted from my account, and beebles would be added to the account of the person who made my loom. Following these transactions, my account balance would be zero. However, I would have exchanged my wool for the butter and the loom that I needed. (The value of the beebles would not matter as long as the same beebles were used for all transactions).
At the end of the day, a full set of transactions may not have been completed. In the clerk's book, some people may have positive balances and others would have negative balances. However, the value of positive and negative balances would be equal, as every time someone was recorded as selling something, someone else would be recorded as having bought it.
The value of outstanding transactions would vary enormously from day to day. Some days most people would have completed their transactions, so the total value of outstanding transactions would be quite small. On other days when a lot of people were in the market, the outstanding balances may be quite large. However, this would not matter, because the total value of positive balances would always be matched by equivalent negative balances.
The only problem would be if people who had nothing to sell ran up negative balances. To avoid this problem, there would be a rule that people with negative balances would need to clear them within five days. This would ensure that trade was fluid.
For security, the clerk would only allow people known to have goods and services to sell and a reputation for honesty to have negative balances. This would be based on their previous record of getting back to zero and building up positive balances. Those with the best records would be able to go negative by greater amounts than those with a poor record. (Traders with a good history would be allowed to have larger negative balances.)
People with negative balances would have to get them back to zero within five days. If someone didn't get back to zero in that time, the clerks would refuse to trade with him. He would be labelled as a thief, because he has taken goods and services and made no payment. Most people would not risk this happening, because if it did, they would be outlawed from the market process.
People with records of theft or foreigners with no reputation would only be allowed to go positive. This would mean they would always have to sell something before they could buy. People with good reputations would have the choice of buying first or selling first, depending on what was convenient for them.
This system would allow trade to develop quite rapidly. The clerk would eventually need to take on assistants to help him. The only problem would be that trade could only take place in one place. To expand trade further, other clerks might start doing the same things in different places in the city.
At the end of each day, the clerks would get together to sort out their balances. If people had a positive balance with one and negative balance with another they would net them off against each other. Some of the clerks would have a positive total in their book and the others would be negative. A clerk would be up one day and down on another, depending on where trade took place on a particular day. The differences would not matter because the total balances across all clerks would balance to zero. (The balances in the books of the clerks are not their assets or liabilities; they would just be accounting records.)
In practice, several clerks may set up this business in the same place. If the first clerk was not serving an area properly, another person with a reputation for honesty may see an opportunity and start a similar business. This would not matter as long as all clerks continued to net off their balances at the end of the day. Some days a clerk would be up, and on another, he would be down. This would not matter as long as he used the same unit as other clerks and netted his balances off against theirs.
Having a choice of clerks with which to deal would benefit the people, as if one started being dishonest, they could punish him by switching their business to another. This would be a strong incentive for the clerks to remain honest. The clerks would watch each other and if one was dishonest, the others would refuse to work with him. This would drive him out of business.
If a clerk made false entries, then the system would break down. For example, a clerk, who noted that a person with a positive balance had not been in for a while, may decide to spend it himself, or lend it to another person. He might presume that when the owner did want to use it, he would be able to get it back. This would be theft, as he has no right to do this with another person's balance. It is obvious that the clerk who spends the money himself has committed a theft. Lending it to another person has the same effect, so it is also theft. The other clerks would expose this behaviour and the culprit would be punished by the people refusing to deal with him.
Provided the people trusted the clerks to remain honest, the economy would have increasing trade. There would be no need for the king to control the money supply. There would be no for him to worry about the balances at the end of the day, because they would always net to zero.
The only limit would be that trade would have to take place in close proximity to a clerk. The clerks could solve this by getting PCs on which to record transactions. They would provide telephone links to shops and businesses so that they could record transactions directly without visiting a clerk. They would also set up booths around the city where people could do transactions without needing to go to the clerk. The clerks would issue code numbers so people could do transactions over the phone.
The kingdom would then have a fully functioning money system to facilitate trade. However, there would be no need to worry about the money supply, or reserve ratios, or the velocity of money, because they would be irrelevant.
There may be some people who would not want to spend their positive balances straight away. They might want to keep a positive balance as protection against future calamities or for when they retire. There may be others, who want to buy things to start a business. Other clerks could set up in business linking such people, assessing risks and collecting a fee for the use of positive balances. This would be a separate role from that of recording transactions. The feature common to both would be the importance of honest records.
This story shows how a sound finance system can function without a central bank, gold reserve ratios, settlement cash, discount rates, and all the other paraphernalia of modern banking.
The only weakness with this system is that the various clerks must be honest. The safest solution would be a set of distributed ledgers provides a better solution to this problem. If all the clerks operated on networked computers, every transaction could be recorded on every clerk's computer. This would make it impossible for a clerk to commit fraud, as the record would be exposed as different from the records of the other clerks. This is a distributed ledger.
A distributed register recording transactions would be the basis for an honest money system.
Return to Money.
