What is Money?

If we’re going to follow the money, we need to understand what Money is.

First an anecdote about Australia’s Money past.

In the early days of colonial Australia, a peculiar coin emerged that would become a symbol of resilience in the face of adversity. This is the story of the Holey Dollar, a coin that was not just a means of exchange but a testament to the human ingenuity.

In 1813, Governor Lachlan Macquarie, the fifth Governor of New South Wales, faced a dilemma. The colony was suffering from a severe shortage of currency, and the few coins that did exist were often hoarded or sent back to England. Macquarie needed a solution, and he found it in an unlikely place – the Spanish silver dollar.

Macquarie ordered the Royal Mint in Sydney to take these Spanish dollars and punch a hole through the center, effectively creating two coins from one. The inner punched out coin, known as the “dump,” was worth 15 pence, while the outer holey part, or “holey dollar,” was valued at five shillings. This ingenious act not only created a new currency but also rendered the coins useless in England. It also created a profit for the Treasury at time of issue.

The Holey Dollar became the first official currency of Australia, and its unique design made it difficult to counterfeit. The coins were stamped with the words “New South Wales” and “Five Shillings” on one side, and “1813” and “G.R. III” (George III) on the other.

The Holey Dollar’s story is not just one of economic necessity but also of the human spirit. It represents the determination of the early Australian settlers to overcome financial challenges and forge a new path. The coins themselves, with their distinctive appearance, became a source of pride and identity for the fledgling colony.

Money is used to buy or exchange for goods, services, assets or investments. That’s what Money does, but not what money is. Money has evolved considerably over the centuries. Particularly in the digital age, Money has transformed from coins to notes and eventually into numbers on a computer screen showing an account balance in a bank. There are still physical cash notes (fiat money), but that represents such a small part of the Money balance to be irrelevant for our purposes and is therefore excluded from this analysis. While it’s theoretically possible to withdraw all one’s funds in fiat money and hide it under one’s bed, that’s not practical in today’s world.

In the cash note world, i.e. fiat money, money can be described as a type of promise to pay citizens, through either the government of the day or the Central Bank. It’s not backed by any other store of value, such as gold. There is no guarantee as to the value of fiat money or what it can buy, just that the piece of paper or plastic with one Dollar on it is a Dollar.

A citizen could theoretically hold all their Money in the form of fiat money in their own safe without the need for a bank. Is that Money in a safe the same money as is held in a bank in a digital world? In short, no.

In Australia the Central Bank is the Reserve Bank of Australia. The Central Bank is basically a banker to the banks and the setter of short term interest rates. The Central Banks controls the  printing of fiat Money. It can also create digital Money.

In a digital world, all Money in a country is accounted for in banks as bits and bytes. The Money in each account is often referred to as cash as if it were equivalent to fiat money. It’s not. It represents a loan to a bank that is normally called a deposit. Except for those cash notes or fiat money that we are disregarding, all Money is held in private banks and the Central Bank. Banks, in the interests of reducing risks, are regulated by the government. This provides citizens who deposit Money with banks the confidence that they can have access to their Money to buy, invest or transfer at any time. However, a bank’s ability to pay is not fully guaranteed by the government, so a risk for depositors still exists. In Australia, only Money up to $250,000 deposited in a bank is supported by the government and that is still not a guarantee. It is a system where the government picks up principal losses after a period of resolution and is limited to a total system limit of $20Bn. This is a far cry from being able to rely on all Money being the unconditional IOU from the government that fiat money enjoys.

All depositors face a risk that a bank will fail and all or part of their money will disappear. Such a situation is playing out in the USA and Swiss banking system in 2023 with Silicon Valley Bank and Credit Suisse Bank respectively. But the system cannot work if deposits, also known as Money, is thought to be at risk by citizens. Governments and Central Banks will bail out the depositors in nearly all circumstances where a bank has liquidity or credit issues even though they are not legally required to do so. The system can’t function with Money failure of any significant size, as that undermines the function of Money. If equity investors in banks lose, it is considered acceptable because that is not Money failure, it’s equity or share failure. But deposits that represent Money must not fail. This brings us to our first Money rule.

Rule 1. The Money that citizens hold in banks is a promise to pay from a private bank that is only surreptitiously and not directly supported by the government. Money is not supported by a direct government guarantee although the Money system operates as if it is.

What we have is an imprecise system, where Money is not managed through a rigid legislative support regime that can be accurately monitored. Under rigid regime, it would be hard for a government to argue that banks should not be paying significant guarantee fees for the benefit received from government support. Banks earn large profits and pay very little for strong implied government guarantees. The Money system allows banks to socialise losses ie have the taxpayer pick up the losses incurred through bad management and mistakes with little accountability on management. Many citizens and most bankers may believe that this system is acceptable, but an understanding of how the Money system works will surely give a variety of views that should challenge the status quo by demanding proper taxpayer compensation and accountability.

Central Bank Digital Currencies

To add a recent but important development, Central Bank Digital Currencies (CBDC) could potentially change how the Money systems work in a fundamental way. A CBDC would be Money held in a depositor’s account with the Central Bank and able to be held on a citizen’s personal digital device is government supported digital Money and not a loan to a bank.  Assuming privacy issue are addressed such a development would be revolutionary.

A CBDC would fundamentally change how private banks operate and the power they have. An unrestricted CBDC would become the Money transaction infrastructure. Private banks would have any implied guarantee removed with barriers to entry reduced for small digital banks resulting in more competition and a better deal for citizens

 However, CBDCs are only just being developed and so are the rules surrounding their implementation. If vested interests have any say, then the rules around CBDCs will likely be restrictive enough to not significantly change the way private banks currently operate. Looking at our own Central Bank actions on CBDCs I’d say, at least from a Money perspective, the use of CBDCs is likely to be very restrictive and not change how the current Money system operates denying citizens better banking and banking products.

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