You can keep your damn money (I'm going to make my own)

What is money anyway? Once upon a time it was bits of precious metals we carried around in drawstring bags. Then the banks got in on the act and offered to store the precious stuff for us and issued paper IOUs for it, which, apart from being the death knell for the drawstring bag trade, made it easier to trade in denominations of pennies and pounds now dollars and cents.

The practise of banks issuing currency was eventually centralised by governments of nation states and when the gold and silver standards were abandoned these pieces of paper were collateralised by nothing in particular other than the promise of the central bank that the money was good. We believe the bank is good because the economy of the nation state is good.

There are places in the world like Hong Kong where banknotes are still issued by two private banks (at one stage there were 13) and collateralised by some gold, silver, some land and their ability to borrow from other banks – particularly from each other.

So, if I have enough collateral, credit and courage could I could issue my own currency, starting with issuing paper IOUs for assets I hold?

Consider ducks.

As the struggling owner of 1000 ducks I am duck rich but cash poor. As a courageous anarcho-capitalist I decide to create my own currency – the Duckaroo (Ausssie birds obviously). Each Duckaroo can be redeemed on demand for one healthy duck. As the market price of a duck is around $20 so in turn one Duckaroo is worth roughly the same in fiat, which in this case is Australian dollars.

Now I can trade my ducks on the market or purchase goods with paper rather than actually carrying the damn birds around under my arms with them crapping down my legs.

Will merchants accept my Duckaroos as payment for goods and services? They don't have to because they are not legal tender. But they might if they believe that there is in fact a duck waiting for them to pick up on demand, that the price of a duck is stable and there is sufficient demand for ducks at the market so they can easily liquidate the duck for $20 in fiat. It would help if they were fond of ducks.

I head to the market and trade all my Duckaroos. Now I have 20,000 dollars worth of fiat, goods and services and I still have 1000 ducks.

And there is more good news. Ducks breed and for each new baby duck I can issue and spend a brand new Duckaroo. The bad news is that ducks are mortal creatures. So now I must put all my efforts into maintaining collateral for each Duckaroo in the marketplace.

Disaster strikes. Avian flu arrives from China. Half of my ducks die. The health of the other half is in doubt. Word gets around and I wake to find a queue of Duckaroo holders in my yard demanding healthy ducks.

Not only are the Duckaroo holders seeking to get their ducks out while they are still able, but also supply and demand economics have pushed the price of a duck up to $40 due to statewide losses from the avian flu. Panic and greed take hold and we find ourselves in the savage grip of a Duck Run.

Remember the 13 Hong Banks which once issued their own banknotes? This is what became of 11 of them. Rumours about a bank being undercollateralised led to bank runs when panicked depositors withdrew their funds en masse. With competition fierce among the many banks and no central bank to bail them out, eleven of them collapsed and were swallowed up by the others, leaving just two big banks still standing today.

So what to do? I am short 500 ducks. I could buy some but the price per beak has gone up so replacing my lost ducks would cost an extra $10,000 that I don't have.

But I might be able to stall if the Duckaroo holders believe that I am good for the ducks – just not today.

So here the strength of the economy kicks in as quasi-collateral in the way that the economies of nation states sort of collateralises their fiat currency, their banknotes that are not IOUs for anything- just attractive pieces of paper that say “You can trust me – I'm from the government”.

Will my local economy support the failing Duckaroo? Will my neighbours lend me some ducks? Would a duck merchant extend me some credit or, if not, will my local bank lend me some money? Will a merchant bank or a loan shark? Will local merchants extend me credit so that I can eat until the duck crunch has passed? Will the government bail me out? Is there a growing demand for duck products as the population is growing and wealthy enough to afford duck rather than the much cheaper chicken? Are interest rates affordable?

If the answer is no to too many of these questions: the Duckaroo is cooked, sorry. The mob at the gate will leave eventually – to get flaming torches and pitchforks.

So where did I go wrong?

Other than relying on perishable goods as a store of value, I was clearly undercollateralised. I needed at least 2000 ducks to issue 1000 Duckaroos in case my entire flock was wiped out. I also need credit and insurance, but from companies which might not be satisfied with a two to one ratio of collateral as lightning often strikes in the same place twice. Or thrice, - or more.

So how many damn ducks are enough collateral for each bloody Duckaroo? What the hell have I got myself into?

Tune in next week - Uncle Donald rides to the rescue. Or does he? We will delve further into this mess and discuss better ways to issue our own currency.