What will a future monetary system look like?

The ways in which money has evolved over the last century are greater than the changes that have happened since it first emerged millennia ago. Money emerged as a means of simplifying barter transactions, acting (in a way) as a central counterparty between buyers of good A and sellers of service B. By the end of the 19th century it had changed from being a physical good (think gold or silver) that both parties to a transaction would accept, into certificates representing physical gold and silver. They were still acceptable to both sides as they knew (or thought they knew) that there was real gold and silver available if they wanted to front up to their local bank.

That started to change as the world’s governments nationalised and monopolised the central banking system. This process started in the early 19th century in Europe and was largely completed by 1913 when the US Federal Reserve system was set up. The 1946 Bank of England Act which formally nationalised the notionally independent central bank merely formalised what had happened earlier. In Australia, the Commonwealth Bank acted in this role, as well as acting as a normal bank, from 1920.

Prior to this process there had been a few attempts to set up government monopoly central banks and fiat currency issue, but these had invariably ended in catastrophe such as with John Law’s Banque Générale in Paris. The reason is that the temptation to issue more and more currency using the legal backing of the State to give it value rather than its scarcity and desirability becomes overwhelming. It’s much easier to print money to “create” wealth for the State, rather than using it just as a means of transacting.

The modern central banks, though, have not (in the West at least) created catastrophic hyperinflation. In consumer price terms, the last 50 years have regularly seen inflation being between 2% (the norm in the last decade or so) and 20% (during the 1970s and 80s). Does this mean that the monetary demons have been slain? Are we now where we should be with money?


The increasing speed of the disappearance of notes and coins, first with the use of cheques and now by credit cards and electronic transfers shows yet again that the value of the system is not in notes and coins but in the ability of the system to create opportunities for trading. The image of Scrooge McDuck swimming in his gold never made any real sense. The money is better used for facilitating transactions, not for recreational purposes.

Basing a currency on gold or silver, or any other commodity, implies that there needs to be some holdings of that commodity to back the currency and meet calls on it. As with Scrooge McDuck, such holdings necessarily impose a cost on the holder: the cost of not only storing and securing such a holding but also the income foregone from its next best use. Holding gold means that the time, effort and capital that went into its mining and production has resulted in copious amounts of gold sitting around doing nothing. It’s a waste.

An alternative to this is to have a central bank (or other currency issuer) promise that they will only issue enough currency to keep it at a certain value in a particular commodity – but this promise has been made by governments many times and very seldom, if ever, has it been kept.

The record of government issued fiat currencies is similarly not a good one. The current system, where the central bank is mandated to a de facto promise to keep their fiat currency relatively steady on a price index is very similar to a promise to keep its value against a given commodity – it just substitutes a basket of goods for that commodity. While this is steadier than an unbound fiat system, it’s still dependent on the promise of the currency issuer, the statisticians getting the index right and the government not reneging.

In centuries past any attempt by a private currency issuer to issue a fiat currency would have received short shrift as it would clearly have been seen as a way to enrich the issuer and therefore not to be accepted. Private currencies always had to be backed by physical holdings of a commodity to give stability to the currency if it was to be accepted – the cost of the holdings being the way to make the currency legitimate. As with the Banque Générale, a private issuer needs to give some assurance against over-issue. They should be more reliable than government ones, as they have no way to force acceptance of their currency, but this is still a temptation.

Enter cryptocurrency: where the currency issuer is not a bank but a computer program running on many widely diverse computers. The difference with these electronic private fiat currency issuers is simple – anyone can create the currency, but only up to a mathematically defined limit which is clear to all. There is a cost to producing the currency: in the case of Bitcoin, Ethereum or other blockchain-based systems it is the computer time and that will rapidly balance to the value of the currency produced. Crucially, once the currency is produced it is simply a computer record, costing very little to store and secure. The collapse of several Bitcoin exchanges and the resulting loss to the owners of their Bitcoin shows this is not zero, but it is comparatively low. Transaction costs exist, but these can be minimal.

The problems with the blockchain method, though, are becoming increasingly clear as its use increases. The impending hard fork in Bitcoin is a good case in point – the inability of the original blockchain to process the number of transactions needed was becoming a significant impediment. While there is a limit of transactions with Bitcoin of around 6 a second (compared to a system like Visa at 30,000 per second) it simply can’t compete. The need to send and receive messages across the entire planet, to decrypt, do calculations, update records and then encrypt again makes this a slow process. Current banking systems might be unfashionable, but they are fast.

The widespread acceptance of private fiat currencies is still some way off and the existing banking system is immensely powerful. The history of the move into internet commerce is instructive – the vast bulk of the brands we still buy and sell, even if now over the internet, are ones that pre-date the internet. Almost all our banking arrangements are still with banks that have existed for decades, if not over a century. This will not change but the products they sell us will. There may be a few innovative start-ups, but these are likely to be swamped by the regulations governing banking and by the banks’ responses.

The vast bulk of people will still need to trust where they are storing their wealth and most are not going to want to be bothered with the technical details for a while yet. I can hardly see Scrooge McDuck with a Bitcoin wallet. The evolution will continue, probably forever, but it will be evolution, not revolution. Inertia is a powerful thing. What will a future system look like? Much like today’s – only changing still faster.

Andrew Reynolds