Haute Lumière
Commerce · III.01 · MMXXVI · daylight
ASSESSMENT · Chapter III.01 — What a Currency Is Made Of
Three instruments: a ten-point quiz, eight reflection questions, five essay prompts. The quiz checks comprehension rather than recall. The reflections are private and first-person. The essays are arguable from more than one side.
THE QUIZ — ten points
Four on recall.
1. Name the four functions of money and say which of them Keynes placed first, and why.
Unit of account, medium of exchange, means of settlement, store of value. Keynes, opening A Treatise on Money (1930), placed the money of account first: money is whatever discharges a contract written in the money of account, so the account is logically prior and the money is derivative of it. One mark for the four, one for the ranking with its reason.
2. State, as closely as you can, what the Bank of England's 2014 Quarterly Bulletin says happens when a bank makes a loan.
That whenever a bank makes a loan it simultaneously creates a matching deposit in the borrower's account, thereby creating new money — and that rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits. Credit is due for the substance; the source is McLeay, Radia and Thomas, 2014 Q1.
3. What proportion of the money in a modern economy is bank deposits rather than notes and coin, and by what two routes is that established in the chapter?
About 97 per cent. Route one is the Bank of England's own stated figure of about 3 per cent currency. Route two is £82 bn of notes and coin against £2,920 bn of M4ex, giving a 2.81 per cent currency share and a 97.19 per cent deposit share. The two agree to 0.19 of a percentage point. The second route is the point of the question: a figure checked by one route is a claim.
4. What actually constrains a bank's lending, if not a stock of reserves?
Capital against risk-weighted assets, the price and availability of marginal funding once the deposit drains to other banks, competition for profitable borrowers, and monetary policy acting on the price of funds. Full marks require naming at least capital and funding, and explicitly rejecting the loanable-funds picture.
Four on application.
5. A colleague says: "If banks can create money by typing, they can create unlimited money." Where does the argument fail?
At retention, not at creation. The creation is two ledger entries; the constraint arrives when the borrower spends and the deposit leaves for another bank, which the lender must fund at a price it does not set, against capital it must hold. The stronger answer notes that the loan must also be repaid, so credit risk prices the whole exercise, and that the constraint is a price, not a quantity — which is why lending is procyclical rather than capped.
6. Chile's Unidad de Fomento is a unit of account that nobody holds and nothing settles in. Why is that an advantage rather than a curiosity?
Because the unit of account and the means of settlement have different design requirements. The unit needs to be stable across decades; the settlement medium needs to be fast, final and cheap. Separating them lets each be optimised, and lets long contracts survive inflation without abandoning the national currency. Credit any answer that names the separation as the mechanism rather than the indexation.
7. An advisor tells a town council that issuing a local currency with a demurrage charge will "make money work for the community instead of sitting in banks." What has the advisor not costed?
The capital layer. Demurrage raises circulation and simultaneously makes the currency useless for accumulating long-lived capital, which is what funds the regenerative projects the council presumably wants. The strongest answers name the consequence directly: the town would become more dependent on bank credit for long assets, not less, and the fix is a second instrument — dated claims on regenerating stocks — not a different rate.
8. Your CFO objects that an index-linked note "exposes us to inflation risk we do not have today." Answer her.
Today the exposure is on the other side and is unhedged: a nominal facility is a real liability that falls if the index rises and rises if it falls, while the asset being financed is a real asset. The indexed note matches the liability to the asset. The honest part of the answer is that the issuer does take index risk, and the paper should state the breakeven — above a 4.40 per cent index drift the note costs more than the facility — and say who bears it.
Two that require the arithmetic to be done.
9. A local currency carries demurrage of 1 per cent a month. A cooperative wants to assemble £1,000,000 over twenty years to build a district heat network. How much must it set aside each year, and how does that compare with a currency with no carrying cost? Show your working.
Effective annual carry:
1.01¹² − 1 = 12.6825%, soi = −0.126825.(1 − 0.126825)²⁰ = 0.06638. Annuity factor= (0.06638 − 1) / −0.126825 = 7.3615. Annual contribution= 1,000,000 / 7.3615 = £135,842. Total contributed= 20 × 135,842 = £2,716,840, against £1,000,000 in a zero-carry currency — a penalty factor of 2.717×. Credit any method reaching roughly 2.7. The point of the question is that a design choice about hoarding has a price in long-lived regenerative capital, and the price is a number.
10. A bank advances a £200,000 residential mortgage. The standardised risk weight is 35 per cent and the total capital requirement is 10.5 per cent. How much equity stands behind the new money, and what is the ratio?
RWA = 200,000 × 0.35 = £70,000.Capital = 70,000 × 0.105 = £7,350. Ratio= 200,000 / 7,350 = 27.21×. The stronger answer states what the ratio does and does not mean: it is not a licence to create 27 times capital without limit, because the funding drain, credit losses and competition all bite before the capital ratio does — and because the risk weight is 35 per cent only for this asset class.
REFLECTION — eight questions, for one person and a pen
These are not for a room. Write the answers by hand if you can; the slowness is the point.
- What did you believe money was, before this chapter? Write the sentence you would have given at twenty. Do not correct it — just look at where it came from and who taught it to you.
- Which of the four functions do you personally lean on hardest, and which do you neglect? Answer about your own habits before answering about any system.
- Name something you have stored value in that was not money — a skill, a relationship, a tool, a reputation. What is its regeneration rate, honestly?
- Where in your life do you already keep a unit of account that is not currency? A week. A shift. A favour. A portion. Who else honours it?
- Think of a debt you have carried, in money or otherwise. Did it get heavier or lighter as time passed, and what made the difference?
- Money stops being weather the moment you see the two entries. What else in your life is currently weather, and might turn out to be somebody's writing?
- If your savings had to be described as a claim on something specific, what would you want them to be a claim on? Answer before checking what they actually are.
- Where have you saved carefully at exactly the moment your household, team or town needed you to spend? What would have had to be true for you to act differently — and is that a moral question or a design one?
ESSAY PROMPTS — five
Each is arguable from more than one side. Each requires at least one source the chapter cites and at least one it does not.
1. The Bank of England said it; what followed? The 2014 bulletin stated the endogenous money position in plain institutional language. Argue either that this settled the question and that the loanable-funds picture survives only in teaching materials, or that the textbook picture persists because it does useful work that the credit picture does not. Use McLeay, Radia and Thomas directly, together with Werner (2014), and at least one undergraduate macroeconomics textbook published after 2014 that the chapter does not cite — read what it actually says about the money multiplier.
2. Is the store of value a function of money at all? The chapter argues that three functions want stability and circulation while the store of value wants appreciation and retention. Argue either that the store of value should be designed out of currency entirely and moved to explicit claims on real assets, or that a money nobody can hold is a money nobody will accept. Use Keynes (1930) on the money of account and Gesell or Fisher on carrying costs, and one source on liquidity preference or on the demand for safe assets that the chapter does not cite.
3. Chartalism and the limits of the tax argument. The chapter attributes the durability of the Exchequer tally to tax acceptance, following the line from Knapp through Goodhart and Wray. Take a position on how far tax acceptance explains monetary adoption — and address the awkward cases: dollarisation in economies whose governments tax in local currency, and private monies that circulated widely without any fiscal anchor. Use Goodhart (1998) and one monetary history the chapter does not cite.
4. Wörgl, and what an experiment has to produce to count. Reported circulation multiples for the Wörgl scrip vary by more than an order of magnitude and none is reproducible from a surviving ledger. Argue either that the episode remains strong evidence for demurrage and the measurement problem is incidental, or that an experiment without a reproducible ledger cannot carry the weight placed on it and the case for demurrage must be made on theory and modern data alone. Use Fisher (1933), and one post-2000 empirical study of a complementary currency that the chapter does not cite.
5. Who should publish the index? The chapter's three-layer design makes the unit of account a published index and concedes that whoever sets the basket holds real power over every long-dated contract in the system. Argue for a custodian — a statutory body, a multi-stakeholder trust, an open protocol with algorithmic revision, or the central bank — and defend it against the obvious capture. Use Ostrom (1990) on institutional design and Shiller (1998) on indexed units, and one source on index governance, benchmark manipulation or standard-setting that the chapter does not cite.