This post is about something I don't understand.
Let's start out simple. There are two parallel imaginary worlds: the green world and the red world.
In the green world people use positively-valued green money as the medium of exchange. If I buy something I give the seller my green money in exchange. Green money flows in the opposite direction from all other goods and financial assets. I am not allowed to take green money from someone without their consent. Only the issuer of green money is allowed to create green money. The borrower of green money undertakes an obligation to give green money to the lender at some future date.
In the red world people use negatively-valued red money as the medium of exchange. If I buy something the seller gives me his red money in exchange. Red money flows in the same direction as goods and financial assets. I am not allowed to give red money to someone without their consent. Only the issuer of red money is allowed to destroy red money. The lender of red money undertakes an obligation to accept red money from the borrower at some future date.
There is a symmetry between the red and green worlds; one is the negative mirror-image of the other. But there is also one asymmetry: the red world has a fundamental problem. Each individual can increase his utility by buying more goods and selling less goods, thereby accumulating an infinitely large stock of red money. The bank that issues the red money needs to put some limit on each customer's holdings of red money, to ensure this does not happen. This is not a problem in the green world, because having zero stock of green money sets a natural limit that stops an individual buying, and the individual is fully aware of that limit.
The real world is a red/green world. It has both green money and red money. A positive balance in a chequing account is green money. A negative balance in a chequing account is red money. If I sell my car to Andy, who gives me a cheque for $1,000, the bank reduces my overdraft by $1,000 and increases Andy's overdraft by $1,000. The bank has transferred $1,000 of red money from me to Andy. IIRC my father nearly always used red money. He nearly always ran an overdraft, paying it off once a year when he sold the harvest, to keep the bank manager happy.
In a red/green world, we can define the stock of "gross money" as the absolute sum of red money plus green money, and we can define the stock of "net money" as green money minus red money.
The Bank of Canada.
Canadian commercial banks have chequing accounts at the Bank of Canada. It's a red/green system. If I bank at BMO, and Andy banks at TD, and I sell my car to Andy who pays by cheque, BMO now has a positive balance of $1,000 at the Bank of Canada, and TD now has a negative balance of $1,000 at the Bank of Canada.
But the Bank of Canada sets a 50 basis point spread between the interest it charges TD on red money and the interest it pays BMO on green money. So BMO and TD can both gain if BMO lends TD $1,000 to eliminate both balances, at a rate of interest that splits the spread between the Bank of Canada's two rates of interest. Which is what Canadian commercial banks normally do. So the gross money stock is small, and normally the same as the equally small net money stock, by the end of each day.
- If the Bank of Canada acted differently, and set the same rate of interest on both red and green money, so the spread is zero, then there would be no incentive for BMO and TD to trade in the overnight market. If BMO's customers always sold more to TD customers than vice versa, BMO's chequing account at the Bank of Canada would become more and more positive, and TD's chequing account at the Bank of Canada would get more and more negative. The gross money stock would rise without limit, though the net money stock would not change.
- Or if TD were a risky bank, and if that risk were bigger than a 50 basis point compensation would warrant, there would be no rate of interest at which BMO would lend to TD that TD would accept. Again it is possible for BMO's account at the Bank of Canada to become increasingly positive, and TD's account increasingly negative.
A red/green world faces the same fundamental problem as the red world. A commercial bank will put a limit on each customer's overdraft. Similarly, the Bank of Canada must, at least implicitly, place a limit on commercial banks' overdrafts.
The European Central Bank.
Eurozone national banks have chequing accounts at the European Central Bank. It's a red/green system. They call it TARGET2. But unlike the Bank of Canada's red/green system, there doesn't seem to be any functioning equivalent to the overnight market that eliminates negative balances every evening. The ECB can hold the net money stock fixed, but the gross money stock can rise without limit. Here is the recent data (pdf).
I think you can see where this is going. I don't understand how it is supposed to work.
Worthwhile Canadian Initiative 
Nick: so with my first card. 1973. For my first trip to Blighty (and Scotland too : https://www.hw.ac.uk/schools/textiles-design/.
in Galashiels.)
Johan: You keep on surprising me with your historical knowledge! I knew you’re well-read, but didn’t know it included this kind of stuff too.
The reason why I picked that sentence from Geva was because it doesn’t apply to the banking system as a whole (central bank as part of it), or Nick’s “one bank”. The same old problem. You have no right to claim (in any meaningful sense) any “sum of payment” from the central bank if you have a checking account with it.
(I know some people might protest, but I add this nevertheless: And if you have a negative balance on that checking account, the central bank cannot claim any “sum of payment” from you. You have a liability in its books (or ledger; which word does JKH prefer?;)) and you get rid of that liability by, for instance, selling goods — or generally, by getting your account debited.)
If non-banks were using central bank checking accounts (something CBs are considering in connection to “e-currency”), could the non-transfer still be called a “transfer” of value? Well, I guess it could. But as we agree, it is not really a transfer.
The payee’s account is credited (we don’t need to know whether the balance is positive or negative). This I could call an increase in the “monetary value” of, or pertaining to, the customer as recorded in the CB ledger. (Assuming payor and payee are not the same.)
The payor’s account is debited (again, no reference to its balance). That is a decrease in her “monetary value” recorded in the CB ledger.
What is that “monetary value”? How does it fit in the big picture? Any suggestions, anyone?
“…or generally, by getting your account CREDITED”! Sorry.
Jacques and Nick:
Yes, one could think that the young people today have a better chance to get rid of what I call the “money illusion” (not to be confused with other kind of money illusions). But who is teaching them, and who taught them when they were kids? Have they, too, had piggy-banks? Don’t they still see money or funds flowing, instead of just electronic records being updated?
My nephews & nieces had a bank account while very young. They saw adults using debit and credit cards, buying online and using ApplePay.
As one of them told me (he was 5 at the time) “credit cards are for paying things and having debts.”
I asked him if he wanted a card. He snapped back “:Uncle, that’s your hotel key.”
I admit they’re bright, as they are from a high socio-economic background and share part of my genes but still, at worst, they are just a few years ahead of the rest.
My students barely carry cash. They use it at the cafeteria (and maybe with their friendly provider in the basement locker hall where no staff goes…).
Antti: “The reason why I picked that sentence from Geva was because it doesn’t apply to the banking system as a whole (central bank as part of it), or Nick’s “one bank”. The same old problem. You have no right to claim (in any meaningful sense) any “sum of payment” from the central bank if you have a checking account with it.”
I don’t see why it shouldn’t apply. All the necessary elements as per the given definition seems to be there: It’s a non-cash payment; the sum (in terms of monetary value) credited to the bank’s CB-account (payee) is the same as the sum debited from the payor’s CB-account; the payee bank’s claims towards the CB have increased by the credited amount; should the payee bank have been indebted to the payor bank before the transaction to the same amount of the monetary value of the payment, then that debt is now discharged as a result of the transaction.
It’s quite immaterial whether the payee bank has a debit balance on its CB checking account, say due to an overdraft. In that case the debit balance is simply reduced, discharged or converted to a credit balance. For example, if the payee bank has a debit balance of 100 before the transaction, and the payment is for the amount of 60, the credit entry will simply reduce the debit balance to 40. The account still has two sides; numbers on the credit side represents a claim on the CB and numbers on the debit side represents the CBs claim on the account holder. The balance dictates which party has ongoing money obligations towards the other and to what amount concerning the account in toto.
Johan:
I said: “If non-banks were using central bank checking accounts”.
I was talking about a non-bank payee and payor. Even if we assumed no checking accounts at CB for non-banks, then currency would be comparable to a positive balance on a checking account at the CB.
Here’s a short post explaining my “no transfer” view: Green Stones Don’t Reside on Accounts.
It no doubt raises more questions than it answers, but I’m here to discuss.
Antti, can you clarify?
Nothing changes even if we consider you and me having CB accounts and the transactions are the same as mentioned (say, with the Fed). Currency is comparable in that, for example, a positive balance of 10 on a CB account represents the same monetary value as a $10 banknote. A credit-debit entry of 10 to your checking account also represents the same monetary value as a $10 banknote.
If you don’t like the “the right to claim the sum of payment” –part in the definition it can obviously be amended to something more precise. For example (Geva: 2015, 2): “… facilitating the transmission of monetary value, particularly in the form of account debits and credits redeemable to monetary objects, that enables the payer to avoid the transportation of monetary objects and their physical delivery to the payee.” Monetary objects = cash (banknotes/coins).
The gist of the issue however remains the same in my opinion.
I am still trying to get this one answered.
Betty does not qualify for an “overdraft”. Andy does. Andy gets an “overdraft”. In Nick’s scenario, Andy sends goods and “red money” to Betty. Betty defaults. What happens?
Johan: I guess I’m just being a crank. I don’t like this either: “…credits redeemable to monetary objects…”.
It sounds like “primacy of currency”, which I discussed with Nick above. Currency IS a credit balance in a CB ledger. So it is unnecessary to talk about currency or “monetary objects”. We can stop at the “credits” in CB books, if we take the CB to be the “third party” in Geva’s earlier sentence.
I just think that Geva’s statements are lacking in generality. Let’s say the payee has a negative balance on his checking account prior to the credit entry. In this case he obviously doesn’t earn any “right to claim the sum of payment from a third party”. But this is not so important. I can see how one can get around my objection here by talking about how the right the payee earns is automatically netted against an obligation towards the bank, or something like that.
What is more important is that we cannot even say what “monetary value” recorded in the CB ledger is. If we could, then we would have solved the “money problem” in economics. I think this problem is the reason why all roads lead to “monetary objects” or currency. It’s nice to think of that as the end of story. Geva seems to hint that those are property that can be stolen, unlike the credits? And yet, currency is just a credit in the CB ledger.
Antti,
I don’t think you’re a crank, far from it (sometimes cranky, but aren’t we all). 😉
Sure, you could interpret it as a case of “primacy of currency”. That’s however entirely justified if we define the payment system according to historical precedence where people used to, and still do, actually carry cash around for making payments and settling debt relations. That happened way before central banks emerged or open-access system of common ledgers evolved into such an encompassing electronic payment system as the one we have today, at least in the more developed regions of the world.
Hence, Geva’s definition is not about how it could be, nor is it a statement of how it will be in the future, in perhaps a non-cash society. For all intents and purposes, it is still an accurate description of how it appears today. Especially in the extended sense pertaining to the kinds of alternatives that are open and commonly accepted for agents to prove they have “current means of payment” outside the scope of access to a common (electronic) payment system. Thus, currency may also be interpreted as something “being current” and usable off-grid, as an ‘ability/property’… i.e., not only having the attributes of a dictate from the government as legal tender, but a claim and proof-of-claim vis-à-vis the currency issuer enclosed within the object itself. A paper copy of your bank/CB account balance from a month ago might not suffice for such a purpose. A bearer instrument seems more apt. Hence, banknotes and coins serve such purpose today, as depositable monetary objects. It’s a two-way street, if you like. Also, in another way, should you have a zero balance on your bank account, with no recourse to make overdrafts, a monetary object deposited would be the thing that brings currency in the adjective sense (read: “debitability”) to your account.
Currency is both monetary objects (physical cash today) and the unit of account in which they are denominated. And if you wish: “a credit in the CB ledger”. I would however quibble with the balance –part (a balance is just a balance). We don’t have to settle for only one description when we can allow for many. Still, we might be moving in the direction as to make the physical parts of the currency-description redundant.