Encyclopedia of Money: R

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RUSSIAN CURRENCY CRISIS

On August 13, 1998, the Russian stock and bond markets crashed amid widespread investor anticipation that the Russian government would devalue the ruble and default on its debt. The stock market lost 75 percent of its value between January and August 1998 (Chiodo and Owyang, 2002). Annual yields on ruble-denominated bonds rose above 200 percent. The expectation of crisis accelerated the crisis. On August 17, the Russian government devalued the ruble, defaulted on its debt, and declared a moratorium on payments to foreign creditors (Chiodo and Owyang, 2002). On September 2, 1998, the Russian government let the ruble float. By April 1999, the ruble traded at 22 percent of its value compared to where it stood before it began to drop in August 1998 (McKay, April 1999).

In 1997, the outlook in Russia remained optimistic. After reporting negative growth in 1995 and 1996, Russian economic growth inched into positive territory at 0.8 percent for 1997 (Chiodo and Owyang, 2002). Inflation subsided to the 11 percent range compared to over 200 percent inflation in 1994 (Chiodo and Owyang, 2002). Oil sold in the $23 per barrel range, a relatively high price at the time. Oil and nonferrous metals accounted for up to two-thirds of Russia’s foreign exchange earnings. Large foreign exchange earnings from trade provide resources to keep domestic currencies strong in foreign exchange markets. Russia’s credit rating was improving, and by late 1997, about 30 percent of short-term government debt belonged to nonresidents (Chiodo and Owyang, 2002).

Some problems remained. One vulnerable point was the public sector deficit, which remained high because of

Russia’s inefficient tax system. In August 1997, speculative attacks sparked currency crises in East Asian economies. This episode alerted foreign investors to other possible soft spots in the global financial system. In November 1997, the Russian ruble came under speculative attack, causing the Central Bank of Russia to lose $6 billion in foreign exchange reserves (Chiodo and Owyang, 2002).

The Russian government was counting on 2 percent economic growth in 1998 to help pay for rising debt. As the price of oil and nonferrous metal fell in the wake of the East Asian Crisis, Russia’s economic situation began to deteriorate. Output would actually fall by nearly 5 percent in 1998. In February, the Russian government requested an aid package from the International Monetary Fund (IMF). It was be July before the IMF approved an emergency aid plan for Russia. The IMF demanded certain reforms before approving the plan.

In April 1998, the ruble came under another speculative attack. On May 19, the Central Bank of Russia increased its lending interest rate from 30 to 50 percent (Chiodo and Owyang, 2002). With inflation in the 10 percent range, these interest rates were unusually high. This action increased the interest rate paid by ruble-denominated assets. Raising domestic interest rates tends to shore up the value of a currency in foreign exchange markets. The currency becomes a ticket to higher interest rates. On May 27, 1998, the Central

Bank of Russia raised its lending interest rate to 150 percent (Chiodo and Owyang, 2002).

Missteps in public relations may have aggravated the crisis. Early in May, the chair of the Central Bank of Russia warned government ministers of a debt crisis. The warning came at a meeting with reporters in the audience. At about the same time, the prime minister of Russia stated in an interview that tax revenue was 26 percent less than targeted, and that the government was “quite poor now” (Chiodo and Owyang, 2002). When the prime minister refused to meet with a deputy secretary of treasury of the United States, regarding him as not high enough in the government, big investors became worried, and began selling Russian bonds and stocks.

Russian gross domestic product (GDP) growth recovered, growing 8.3 percent in 2000 and roughly 5 percent in 2001 (Chiodo and Owyang, 2002). The year following the crisis, Russia saw consumer prices soar

92.6 percent (Chiodo and Owyang, 2002). By 2000 and 2001, consumer price inflation had subsided to a range of 20 to 22 percent. In 2000, a world escalation of oil and commodity prices put the government’s budget in the surplus column for the first time since the formation of the Federation.

See also: Currency Crises, Foreign Debt Crises

References

Chiodo, Abbigail J., and Michael T. Owyang. “A Case Study of a Currency Crisis: The Russian Default of 1998.” Review, Federal Reserve Bank of St. Louis, vol. 84, no. 6 (November/December 2002): 7–18.

McKay, Betsy. “Ruble’s Decline Energizes Russian Firms Who Manage to Win Back Consumers.” Wall Street Journal (Eastern Edition, New York) April 23, 1999, p. B7A.

Sesit, Michael R., and Sara Webb. “Ruble’s Woes Could Shake Market Anew.” Wall Street Journal (Eastern Edition, New York) July 6, 1998, p. C1.

ROYAL BANK OF SCOTLAND

The Royal Bank of Scotland, like the Bank of England, began when a group of holders of public debt received a royal charter to incorporate as a banking institution. Parliament granted the royal charter creating Scotland’s second public bank on May 31, 1727. The Scottish Parliament had chartered Scotland’s first

public bank, the Bank of Scotland, on July 17, 1695, before the unification of Scotland and England. In the Rebellion of 1715, the Bank of Scotland had appeared to stand on the Stuart side, a point frequently recalled by those who wanted to create a rival bank, the Royal Bank of Scotland. Parliament later chartered a third Scottish public bank, and also encouraged the growth of private banks. Scotland promoted competition among banks to a much greater extent than England, pioneering the development of free banking, which flourished in the United States in the first half of the 19th century.

The Royal Bank of Scotland earned a place in the history of money and banking when it developed the antecedents of overdraft privileges. In his famous book, An Inquiry into the Nature and Causes of the Wealth of Nations, perhaps the most famous book on economics, Adam Smith attributed this important banking innovation to the public banks of Scotland. Although he does not credit a single bank for the innovation, his description captures the spirit of the innovation in the language of the day:

They invented, therefore, another method of issuing their promissory notes; by granting what they called cash accounts, that is by giving credit to the extent of a certain sum (two or three thousand pounds, for example) to any individual who could procure two persons of undoubted credit and good landed estate to become surety for him, that whatever money should be advanced to him, within the sum for which the credit had been given, should be paid on demand, together with the legal interest. Credits of this kind are, I believe, commonly granted by banks and bankers in all different parts of the world. But the easy terms upon which the Scottish banking companies accept of repayment, are so far as I know, peculiar to them, and have, perhaps, been the principal
cause, both of the great trade of those companies and of the benefit which the country has received from it. (Smith, 1937, pp. 282)

Other authors, such as Glyn Davies, confer the credit for this innovation to the Royal Bank of Scotland, and cite this innovation as the beginning of the flexible overdraft. The Royal Bank of Scotland (now called the Royal Bank of Scotland, Limited) remains one of the leading commercial banks of Scotland. In 2008, it

became one of the leading beneficiaries of the United Kingdom’s plan to bailout banks who had overinvested in toxic assets. In 2009, it became officially classified as a public-sector entity, because the United Kingdom’s

government had absorbed such a large share of its liabilities (MacDonald and Norman, February 2009).

References

Checkland, S. G. 1975. Scottish Banking: A History, 1695–1973.

Davies, Glyn. 1994. The History of Money.

MacDonald, Alistair, and Laurence Norman. “World News: Bank Bailouts, Sinking Revenue Fray U.K.’s Ledger.” Wall Street Journal (Eastern Edition), February 20, 2009, p. A10.

Smith, Adam. 1937. An Inquiry into the Nature and Causes of the Wealth of Nations.

ROSSEL ISLAND MONETARY SYSTEM

Rossel Island, about 200 miles southeast of New Guinea, can lay claim to one of the most novel and complicated primitive monetary systems, one in which time was a significant factor in measuring the value of goods. The actual pieces of money had been handed down virtually unchanged to successive generations since time immemorial and allegedly were of divine origin.

Rossel money split into two variations. Dap money came in single polished pieces of shells, and ko money in

sets of 10 discs made from shells. Dap money covered a larger range of values and stretched into the smallest values, whereas ko money exchanged hands in the larger transactions. These two variations bore some gender connotation, dap money was looked on as men’s money, and ko money as women’s money. Some goods were only priced in one type of money, and other goods in a combination of dap and ko money.

The system of denominations of shells of different values made the Rossel money unique among primitive

currencies. The actual names were a bit clumsy, but 22 different values are represented. For simplification it

is easiest to regard the lowest denomination as number 1, the next lowest denomination as number 2, and so on, until the largest denomination of number 22 is reached. Dap came in all 22 denominations, but ko came only in

denominations of numbers 8 through 22. One denomination was not a multiple of other denominations, and no one denomination was equivalent to a fixed number of other denominations, contrary to the U.S. monetary system in which 100 pennies equal a dollar. A good costing a number 10 could not be purchased with anything but a number 10, and not in a multiple of smaller denominations.

The differences in value between denominations were based on the amount of time one denomination would have to be loaned out before repayment could be required in another denomination. If a number 10 was loaned out for a length of time, the loan had to be repaid in a number 11. A loan of a number 10 for longer

lengths of time called for repayment in a number 12, or a higher denomination, depending on the length of the loan.

Transactions involved a highly elaborate system of credit. Suppose individual A sought to purchase a product

priced at number 10 in dap, and this individual owned denominations below number 10 and above number 10, but not in number 10. This individual would borrow a number 10, and would repay the loan in the future with a denomination higher than a number 10, as a means of paying interest. This individual would not mind this arrangement, having the opportunity to loan out his own dap denominations and earning interest also. If a number 22 was loaned out, an initial interest payment was made in a smaller denomination, and in the future the loan was repaid with another number 22. A special class of brokers arranged these necessary transactions.

The currency units, or shells, of the higher-valued denominations (number 18 and above) were known on an individual basis by active financial traders. Only seven currency units of denomination number 22 were in existence, all owned by chiefs. The higher values were considered sacred. When a number 18 exchanged hands, the parties involved crouched down. Numbers 19 to 22 were kept enclosed, always protected from the light of day.

ROMAN EMPIRE INFLATION

During the third and fourth centuries CE, inflation in the Roman Empire rose to astronomical numbers, aiding and

abetting those internal forces of economic, political, and social decay that made the Empire easier prey for the

barbarians.

Early in the first century, Augustus had minted full-valued gold and silver coins. In the following two centuries, the Roman emperors slowly whittled down the weight of the coins and reduced the fineness of the silver coins. In the second century, the silver content of the denarius sank to 75 percent during the reign of that philosophic prince, Marcus Aurelius. By mid-third century, creeping inflation had gradually lifted prices about threefold.

Early in the third century, the Caracalla replaced the silver denarius with a new silver coin, 50 percent silver in content, called the Antoninianus. At midcentury, this coin still contained 40 percent silver, but thereafter debasement gathered momentum at a heady pace and reached a climax under Gallienus, emperor between 260 and 268 CE. The silver content sank to 4 percent, and prices—already triple the first-century level—finishing the third century at 50 to 70 times higher than the first-century price level.

The political stage mirrored the monetary disorder, or vice versa. In a space of 40 years, starting with the assassination of Gordian in 244, 57 emperors donned the imperial purple, until the accession of Diocletian in 284 ended the revolving door for the imperial title. The root cause of the inflation could be found in the fiscal affairs of the Roman government. The government paid its expenses in coins and had no major credit market in which to raise funds when expenditures exceeded tax revenue. Perhaps because of the inertia of tradition or political opposition, tax rates could be changed only with great difficulty. The more notorious emperors found that raising funds through taxes was not as easy as raising funds by condemning wealthy senators and citizens on trumped-up charges and confiscating their estates. The remaining alternative was debasement of the currency.

When Aurelian assumed the reins of power in 270, facing galloping inflation, he adopted a currency reform that was almost a good as printing paper money. He simply raised by about 2.5 times the nominal or face value of the silver-plated copper coins that had replaced the silver coins of the empire. Under his reign, the

treasury began supplying sealed bags that contained 1,000 of these silver-plated coins. During this inflationary ordeal, the government kept the gold coins much purer, but it paid its expenses in silverplated coins, which were legal tender.

Diocletian was the first emperor to aggressively combat the rampant inflation. He came to power in 284, amid an economy flooded with inferior coinage, and in 295, he put in place a major reform of the currency, issuing full-weight pure gold and silver coins. His aureus equaled onesixtieth of a pound of gold, and his pure silver coin equaled one-ninety-sixth of a pound of a silver. His coins were comparable in weight and fineness to the coins in Nero’s time, when prices were 100 times lower. Inflation continued to surge through the Roman economy and, perhaps out of frustration, Diocletian resorted to wage and price controls in 301. Raising prices

above legal levels became a capital offense, and inflation may have begun to slow a bit.

Constantine became emperor early in the fourth century. He eased up the wage and price controls and continued Diocletian’s policy of increasing the value of the currency. He minted a coin called the gold solidus, equal to oneseventy-second of a pound of gold. This coin maintained its value for 700 years, becoming one of the most famous coins in history. After making Christianity the official faith in 313, Constantine looted the pagan temples of vast quantities of gold to supply his mints. The government mints, however, continued to turn

out huge amounts of the debased copper coins, and the added supply of gold may have added fresh fuel to the fires of inflation. The debased denarii continued to fall in value. By the mid-fourth century, one gold solidus in Egypt equaled 30 million denarii. By then the government protected itself by collecting taxes in gold or in kind. The mass of the population paid the penalty for the inflation while the wealthy hedged against inflation

by investing in gold and land. The inflation began to decelerate toward the end of the fourth century, but by then the empire was tottering in the face of a barbarian onslaught. The Visigoths captured Rome in 410, and in 476, Odoacer the Barbarian replaced the last Roman emperor, Romulus Augustulus. Constantinople continued to mint the solidus.

RIKSBANK (SWEDEN)

The Riksbank, or Bank of Sweden, the oldest central bank in the world, was the first European bank to issue banknotes. The English goldsmiths issued receipts that circulated as money, but the Riksbank was the first bank to issue paper money.

The Riksbank came into being in 1656 as a private bank split into two departments. One department was an

exchange or deposit bank organized along the lines of the Bank of Amsterdam. It accepted deposits of coins and precious metals, and these bank deposits changed ownership without precious metals or coins leaving the bank. They served as money, and were backed up by 100 percent reserves of precious metals. The second department was a lending bank.

The Riksbank issued its first banknotes in 1661. Other banks had already pioneered the use of bills of exchange

and transferable bank deposits that supplemented the circulation of coins. Sweden turned to banknotes as a

medium of exchange because payments in copper, which served as money in Sweden, were bulky and heavy, even for domestic transactions. Sweden adopted copper as the basis for money in 1625, perhaps because Sweden boasted of the largest copper mine in Europe and the Swedish government owned a share of it. Copper mines paved the way for banknotes when, for convenience and utility, they began paying miners in copper notes that could be redeemed for copper at the mines. These notes were preferable to copper coins and traded at a premium. In 1668, ownership of the Riksbank passed into the hands of the government,

making it the oldest central bank in operation today. By the early 1700s, banknotes were no longer a rarity in

Europe. The Bank of England was chartered in 1694 for the purpose of making loans and issuing banknotes, and by 1720, France was learning the disastrous consequences of issuing banknotes without discipline.

In 1789, the Riksbank began issuing government currency, and the Riksbank Act of 1897 conferred on the Riksbank a monopoly on the issuance of currency in Sweden. As late as 1873, the number of central banks in the world remained in single-digit territory, but by 1990, more than 160 central banks dotted the financial

landscape, the oldest being the Riksbank.

References

Bank for International Settlements. 1963. Eight European Central Banks.

Kindleberger, Charles P. 1984. A Financial History of Western Europe.

Samuelsson, Kurt. 1968. From Great Power to Welfare State: 300 Years of Swedish Social Development.

Sveriges Riksbank. 1994. Sveriges Riksbank: the Swedish Central Bank, a Short Introduction.

RICE CURRENCY

The history of rice currency takes into scope geographical areas as diverse as the Far East and the American colonies, and touches on familiar subjects in the history of money, including debasement, Gresham’s law, paper money, and religious associations.

The most developed system of rice currency emerged in feudal Japan. At the opening of the 17th century, Japan added up its wealth, measured in koku of rice, and found the country’s wealth equivalent in value to 28 million kokus. After the 16th century, copper, gold, and silver circulated alongside rice, but values were expressed in rice, debts were contracted in rice, and taxes were collected partly in rice and partly in metallic

money. Workers received rice in payment for work, and the retainers and attendants of feudal lords received

stipends in rice.

Large landowners issued rice notes, maintained large storehouses to redeem those notes, and often sought to redeem the notes at harvest season to make room for the new crop. When they discovered that some of the note bearers never claimed the rice, they began, in the manner of the goldsmith bankers, to issue more notes than they could actually redeem in rice. After a rash of abuses, the Tokugawa banned this practice in 1760.

Rice currency shared an inconvenience common to commodity money— it was bulky to transport for large

commercial transactions. With the growth of trade, Japan began to supplant rice currency with metallic money, but not without hearing from the political philosophers, who saw metallic money as the opening wedge for all kinds of evil. Perhaps these philosophers echoed the Confucian emphasis on social stability and saw metallic money as a revolutionizing influence. Other ancient societies, including Sparta of ancient Greece, saw

metallic money as an immoral influence. Rice currency survived in some of the remote villages of Japan up to the eve of World War II.

In the 19th century, local governments in Burma measured their revenue in baskets of rice. The Burmese ate the good rice and circulated as money the inferior broken rice unsuitable for food or seed, giving history another example of currency debasement and Gresham’s law.

Rice was the most important primitive currency in the Philippines. In 1775, the Sultans of Magindan collected taxes from the Philippines in unthreshed rice. The prime monetary unit was a handful of unthreshed rice, called palay. A scale of denominations of palay rose from 1 handful to 1,000 handfuls. A day’s wage of a mountain wood gatherer was 5 handfuls. Some of the Philippine tribes endowed rice with religious significance. No women could enter a rice storehouse, and men had to perform certain religious rituals before entering.

In 1739, the colony of South Carolina enacted a law that made rice an acceptable means for paying taxes. The following year the colonial government collected 1.2 million pounds of rice. The government issued “rice orders” to public creditors, which were redeemable after taxes were collected in rice at a rate of 30 shillings per 100 pounds of rice. These rice orders circulated as money, and longterm contracts were struck in terms of rice.

As a commodity, rice was relatively light, making it easier to transport than some commodities, and it could be

stored up to eight or nine years. Rice could serve the monetary functions of a medium of exchange and store of value better than most monetary commodities, which accounts for its relatively rich history as a form of money.

See also: Commodity Monetary Standard, Virginia Tobacco Act of 1713

References

Brock, Leslie V. 1975. The Currency of the American Colonies, 1700–1764.

Einzig, Paul. 1966. Primitive Money.

RETURN TO GOLD: 1300–1350

During the first half of the 14th century, Europe saw gold currency displace silver currency as the primary circulating medium. The Carolingian reform of the eighth century had ended gold coinage in Europe, and for over 400 years Europe had contented itself with minting the silver denarius, a small denomination coin, predecessor to the modern penny. A critical development in returning Europe to gold coinage was the

discovery of Hungarian gold deposits around Kremnica in Slovakia, which became producing mines around 1320.

In the mid-13th century, Florence and Genoa had introduced gold coinage and Venice followed later in the century with the gold ducat to rival the Florentine florin. Dependence on African gold restricted the supply of the early Italian gold, limiting its circulation to the Mediterranean area.

After 1320, Hungarian gold grew in abundance, enabling Charles Robert of Anjou, King of Hungary, to began minting gold coins in 1328. These gold coins imitated the Florentine florin and were the first gold coins minted north of the Alps. An exchange of Bohemian silver for Hungarian gold enabled John the Blind of Luxemburg, king of Bohemia, to begin coinage of gold florins coincidentally with the Hungarian coinage as

part of a Hungarian-Bohemian monetary cooperation.

Hungarian gold profusely poured into Italy in exchange for Italian goods and services. In 1328, Venice effectively abandoned a silver standard in favor of a gold standard, and coinage of the gold ducat began to vastly outstrip the silver grossi.

In the 1330s, France and England borrowed from Italian bankers large sums of gold florins to finance wars. The pope also subsidized France with vast sums of florins, and in 1337, France began minting large quantities of it own gold coin, the ecu.

Gold coinage began on a large scale in the Low Countries around the same time. In 1336 the mint of Flanders began striking large quantities of gold coins, and the mints of Brabant, Hainault, Cambrai, and Guelders first struck gold coins in 1336 and 1337.

Most of the German mints striking gold coins during the 14th century were located in the valleys of the Rhine and Main. One important exception, Lubeck, the principle city of the Hanseatic League, received royal permission to mint gold and silver coins in 1340. In 1342, Lubeck began striking gold Lubeck coins.

England had made an abortive effort to coin gold pennies in 1257, roughly coinciding with the appearance of gold coinage in Italy. England’s second and more successful effort at gold coinage began in 1344. Edward III engaged Florentine mintmasters and issued a gold coin, the “leopard,” which proved unsuccessful because its official value in terms of silver exceeded its market value. After adjustments in metal content, Edward II minted another gold coin, the “noble,” valued at 6 shillings and 8 pence. Nobles, half-nobles, and quarter-nobles became important components of English coinage. Scotland first launched a gold coin in 1357, but the first gold coinage failed, and a successful gold coinage had to wait until the end of the century.

As gold coinage spread silver coinage took on the role of subsidiary coinage suitable for small, local transactions, a role the silver continued to play until alloyed token currency replaced full-bodied metallic currency.

References

Chown, John F. 1994. A History of Money.

Spufford, Peter. 1988. Money and its Use in Medieval Europe.

RESUMPTION ACT OF 1875 (UNITED STATES)

The principle objective of the Resumption Act of 1875 was to provide for the resumption of specie payments on greenbacks, the fiat paper money born of the Civil War, which was still current in the 1870s.

The act had three important sections. The first section provided for the retirement of the fractional paper currency that been current since the Civil War. The fractional paper currency was in denominations of 10, 25, and 50 cents. The act of 1875 provided for the issuance of subsidiary silver coin to replace the fractional currency. This provision was a bow to the silver interests because only gold coins circulated at the time. The second section got rid of seigniorage, or mint charges, on the coinage of gold, a provision that pleased the mining interests. The third section of the act removed limitations on the total number of banknotes that national banks could issue, a provision that met the demand for what then was called free banking. The treasury was to retire

greenbacks in an amount equal to 80 percent of the increase in national banknotes, until greenbacks in circulation fell to 300 million.

The third section took up the heart of the legislation, the redemption of greenbacks. After January 1, 1879, greenbacks were redeemable in coin when brought to the assistant treasurer at New York in sums no less than $50. The act also authorized the secretary of treasury to “issue, sell and dispose of, at not less than par, in coin” any of the bonds authorized under existing legislation.

A certain amount of pessimism surrounded the Resumption Act of 1875. Many opponents felt that resumption was not feasible, that people would show up in mass to exchange greenbacks for gold, that it would trigger an unbearable contraction of the money supply, and that Congress would not stand firmly in favor of resumption. In 1878 a bill to repeal the Resumption Act failed to pass Congress by a narrow margin, and Congress did raise from 300 million to 346 million the maximum number of greenbacks that could remain in circulation. Nevertheless, the expected eagerness to exchange greenbacks for gold had been overstated, and resumption took place without difficulty.

The term “coin” in the legislation was generally assumed to refer to gold coins. In 1878, the Bland–Allison Silver Purchase Act made silver legal tender, opening up the possibility that bonds sold to raise coin—gold coin—could be redeemed in silver. Advocates of silver felt that redemption of bonds was legitimate, but the proposal aroused strong opposition. President Hayes in his veto message on the Bland–Allison Act (the act was passed over a presidential veto) cited the large number of bonds the government had sold. He noted that the bonds were sold for gold, and that the bondholders expected the bonds to be redeemed in gold, and would not have bought the bonds otherwise. In the words of his veto message:

National promises should be kept with unflinching fidelity. There is no power to compel a nation to repay its debts. Its credit depends on its honor. The nation owes what it has led or allowed its creditors to expect. (Watson, 1970, 154)

Despite the provisions of the Bland–Allison Act making silver legal tender, the U.S. government maintained its commitment to redeem public bonds in gold.

The Resumption Act of 1875 is one of the important pieces of coinage legislation in U.S. history because it ended an era of fiat money.

See also: Bland–Allison Silver Repurchase Act of 1878, Free Silver Movement, Greenbacks

References

Carothers, Neil. 1930/1967. Fractional Money.

Hepburn, A. Barton. 1924/1967. A History of Currency in the United States.

Meyers, Margaret G. 1970. A Financial History of the United States.

Ritter, Gretchen. 1997. Gold Bugs and Greenbacks: The Antimonopoly Tradition and the Politics of Finance in America.

Watson, David K. 1970. History of American Coinage.

REPURCHASE AGREEMENTS

A repurchase agreement is the sale of a security coupled with a promise to buy back the security at a specific price and date in the future. It is called a repurchase agreement but it is actually a loan. The seller receives cash for the security sold. The buyer of the security is loaning cash to the seller, and holding the security as collateral. The seller agrees to buy back the security at a higher price after a certain amount of time has elapsed. By repurchasing the security at a higher price in the future, the seller is in effect paying interest on funds borrowed from the buyer. Typically, the selling price is set equal to the repurchase price plus a negotiated amount of interest. If the borrower fails to repurchase the security at the agreed on date in the future, the lender can sell the security to a third party and recoup the funds lent. If the lender fails to resell the security to the previous owner, the previous owner can use the funds for repurchasing the security to purchase another investment.

Repurchase agreements have long played a role in the U.S. monetary system. As early as 1917, Federal Reserve Banks used repurchase agreements to extend credit to commercial banks. During the 1920s the New York Federal Reserve used repurchase agreements to extend credit to nonbank dealers in short-term credit instruments.

As U.S. inflation led to higher interest rates in the post–World War II era, repurchasing agreements grew in popularity. Nonbank dealers in treasury bonds went searching for less costly financing than what commercial banks, their traditional sources of credit, were offering. At the same time, large state and local governments and nonfinancial corporations discovered that, despite rising interest rates, bank deposits paid zero interest. By being party to a repurchase agreement these institutions could earn interest on funds idly sitting in interest-free bank accounts. Purchasing a treasury bond under a repurchase agreement involved minimal risk, negotiable maturities, and routine mechanics. Treasury bond dealers and institutional cash managers created a

market for repurchase agreements. After the 1970s the growth in U.S. Treasury marketable debt and rising

short-term interest rates made repurchase agreements attractive to all kinds of creditors, including school districts and other small creditors that could not earn interest on checking accounts (Garbade, 2006). Bepurchase agreements became a common vehicle for the short-term investment of surplus cash. Congress lifted the ban on interest-bearing checking accounts in 1980.

The securities most often involved in repurchase agreements are U.S. Treasury and federal agency bonds, but repurchase agreements can be arranged for mortgage-backed securities, and various short-term money market credit instruments, including negotiable bank certificates of deposit.

Repurchase agreements are nearly all short-term agreements. Overnight repurchase agreements are the most common type of treasury bond repurchase agreement. Other standard maturities for repurchase agreements include one, two and three weeks, and one, two, three, and six months. The parties to the repurchase

agreement may negotiate flexible terms to maturity.

The purchaser of a security in a repurchase agreement only earns the interest that is agreed on in the contract.

A treasury bond in a repurchase agreement will usually remain registered in the name of the seller. The seller in the repurchase agreement will directly receive any coupon payments earned by the bond while the buyer is

holding it.

U.S. commercial banks regard repurchase agreements as a close substitute for Federal funds borrowing. The interest rate commercial banks pay on repurchase agreements is usually 25 to 30 basis points below the Federal funds rate (Lumpkin, 1987). The interest rates on repurchase agreements are a bit lower because repurchase agreements are backed by high-quality collateral. Rather than borrow funds in the Federal funds

market, a commercial bank may arrange an overnight repurchase agreement with one of its large depositors. Some countries include the repurchase liabilities of depository institutions in the broader measurers of the circulating money stock. The Federal Reserve Bank of New York also arranges repurchase agreements

with primary dealers in treasury securities as a part of its open market operations.

REPORT FROM THE SELECT COMMITTEE ON THE HIGH PRICE OF BULLION

The so-called Bullion Report, published on June 8, 1810, ranks with the most famous documents in the history of monetary theory. The report was actually written by Henry Thornton, a prominent banker and economist. Thomas Malthus and David Ricardo, the most famous economists of the day, rallied to support the conclusions of the report, which cited fiat money (money inconvertible into a precious metal at an official rate) as the cause of the high price of bullion. Actually, the first volley had come from the pen of Ricardo, who wrote newspaper articles and pamphlets on the subject, one entitled The High Price of Bullion (1810).

During the French Revolution and Napoleonic Wars, the Bank of England suspended convertibility of banknotes into metallic coinage and precious metal, an action that would become common practice during future wars but was then unprecedented. Inflation measures calculated from price indices were unavailable at the time, but the price of gold bullion in British pounds soared and the British pound depreciated relative to other European currencies in foreign exchange markets. Discussions on the high price of bullion and currency depreciation led to the appointment of a select committee to make an inquiry.

The current state of knowledge of monetary theory would have the finger of suspicion immediately turn to the issuance of fiat money, but at the threshold of the 19th century other causes were cited for the high price of bullion and the depreciation of the British pound. To the observation that the high price of gold was due to increased demand for gold to

supply French armies, the Report answered:

Your Committee is of the opinion that in the sound natural state of the British currency the foundation of which is gold no increased demand for gold from other parts of the world however great or from whatever causes arising can have the effect of producing here for a considerable period of time a material rise in the market price of gold. . . . it was to be expected that those who ascribed the high price here to a great demand abroad, would have been prepared to state that there were corresponding high prices abroad. . . . [I]t does not appear that during the time when the price of Gold bullion was rising here as valued in our paper there was any corresponding rise in the price of Gold bullion in the market of the Continent as valued in their respective currencies. (Chown, 1994, 239)

The select committee was equally unimpressed with theories that attributed the depreciation of the pound to harvest failures, Napoleon’s blockade, subsidies of foreign allies, and support of armies in foreign lands. In the words of the report:

From the foregoing reasoning relative to the state of the Exchanges if they are considered apart, Your
Committee find it difficult to resist an inference that a portion at least of the great fall which the Exchanges lately suffered must have resulted not from the state of trade but from a change in the relative value of our domestic currency. But when this deduction is joined with that which your Committee have stated respecting
the market price of Gold, that inference appears to be demonstrated. (Chown, 1994, 241)

The report recommended a return to convertibility as soon as possible, but the exigencies of war outweighed the logic of the report and a resumption of convertibility had to wait until 1821.

The bullionist controversy demonstrated the difficulty of pinpointing the causes of currency depreciation and inflation. Often the blame was laid at the feet of shortages, greedy labor unions, monopolies, and speculators, when a more careful examination placed the cause in undisciplined growth in money stocks. The report recommended a return to convertibility as a means of maintaining monetary discipline.

See also: Bank Restriction Act of 1797, Monetarism, Gold Standard, Real Bills Doctrine

References

Chown, John F. 1994. A History of Money.

Spiegel, Henry Williams. 1971. The Growth of Economic Thought.

RENTENMARK

The rentenmark was the currency that the German government issued in the aftermath of the hyperinflation that occurred in Germany immediately following World War I. Hyperinflation had completely discredited the mark, leaving the price of something as simple as a newspaper at 70 million marks. Toward the end of 1923, the rentenmark replaced the mark as a new, stable currency.

A costly war and heavy war reparations had left Germany virtually bankrupt, and without the gold and foreign

exchange reserves needed to support a paper currency. Usually, governments seeking to restore monetary stability had arranged foreign loans that allowed them to issue a new currency convertible at an official rate into gold and foreign exchange. Germany, lacking access to foreign loans, faced the challenge of establishing a new currency that would command the confidence of the public without the backing of significant reserves of gold and foreign exchange.

Germany handled these monetary difficulties in much the same spirit that France handled similar difficulties in the past. Early in 18th-century France, John Law’s Banque Royal had issued paper money on the security of land in Louisiana, a financial venture that set the stage for France’s first paper money debacle. Later the revolutionary French government issued paper money called “assignats,” backed by land confiscated from the church. At first the church land was reserved for sale to owners of assignats, but too many assignats were issued and the plan ended in a storm of hyperinflation.

The Deutsche Rentenbank, a new bank of issue organized to issue rentenmarks, held collateral in the form of agricultural and industrial mortgages. Theoretically, the agricultural and industrial mortgages could have been liquidated and the proceeds used to redeem the rentenmarks, but in practice such a liquidation would have been difficult. One rentenmark was worth 1 billion of the old marks.

In addition to reforming the currency, the German government reformed its fiscal affairs, balancing the budget in terms of rentenmarks and ending government dependence on the central bank to purchase government bonds. The German government, by getting its own house in order, diffused the pressure for inflationary

finance. In turn the Rentenbank, by strictly limiting the issuance of rentenmarks, ended the spiral of inflation,

showing the world that gold and foreign exchange reserves were not necessary for a stable, noninflationary currency. The experience of the rentenmark underlined the role of government fiscal mismanagement as the force that invariably fuels hyperinflation.

Late in 1924, Germany received a sizable loan under the Dawes Plan, enabling it to reorganize the Reichbank,

which had suspended the issuance of banknotes after the formation of the Rentenbank. The Reichbank again took over responsibility for issuing banknotes and the rentenmark was renamed the reichmark. The reichmark was convertible into gold but gold coins did not circulate as currency, a system that spread to the rest of the world during the 1930s. Following World War II, the reichmark was discontinued and replaced by the

deutsche mark.

Although land-secured paper money had twice led France into the chaos of hyperinflation, Germany had embarked on a land-secured system of paper money determined to contain inflationary pressures. Germany’s experience with the rentenmark demonstrated that a society may avoid inflation and stabilize the value of a currency by strictly limiting currency supplies. By strict monetary discipline, Germany’s experiment succeeded where similar efforts had failed.

See also: Deutsche Mark, Hyperinflation in Post–World War I Germany, Gold Mark of Imperial Germany

References

Davies, Glyn. 1994. A History of Money. Kindleberger, Charles P. 1984. A Financial History of Western Europe.

Stolper, Gustav. 1967. The German Economy: 1870 to the Present.

REDENOMINATION

The term “redenomination” refers either to a change in the number of zeros associated with a given currency, or it can apply to the introduction of a new currency. On January 1, 2005, Turkey slashed six zeroes from its currency. One million of the old Turkish lira converted to one of the new Turkish lira (Economist, August 2004) Before the redenomination, 1 euro equaled 1.8 million Turkish lira. After the redenomination, 1 euro equaled 1.8 new Turkish lira. In July 2008, Zimbabwe slashed ten zeroes from its currency (US Fed News

Service, July 2008). At the time of Zimbabwe’s redenomination its currency was trading a 110 billion Zimbabwe currency to one U.S. dollar. When a currency is redenominated, balance sheets, debts, and financial portfolios are adjusted accordingly.

The introduction of the euro can be viewed either as the introduction of a new currency or a redenomination but it raised many redenomination issues. Debts and balance sheets in displaced European currencies had to be redenominated in terms of the Euro. Each government enjoyed certain autonomy in deciding the redenomination process for their own currencies. The French and Italian authorities decided that their debt would not have any decimal places after redenomination whereas German authorities used decimal places. The timetable allowed governments to implement redenomination anytime between 1999 and 2002.

More commonly, redenomination refers the removal of zeroes from a currency. There are several reasons why countries undertake redenomination. One obvious reason is that it simplifies the mathematics of currency transactions. Extra zeros put a burden on accounting and statistical records, data processing software, and payment systems. From political and psychological perspectives, slashing zeroes wipes out evidence of past hyperinflation and monetary chaos, and serves as a commitment from government that uncontrolled inflation is a thing of the past.

Redenomination may represent the finishing touches on tough but successful economic reform measures. Less common is the case where governments use redenomination to confiscate resources. Laos only gave its citizens one day to exchange old currency for new currency in 1976 (Mosely, 2005).

The Soviet Union in 1991 and Nicaragua in 1988 only gave citizens three days to swap old currency for new

currency (Mosely, 2005). In these situations, some citizens will not succeed in getting their old, worthless currency exchanged for the new currency. The loss to the citizens left holding the old currency becomes revenue to the government.

Between 1960 and 2003, developing and transition economies redenominated currencies on 60 different occasions (Mosely, 2005). In 14 of these cases of currency redenomination, only one zero was removed. In nine cases six zeros were removed. The median redenomination removed three zeros. Nineteen countries

redenominated only once, and ten countries redenominated twice. As of 2003, Brazil has redenominated six times, the former Yugoslavia/Serbia five times, and Argentina four times (Mosely, 2005). A few countries have added digits to their currency: South Africa, 1961; Sierra Leone, 1964; Ghana, 1965; Australia,

1966; the Bahamas, 1966; New Zealand, 1967; Fiji, 1969; the Gambia, 1965; Malawi, 1971; and

Nigeria, 1973 (Mas 1995). Adding digits makes the currencies more comparable to a key currency such as the U.S. dollar. Triple digit inflation or higher often leads to redenomination, but not always.

Japan has debated redenomination for the yen. In 2008, the yen often traded around 110 yen per one U.S. dollar. The introduction of the euro prompted concern that the yen’s stature as an international currency might suffer from new competition. A sluggish Japanese economy in the 1990s encouraged Japanese policy makers to consider the advantages of redenomination. In 1999, the ruling Liberal Democratic Party formed a committee to evaluate the idea of removing two zeros from the yen.

Among highly industrialized countries, Korea has the highest exchange rate with the U.S. dollar. The U.S. dollar is equal to more than 1000 Korean won. South Korean Officials have also discussed the possibility of redenomination.

References

Economist. “Nought to Worry About: Zeroing on Too Many Zeroes.” August 28, 2004, p. 67.

Mas, Ignacio. “Things Governments Do to Money: A Recent History of Currency Reform Schemes and Scams.” Kyklos, vol. 48, no. 4 (1995): 483–513.

Mosley, Layna. “Dropping Zeros and Gaining Credibility? Currency Redenomination in Developing Nations.” Conference Paper, American Political Science Association, 2005 Annual Meeting, pp. 1–28.

US Fed News Service. “VOA News: Zimbabwe’s Central Bank Snips 10 Zeros in Currency Redenomination.” July 30, 2008.

REAL BILLS DOCTRINE

The real bills doctrine holds that if banks make loans only to finance short-term commercial transactions, the money supply will expand and contract to meet the needs of trade and fluctuations in the money supply will not be a source of economic instability leading to either inflation or deflation. The self-liquidating nature of these loans, and their use to finance the production of goods and services, allegedly checks the rise of

inflationary forces. The doctrine found favor with Adam Smith and it has commanded some interest to the present day.

To appreciate the doctrine one must first understand that when banks advance loans, the money supply expands. When banks allow money to build up as vault cash or other forms of reserves, the money supply contracts.

The real bills doctrine first broke into public debate in the United Kingdom during the Napoleonic Wars. Under the stress of wartime finance, Great Britain had suspended the convertibility of banknotes into precious metal, putting Britain on an inconvertible paper standard comparable to inconvertible paper standards in the United States or the United Kingdom today. So-called bullionists argued that the money supply should remain proportional to precious metal reserves, such as gold reserves, to maintain its value and avoid inflation or deflation. Antibullionists defended the suspension of convertibility on the grounds of the real bills doctrine and attributed problems of rising prices and currency depreciation to other causes. After the Napoleonic Wars, the United Kingdom established a gold standard and a new monetary debate developed between the banking school and the currency school. Both schools supported the gold standard but the banking school felt that

banks should have the flexibility to make loans according to the real bills doctrine, allowing the money supply to expand and contract to meet the needs of trade. The currency school made the case that the money supply should remain proportional to gold reserves, and should only change as gold flowed in and out of the country.

In the early stages of development the Federal Reserve System followed the real bills doctrine in practice. During the post–World War II era the real bills doctrine and similar doctrines have lost credibility in favor of proposals to increase the money supply at a fixed rate, such as 3 to 5 percent per year, to encourage the economy to mirror the same stability.

References

Klein, John J. 1986. Money and the Economy,6th ed.

Perlman, Morris. “Adam Smith and the Paternity of the Real Bills Doctrine.” History of Political Economy, vol. 21, no. 1 (Spring 1989): 77–90.

Spiegel, Henry Williams. 1971. The Growth

of Economic Thought.

RADCLIFFE REPORT

In 1957, the British government formed a committee “to inquire into the working of the monetary and credit system, and to make recommendations.” In August 1959, this committee issued a report called the Radcliffe Report after the committee chairman, Lord Radcliffe, that played down the importance of keeping the growth of the money stock within strict limits. The report became a symbol of the kind of government views of monetary policy that let inflation accelerate and develop a momentum of its own in the 1970s. According to Glyn Davies (1994), “No official report has ever in British history (nor I believe elsewhere) shown such skepticism regarding monetary policy in the sense of trying to control the economy by controlling the quantity of money” (400).

The report was sprinkled with such exaggerated statements suggesting that banknotes are a relatively unimportant part of the money supply and that the supply of banknotes should respond passively to the needs of trade.

The report cited two main factors that impaired the operational significance of regulated money stock growth. The first factor was the importance of monetary substitutes that were always ready to come forth and fill gaps in the money supply. Obvious examples of money substitutes, or near-monies, were savings accounts and

government bonds. The report stressed that it was an individual’s liquidity position, rather than money holdings, that shaped that individual’s spending decisions. An individual with modest money holdings might nevertheless be in a very liquid position financially.

The second factor hampering the effectiveness of regulated money stock growth was the velocity of circulation. An increase in velocity has the same economic impact as a money stock increase, and changes in velocity can offset changes in money stock growth. The flavor of the report’s findings is captured in the following passages:

If, it is argued, the central bank has both the will and the means to control the supply of money . . . all will be well. Our view is different. It is the whole liquidity position that is relevant to spending decisions. . . . The decision to spend thus depends upon the liquidity in the broad sense, not upon immediate access to money. . . . Spending is not limited to the amount of money in circulation. (400, author’s emphasis)

In a highly developed financial system the theoretical difficulties of identifying “the supply of money” cannot be lightly swept aside. Even when they are disregarded, all the haziness of the connection between the supply of money and the level of total demand remains: the haziness that lies in the impossibility of limiting the velocity of circulation (Davies, 1994, 401).

The findings of the Radcliffe Report essentially threw out the control of the money stock in the arsenal of weapons against inflation, a weapon that was sorely needed in the 1970s. The views expressed in the report became economic orthodoxy in the 1960s, and treated as the accepted view in economics textbooks. As inflation mounted in the 1970s, the views of the Radcliffe Report came under increasing criticism, and by the 1980s the quantity theory of money had largely supplanted the views of the Radcliffe Report. The quantity theory of money emphasizes the connection between the quantity of money and inflation.

See also: Bank of England, Deutsche Bundesbank, Equation of Exchange, Monetarism, Velocity of Money

References Davies, Glyn. 1994. A History of Money.

United Kingdom. 1959. Report of the Committee on the Workings of the Monetary System, Cmnd. 827.