Money is the only asset in an economy that has general liberating power. It is the institution that makes market relations possible and that allows the establishment of the market.
However, the trust that agents place in it is neither spontaneous nor self-fulfilling. It is not just a collective belief in the stability of money.
History is strewn with crises which show that monetary systems can lead to breaches of confidence, the economic and human consequences of which are often considerable (the bank failure of John Law in 1720 but also, for example, the crisis of the Argentine peso in 2002).
Read Also: ROCE Calculation: How to Measure Return on Capital Employed
The trust that the payment community builds in the currency is a long-term one and is based on the quality of the institutional framework relating to the monetary system. The state and the central bank are its two essential representatives.
However, the foundations of confidence in money rest on different bases depending on whether the institutional framework is that of metallic constraint or that of institutional constraint.
Table of Contents
Confidence in money and metallic constraint
Until the political decision of the demonetization of gold which occurs in the first decades of the 20th century, the monetary constraint, that is to say the device which validates the counterpart of the currency in circulation, is a real asset. (silver or gold).
Read Also: Profit Margin Calculation: Essential Techniques
A distinction is typically made between the case where the monetary constraint results in the direct circulation of metallic money and the case where it results in the circulation of credit money backed by a metal.
In market economies which have not yet experimented with credit money or which have suffered monetary crises, confidence in money is based directly on the precious metal which circulates as a means of payment within the territory concerned.
This trust is validated by the public authorities (the royal seal on a gold Louis) and by a central bank which organizes its circulation. In this case, the constraint is essentially metallic even if, as F. Simiand asserts: “gold is the first of the fiduciary currencies”.
Read Also: Exchange Rate Calculation Explained
In market economies that institute credit money while retaining the metallic constraint, confidence in money is based on the institutions’ mastery of gold convertibility. The case of the Bank charter act adopted in the United Kingdom in 1844 which distinguishes, within the Central Bank of England, an issuing department and a credit department is a good example of institutional construction of trust which articulates the credit currency with metallic stress.
Confidence in the currency and institutional constraint
With the abandonment of gold-convertibility, confidence in money changes in nature. The counterpart of the currency in circulation is no longer based on a real asset but on the quality of the monetized claims. This consideration is validated by the State and the central bank on the one hand, but also made possible by second-tier banks which, in modern monetary systems, ensure the bulk of monetary creation.
Confidence in the currency depends primarily on the credibility of the central bank and its ability to ensure monetary stability. This translates in particular into the fight against inflation and the prevention and rapid resolution of banking and monetary crises (fight against deflation).
Read Also: Capital Expenditure Calculation: A Complete Guide
This credibility is built over the long historical period and constitutes the base of the hierarchical trust in the currency in the sense of M. Aglietta and A. Orléan. This credibility also depends on the effectiveness of the articulation between the governance led by the central bank and that led by the State.
If, in the current economies, a certain degree of independence of the central banks seems acquired, the question of their democratic legitimacy to establish the ethical confidence in the currency remains posed (example of the debate on the weak democratic responsibility of the European Central Bank) .
Confidence in the currency also stems from the effectiveness of the competition mechanism between second-tier banks. They are the ones that monetize most of the claims to the real economy and that feed the money supply.
Read Also: How to Calculate Disposable Income
As such, confidence in the currency is a function of the dynamics of the real economy to which the banks respond, but also of the relationship between the second-tier banks and the central bank, which provides ex post regulation of the monetary system.
As such, liquidity and/or solvency crises of banks weaken confidence in money (money is a public good). Today, banking regulation is one of the issues of confidence in money (example of the European Banking Union).