Improving Local Currencies, or How To Make a Good Thing Better

by Thomas H. Greco, Jr.

February 17, 1998

The local currency and exchange movement may be the most important development in human liberation since the Magna Carta.  It evidences a move toward economic freedom which is every bit as important as political and religious freedom.  The proliferation of mutual credit systems like LETS, and local currencies like Ithaca HOURS, demonstrates the intensifying need which people feel for satisfaction of basic human needs and greater control over their own destiny.  It provides a hopeful sign that we are not powerless in the face of increasing concentration of money and power, and the rapid globalization of capital and markets.

Those pioneers who have dedicated themselves to developing and implementing these prototypes deserve our deepest gratitude and respect.  Nevertheless, there is still much to be done.  Just as the early airplanes showed that manned flight was possible, these early exchange system are demonstrating that the specialization of labor and the equitable exchange of value in the marketplace are not dependent upon centralized banks and national currencies.  Indeed, they are providing a means by which communities can maintain high quality of life standards and thrive economically in the face of global competition and capital mobility.  As the Kittyhawk was not the last word in aircraft, so too are our current local exchange prototypes far from optimal.  We should expect, and indeed require, refinement and improvement of our local currencies and systems of exchange.  This article attempts to clarify the relationships among the various participants, and to define some terms which may be helpful in understanding the way a system functions.

Gift Exchange vs Reciprocal Exchange

The market has become the dominant institution in economic exchange, but market mechanisms are certainly not the only means of exchanging goods and services.  There is an enormous amount of work which is unpaid, and there are many exchanges which do not involve markets and money.  Indeed, the imposition of money into the exchange process can be destructive to the close interpersonal relationship which are a necessary component of healthy families, for example.  Besides all of the economic activity which goes on within households, there is a huge amount of goods and services which change hands as gifts.  I would contend that, in general, the more exchanges we can manage without money and markets, the better.  Nonetheless, I am a firm believer in the efficacy of markets in particular situations, provided that they are free and competitive and not dominated by any particular trader, company, or group.

Reciprocal exchange is the ideal to be sought within a market realm.  We can think of the economy as a game of put and take.  Reciprocity demands that each person puts in as much as s/he takes out.  In other words, in reciprocal exchange one is expected to give as much as s/he gets.  This is an important point to keep in mind when designing local exchange systems.

Although altruism and charitable giving might be built into a local exchange system AS AN ADJUNCT, the essential characteristic of such systems should be RECIPROCITY.  No one should be made, by virtue of a system’s design or defect, an unwitting or unwilling donor to someone else’s benefit.  An exchange system which has both equity and integrity must insist upon strict reciprocity.

Money is an I.O.U.

Although we may not refer to local currencies as money, they perform the same essential function as money and bear the same basic characteristics as money.  This goes for credits in a ledger system as well as for circulating paper notes.  It has been said that "Every piece of money is a credit instrument."  That means it is an i.o.u.  The natural question, then, is "Who owes what to whom?"  Who or what stands behind the i.o.u.?  The answer may not always be obvious.  When a community of traders agrees to accept a particular currency, they are making a commitment to stand behind it, that is, to give real value in exchange for it.  When others who are not a party to the agreement accept the currency, they are expressing their confidence that the issuers of the i.o.u. will pay what is owed, although the time frame may or may not be precisely specified.

Basis of Issue

Another important question with regard to a local currency is, "What is the basis of issue?"  In other words, how does it first come into circulation?  In general, currency comes into circulation when someone first spends it, i.e., when s/he gets real goods or services and the seller accepts the currency as payment.   Reciprocity demands that the issuer be willing and able, at some point in time, to redeem it (by accepting it as payment for goods or services s/he sells).

Mutual Credit and Paper Notes

There are presently two predominant forms of local exchange.  These are mutual credit systems, like LETS, which uses a ledger of accounts to keep track of exchanges, and local currency systems, like Ithaca HOURS, which use circulating paper notes to give people a way of tracking their exchanges. There are many variations on both themes.   Some ledger systems which call themselves LETS, may, in fact, depart significantly from the original and official LETS protocols.  Likewise, there are many HOUR currencies springing up which correspond to the Ithaca model, but may differ in some of their details.

Essential features of LETS

LETS is a membership association in which each member has an account.  All accounts begin with a balance of zero.  When a member sells something to another member, his/her account receives a credit (plus); when a member buys something his/her account receives a debit (minus).  A credit causes an account balance to increase, while a debit causes an account balance to decrease.  Accounts are allowed to have negative as well as positive balances.  In fact, there can be no positive balances unless there are also negative balances.  In such a system of mutual credit, the total of all the credit balances must always equal the total of all the debit balances.   What this means is that the amount of value owed by those who have debit balances is always equal to the amount which those with credit balances expect to receive.   This is a system of strict reciprocity.  Of course, as in any system, there will always be some who will default on their obligations, i.e., some of those with debit balances will fail to provide the amount of goods and services they committed themselves to when they incurred those debits (by buying).  These defaults should be recognized at some point and "written off."  In doing so, that amount of debits and an equal amount of credits must be taken off the ledger.  What this suggests is the need for the system to have a capital fund, i.e., a supply of credits which can be used to offset "bad debits."  How this fund might be provided will be discussed shortly.

In a mutual credit system, we may think of the "money supply" as being the total amount of debits or credits.  Since these are two sides of the same coin, and since debits and credits are always equal, we need only count one of them.  One of the elegant aspects of a mutual credit system is that the "money supply," within reasonable bounds, adjusts itself automatically in relation to the amount of trading that members wish or need to do.  There need be no central authority which must decide whether the supply of credits should be increased or decreased in order to keep the market value of the credits constant.  The only thing to be decided is the maximum amount of debit balance which should be allowed on each particular account to minimize the risk of default.  In usual practice, account balances will be well below that amount.

The primary role in a mutual credit system is that of registrar, which is strictly non-political.  The duties of the registrar are to record the transactions as reported by the members, and to update the members’ accounts.

How HOURS Work

Ithaca HOURS, and the many similar HOUR currency systems which have been modeled after it, are paper currency notes that circulate in a local economy.  Unlike LETS, Ithaca HOURS is NOT a membership organization.  The HOUR notes are put into circulation by the operator of a newspaper called Ithaca Money.  The HOUR notes are delivered to advertisers when they buy an ad (for cash) in the newspaper.  As I understand it, those who advertise in Ithaca Money generally agree to accept hours for at least partial payment but have no obligation to do so.

As mentioned before, it is important to ask, what is the basis of issue, and who or what stands behind the HOUR currency?  There is generally a great deal of confusion about currency issuance and the obligations which are associated with it.  It is crucial that we understand how and where the currency originates, how it is placed into circulation, how it will be redeemed, and who will redeem it. In the case of Ithaca HOURS, the answers to these questions are not entirely clear.  I think the ambiguity can easily be resolved once we understand a few basic points.

Fish or Fowl?

A local currency must originate somewhere.  Somehow the notes must be printed and distributed and their use in exchanging valuable goods and services must be initiated.   Now here’s the first point - the originator may be either a principal or an agent.  What’s the difference?

A principal is one who initially receives valuable goods and/or services and uses the notes to pay for them.  It is the principal who ISSUES the currency into circulation by buying goods and services with it.  The currency notes are a generalized I.O.U. which must be redeemed at some point in time.  Redemption occurs when the notes are accepted by the principal in payment for the goods and services s/he sells.  A currency which makes no adequate provision for redemption is bound for trouble.  The collapse of innumerable government and bank-issued currencies over the past decades testify to this.

An agent performs a different role. An agent does not spend the currency notes into circulation. S/he does not issue the notes but merely distributes them to the principals who will issue them (spend them into circulation).  The agent, therefore, is not responsible for redeeming the notes.  That is the obligation of the principals who are the ones who spend them into circulation.  The agent also serves as registrar, recording the amount of notes distributed to, and received back from each principal.

What we need to know about Ithaca Money is whether it acts as principal (issuer) or agent.  If it acts as principal, Ithaca Money must be willing and able to redeem its entire issue of HOURS by providing an equivalent amount of goods and/or services to those who hold the notes.  In this case the HOUR notes represent its i.o.u’s. Is that how Ithaca Money regards the HOURS it distributes?

Ithaca Money does accept HOURS in payment for advertising, but is it prepared (willing and able) to redeem the entire issue this way?  If Ithaca Money is not so prepared, then there could, and likely will, develop an eventual problem of currency debasement.  In other words, of "too much currency chasing too few goods and services," which will show up as HOUR price inflation.  In the worst case scenario, the currency could collapse, i.e., lose the confidence of the community and cease to be accepted.

On the other hand, if Ithaca Money acts only as agent, then the responsibility for redemption of the notes rests upon the advertisers who first received them from Ithaca Money.  They are the ones who first issue the notes into circulation by using them to pay for goods and services.  Do the advertisers who receive the notes realize that they bear this responsibility?  Do they know what they must do in order to fulfill that responsibility?  Is there adequate assurance that they will do so?

How might such assurance be obtained?  I think it is not at all necessary to be legalistic about this, but the nature of the agreement should be clear and explicit.   One way to achieve this would be to have each advertiser to whom HOURS are distributed, sign a simple agreement.  This agreement might state that:

ITHACA MONEY is acting as agent for its advertisers, and ANYONE WHO ACCEPTS HOURS FROM THE AGENT IS OBLIGATED TO RETURN AN EQUAL NUMBER OF HOURS TO THE AGENT IF AND WHEN THEY CHOOSE TO DISCONTINUE THEIR PARTICIPATION IN THE PROGRAM.

The actions or inactions which constitute discontinuation of participation must be defined.  Discontinuation could be defined as being no longer willing to accept HOURS in payment for goods and/or services.  This might not be enough, however, since there would probably be no formal declaration of that to the agent.  The agreement could be greatly strengthened if discontinuation was defined as non-renewal of their ad in Ithaca Money.  Even without having any intention of legal enforcement, having such an agreement would provide greater assurance that an advertiser will not spend HOURS and then fail to earn them back, i.e. take value from the community without putting back an equal amount (reciprocating).

The requirement of returning HOURS to the agent would provide the proof that the I.O.U.’s issued by the advertiser have been honored (redeemed).  The loop will have been closed and reciprocity will have been achieved. Figures 1 and 2 show pictorially how currency notes are issued, circulated, and redeemed when Ithaca Money acts as issuer and agent, respectively.

Ithaca Money as Issuer

Adding a Capital Cushion

When a conventional bank is established, the founders must put in some capital of their own.  This capital fund is necessary to cover the start-up costs, but it also serves to provide added security for depositors in case some of the bank’s assets which back the deposits should lose some or all of their value.  The capital fund, then, provides resources which can be used, if necessary, to cover the cost of bad debts.

A local exchange system, too, is a business of a sort.  Although it may not be operated for profit, it still incurs costs of operation.  While most systems have been started with grants and volunteer labor, that may not be an adequate basis for operation in the long run.  In order for the system to be independently sustainable, it must eventually generate sufficient revenues to cover its costs.  Some of these costs may be unavoidable cash costs, while others might be adequately covered with local currency.  A capital fund will provide credits or backed currency against which bad debts can be charged.  How might the system acquire a capital fund, and how might it generate sufficient revenues to sustain its operations?

Let’s consider the latter question first.  Operating revenues must generally come from fees which the system charges its clients and patrons for services like advertising and/or accounting.  But there is also another way, which will be described in a moment.  The capital fund could come from grants or loans, but it too might be obtained in another way.  What is this other way?

Ithaca Money as Agent

Using Excess Business Capacity to Support Local Currency

Every community has an economic base comprised of natural resources, skills, productive capacity, etc.  While each community has its own distinct array and assortment of these, there is almost always excess capacity, i.e., the businesses in the community are able to make and sell more than they actually do.  Further, the cost of that additional production is usually very low in comparison with the average cost per unit of output.  Economists call this cost of the last unit produced, the marginal cost.

Everyone is familiar with discount coupons.  They are typically used by restaurants and retailers to attract more cash business and repeat customers, i.e. to utilize some of their excess capacity.  Since their marginal cost is low, they can afford to grant the discount and still add to their overall profit.

This phenomenon of excess capacity can be harnessed to accomplish at least three important community objectives.  It can provide a funding source for non-profit and community improvement groups, including the local currency system, and at the same time, it can provide a way of introducing and promoting the use of a local currency.   Further, excess business capacity can provide the local currency system with a capital fund to provide added security against currency debasement.  The essential process for doing this has been variously described by at least three local currency/exchange advocates.  The Community Service Credit System which I describe in Chapter 15 of my book New Money for Healthy Communities, lays out the basic approach.  Variations on the theme which I have been trying to promote in Arizona are Community Service Coupons and Youth Employment Scrip.  Joel Hodoroff has been promoting a plan in the Minneapolis/St. Paul area for several years.  His efforts have recently come to fruition in a pilot project called the Community Hero Card which was launched there in the Spring of 1997.

Using Excess Business Capacity to Support Local Currency

Community Way

A particularly elegant description of the process by Michael Linton and Ernie Yacub was published in the summer of 1996 in a Canadian magazine called Making Waves.   Their plan is called "Community Way."  Implementation of Community Way in Vancouver, BC is in the planning stage, and there have been some promising discussions about launching it in the San Francisco Bay area.  I believe that Community Way has the potential to shift tremendous amounts of resources into the "third sector" (non-profits), and at the same time, give the local currency movement a big boost into the mainstream.  Once the first prototype is up and running smoothly, I think it will proliferate rapidly.

How does it work?

Whether a system uses ledger credits, like Community Way, or circulating paper notes, like my Community Service Coupons, the process is conceptually the same.  The bare-bones process for Coupons is this:

Step 1.  A business agrees to accept the local currency as partial payment for whatever it sells (just as it would its discount coupon). It also agrees to donate back to the system a portion of its local currency revenue. This may be a fixed numerical amount or a percentage of local currency income.

Step 2.  This commitment provides the system with a capital fund (in local currency), which allows the system to issue (spend) notes or credits, knowing that the business will redeem them, completing the reciprocity circuit.

Step 3.  The system then allocates the notes or credits to non-profit organizations or community service groups.  These groups can then use them to pay their volunteer workers, purchase supplies, or pay for services.  The system can use some of these donated notes or credits to pay the people who do the work of running the system, and to build its capital fund cushion.

Step 4.  The volunteer workers can then spend them at the businesses which have agreed to accept them, or they can sell them for cash to cash-rich supporters who then spend them at the businesses which have agreed to accept them.   Others in the community may be willing to accept them as a payment medium, knowing they can be redeemed at any donor business.

Step 5.  When the business donates back to the system the amount of notes it agreed to, the circuit is complete, the obligation has been discharged and the notes are retired until another business makes a donor commitment.  Then the notes may be reissued.

Of course, the notes may change hands many times before they reach the donor business, and it is hoped that they will, allowing the notes to serve not only as a fund raiser for community improvement activities, but also as a supplemental medium of exchange.  One further advantage of this approach is that the donated notes increase the available supply of notes, making it easier for those choosing to leave the system to repay the notes they owe.

What if a business takes in more notes than it agreed to donate back to the system?   In this case, the business can spend the excess notes at other participating businesses which are eager to have them in order to fulfill their own obligation to the system.  There are a number of other details associated with such plans but they need not be discussed here.

Figure 3 shows pictorially how the notes are issued, circulated, and retired so that reciprocity is achieved.

This is what it shows:

1.  The system distributes notes to non-profit organizations on behalf of business donors.

2.  The non-profit organizations use the notes to pay workers, buy supplies, and pay for services.

3.  The non-profit workers sell the notes for cash to cash-rich supporters.

4.  The supporters spend the notes at participating businesses.

5.  The business donates the notes to the system as agreed.

Once the notes return to the System, they are retired.

The diagram shows who gets what when the notes change hands.  The non-profits, including the System, get labor, services and supplies; the workers get cash or discounts at participating merchants; the supporters get discounts at participating merchants; the participating merchants get the benefits associated with being a donor.  These are (1) more business, (2) good will in the community, (3) advertising, (4) a better environment in which to conduct business, and (5) a stronger local economy.

 

This article is a draft of a chapter for a forthcoming book.

Mr. Greco may be contacted at:

P.O. Box 42663, Tucson, Arizona  85733, Telephone: (520) 577-2187

E-mail: circ@azstarnet.com

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