Proper Management of the System Trading Account in Mutual Credit and Local Currency Systems

Thomas H. Greco, Jr.

June 22, 1998    Copyright 1997 Thomas H. Greco, Jr.

In the administration of mutual credit and local currency systems, a great deal of confusion derives from the failure to recognize one basic point. The system administration involves two separate and distinct functions, an administrative or clearing function, and a trading function.  On the one hand, it acts as agent for its members, providing credit-clearing for their exchange transactions (using checks, cards, or some other accounting device), or distributing local currency notes to its members who then spend them into circulation.  Note that it is the members who issue the notes, not the system administration.  The system administration, acting in its agent capacity simply has the notes printed and distributes them to its members.   These notes, like a line of credit, represent potential money, not actual money.   They become actual money only when they are spent, i.e. when someone receives real value for them (goods and/or services).  This is the point at which they are issued into circulation.

However, the system administration may also have a trading account. In its role of trader, it acts like any other member of the association.  In this capacity it does have the power to issue currency into circulation.  Like any other member, it issues local currency into circulation when it receives valuable goods and services and pays for them using credits charged against its trading account or notes which have been allocated to it.

Every unit of local currency that gets issued should give rise to a commitment by the issuer (the one who initially received value for it).  This person (account) has agreed to take back the currency (credits) s/he issued in exchange for goods and services.

With regard to each and every local currency unit, we need to ask the following question:

Who initially received value for it?

That person (or entity) is the actual issuer.  That person is the one who is expected to redeem the credits or currency by selling goods and services sometime in the near future.  It is that person's commitment upon which the value of the credits or currency stands.

If the system account receives an amount of official cash or any other value (like accounting services, for example) and gives local currency in exchange for it, then the system account is the issuer of that local currency.  The system account is expected to redeem that currency by selling goods and services sometime in the near future.   It is the commitment of the system account upon which the value of those currency units stand.

When mutual credit systems or local currencies are established, the question inevitably arises, "How should the system trading account be managed?"  Indeed, we might question whether the system should be allowed to have a trading account at all?   Given the weight of experience that shows mismanagement and improper issuance of credits to be more the rule rather than the exception, this is not an unreasonable question.  It might be safer, and more ideal, to restrict the system to providing the clearing function for its members and allocating paper currency notes as physical representations of their lines of credit.  That part is pretty simple and straight forward.

However, when a system begins trading on its own account, there is the temptation to overspend, that is, to incur debits far in excess of its ability to earn credits.   Many LETS and local currencies systems have fallen into this pit.  Given the costs of launching a system, some way must be found to capitalize the business and to recover that capital investment over a reasonable period of time.  To attempt to launch a system with no capital, and to finance the start-up by spending credits into circulation, is to court disaster.

Alas, a local exchange system is a business, and it must be run like a business.   Adequate financing must be secured and proper accounts must be kept.  In business, it is usually required that there be some investment capital acquired to start the business and to cover the shortfall of revenues relative to expenses while the business is building up its customer base and developing adequate revenues to keep it going.  The start-up expenses are usually "capitalized," i.e. they are written off against future revenues rather than being charged against current revenues at the beginning.  This is in keeping with the fundamental accounting principle of matching revenues against expenses.

Similarly, a fundamental principle of banking is that in issuing any currency (or credits), credits or notes issued should be matched against the means of their redemption, i.e. goods and services available for purchase in the market.  For example, if it takes $50,000 to get a business started, that investment must be recovered over the life of the project.  In the case of a mutual credit or local currency system, the services provided by the system will be obtained by its members, and paid for, over a long period of time.  It is usually impossible for the system to provide $50,000 worth of services within the first few months or even the first year.

The system must be self-supporting.  It has necessary expenses of operation, and, hopefully, revenues sufficient to cover its expenses.  If it does not have sufficient revenues, it will not be sustainable.  It may flourish for a while, but, like any business which has persistent losses, it must ultimately fail.

It makes eminent sense for a local trading or currency system to cover as much of its expenses as possible, using its own currency.  To do so, of course, the system must have its own trading account. The question then resolves to laying out strict rules for managing the system trading account in order to avoid trouble.

Conversion of Official Money to Local Money

As we said above, a fundamental principle of accounting is to match revenues against the expenses incurred in producing those revenues.  A fundamental principle of banking is to match the issuance of money against the flow of goods and services into the market, since they provide the value upon which that money is based.

Suppose a supporter of the local currency system wishes to help launch the system by buying local currency units for dollars.  How can this be done in a way which is helpful and does not lead to local currency inflation?

Suppose, for example, that this supporter provides $500 in official money.  Should he be given 500 local currency units to spend as he wishes.  The answer is, "it depends."  What it depends upon is how the money is used, and the ability of the system administration to convert that $500 contribution into immediately available goods and services.  The important point is to match the local currency issued to the flow of goods and services into the local currency economy.  Let's look at some possibilities.

If the system administration spent the $500 in official money on fresh produce from the Farmer's Market and offered it for sale for local currency, then it would be perfectly reasonable to make an immediate issue to the donor of 500 local units.  The donor could use his units to buy the produce and the circuit would be complete.  Those local units would then be retired.  Of course, the more likely scenario, and the one to be desired, is that the notes would change hands a few times before coming back to the issuer, which is the system trading account.

Suppose, however, that the administration used those $500 in official money to buy food to give to poor families.  Admirable as that is, it does nothing to put goods and services into the local currency economy. If the official money donor were to be issued local currency units, there would, in this case, be nothing for him to spend them on.   This would cause local currency debasement (price inflation).

Now suppose that the system administration spent the $500 in official money to fix up a house which it intends to rent out for official money.  That, too, adds nothing to the supply of goods and services available for purchase in the local currency economy.   It, also, would cause local currency debasement (inflation).

On the other hand, if the system trading account would accept local currency for the rent, there would now be some value in the local currency economy which can absorb the new currency units.  However, attention needs to be paid to the time within which that value becomes available.  If the local units are issued at the time of the official money contribution and it takes six months for the house to be made ready for rental, there's an obvious mismatch between the flow of new currency into the local currency economy and the flow of real value into it.  This, too, would cause inflation in the near-term.  In this case, it would be better to treat the official money contribution as a loan, since the money is used as a capital expenditure.  That loan could be repaid in local currency, not in a lump sum at the beginning, but over a period of time which more closely matches the rental availability of the house.  The local currency payments on the loan should start only after the renovations are completed and the house is ready to be rented.  These payments should be spread out over the several year life of the renovations that were made with the money.

Again, let me emphasize the fundamental principle which must be adhered to in order for the local currency to remain sound and avoid depreciation of the local currency unit (inflation):

The issuance of local currency into the local currency economy must be matched to the flow of goods and services into the local currency economy.  Money should be issued on the basis of goods and services on their way to market, not on the basis of long-term investments or loans, nor on the basis of charitable spending.

The system trading account should be viewed as any other member account.  Whenever the system issues local currency on the basis of value received, it is committed to redeem that currency by selling goods and services.  Normally, what the system has to sell is clearing services.  The administrative costs of operating the system, and recovery of the initial investment to start it, must be covered by fees and assessments charged to its members.  If, for example, the system issues local currency in exchange for cash, or to pay its employees, it must recapture those local currency units within a reasonably short period of time by charging for the services it provides.  Start-up and initial operating costs may also be covered by grants and donations.  But subsidized operation may not be sustainable and makes the system dependent upon continued subsidies.   This may be necessary at this early stage of local currency development, but eventually, it will have to pay for itself.

If the system administration chooses to operate some business enterprises, like, for example, a tool library, those businesses should have their own trading accounts, separate from the system trading account.  Now, when a cash input is made to buy the tools which will be rented out for local currency, that cash input should be considered to be a loan.  It needs to be recovered over the lifetime of the tools to provide for their eventual replacement when they wear out.  Some of the expenses of operating the tool library can be paid for using local currency.  These will allow some of the rental fees to be paid with local currency, as well.

In general, cash expenses must be covered in cash, while some of the local value added can be paid for using local currency.  Each business, then, must price its goods and services accordingly, receiving part in cash and part in local currency.

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