3d illustration currency sign yuan on abstract futuristic network technology background. Photo: iStock
3d illustration currency sign yuan on abstract futuristic network technology background. Photo: iStock

China’s money is becoming stronger on the currency market. Is this news or was it predictable? Think about investment opportunities inside China, and China’s worldwide export, import and overseas investment activity. The situation is like that of America in the 20th, and England in the 19th century: The rest of the world looks to the cutting edge of technical progress and innovation. China is becoming just such a leader: If it isn’t there right now, wait for it to go to Mars!

Some folks say – and we are among them – “the next hundred years will belong to China.” If it works out that way, Chinese money will supplant the US dollar as the world’s currency, especially for international transactions, investments, banking, imports and exports.

Under what circumstances might such a transition (since today’s world of international finance is dominated by the US dollar) take place? To answer the question, we first recite the history behind the current state of affairs. And even before the history, we need a bit on the theory of money if we are to know what it is we do when we say we create a form of money.

And by the way, prior to the theory, we will spend a moment explaining why it is that cryptocurrencies, Bitcoin for example, are not fundamental money at all – they are merely parasitical constructs, wobbly and unstably perched atop the much deeper foundations of true monetary social institutions, institutions that must exist if China or any other society is truly to create a secure, deeply rooted financial payments system.

Fair warning: Oddly enough, our idea for a “money machine” rooted in China may involve a kind of diminishment of Chinese sovereignty. However, such a give-up is the price paid if we replace political uncertainty with standard rule of law.

Money a social instrument

First, let us lay out a bedrock idea: “money” is a social instrument needed to create a special kind of safety and security. It is an instrumental institution necessary if economic activity in the form of trade is trustworthy. Too many words. Let us provide an example.

The most important idea in economics requires money to be in the background. The most important idea in all economics is that specialization in production greatly improves efficiency, and enormously increases total output.

Adam Smith’s famous story about a pin factory makes it clear. To paraphrase him, a single worker who, alone, makes ordinary stick pins might make 10 pins in one day. But divide the manufacturing process into 10 steps, where the first man draws pin wire from a red-hot steel block, the second man cuts the wire … the 10th man places polish on the finished pins, daily production rises to 1,000 pins per day, or 100 pins per worker, 10 times better than if one man performs all functions alone.

Why is money’s “instrumentality” needed in a specialized, productive world? Allow us to change the example to make our point.

The hunter and the fisherman

Two semi-specialized cavemen meet in the woods. Nimrod the hunter has a deer. Indeed, back home he has a plenitude of deer meat, since he has specialized in hunting. But he wants to vary his family’s diet with some fish, and he is not good at fishing. He meets Boy Neptune, who has a fat salmon in his creel. Boy Neptune has a holding pond full of salmon, but his children are tired of fish three times a day and would like deer meat this week. But this fisherman is no good at hunting. He can gather far more protein per hour spent fishing than he does look for deer.

A trading discussion ensues. Hunter and fisherman agree that one deer is “worth” 10 salmon. The fisherman has only one deer, and in any case, 10 fish all at once would not suit the needs of the hunter’s family, who much prefer to have one fish per week for the next 10 weeks, rather than 10 fish at once. On the other hand, the fisherman’s family is happy to accept one deer all at once, since they can smoke and preserve excess deer meat, so as to spread out deer eating over the next couple of months.

The solution seems obvious: The fisherman takes the deer away today, giving over to the hunter the one salmon in his creel, along with a promise to return to their meeting place, once a week, for the next nine weeks, delivering a salmon each time, for total trade of one deer today for one salmon each week, beginning right now, extending over the next two months and one week. The fisherman hands over a nine-dollar promissory note, declaring that he “owes” the hunter nine dollars’ worth of fish, to be delivered over the next nine weeks. (For convenience, we say fish are “valued” at a dollar apiece, and deer at 10 dollars a head.)

What’s not the like? What is missing? Trust, enforceability, guaranteed delivery etc, that’s what. Missing is a payments system, a fancy word for the social institutions that are the behavioral reality of trustworthy money, and are absolutely necessary if “money,” the promissory note here, is ever to be “acceptable as a medium of exchange” (the classic “function” of money).

A payments system creates property rights and contract security for mutual promises that result from the general fact that mutually beneficial trades, arising from specialization, are to be well defined, enforceable by third parties, insurable, recordable and, when systems become complex enough, alienable out of the hands of the original trading parties.

In other words, what is the deer hunter to do if the fisherman does not show up in the third week? Does the hunter have some sort of document he can show “the sheriff”? Does the sheriff have access to some sort of court, where more-or-less peaceable social pressure is brought to bear to make the fisherman perform his part of the contract? Is some third party, operating as an “insurance company,” able to pay off the hungry hunter and take over the debt, later collecting it in full, plus costs, according to some kind of court order?

Take the story down as many roads as you wish, in order to see how many lawyers, accountants, sheriffs, and myriad other “officers of the payments system” are needed to “make money work.” Just having lumps of gold in the story, or bitcoins, or any other of the superficial “tip of the iceberg” external signs of a payments system are not at all enough. The golden nuggets are not important, as long as the social machinery works, as it must, to define, record, enforce, trade and ensure promises for the immediate, conditional or future exchange of value: The social institutions then allow the “functions of money” (medium of exchange, store of value, unit of account) to be securely performed, whether or not the “external signs” of the financial products take the form of gold, paper, or electronic records.

United States, and a unified state

Back to China, and the history of American dominance of the world’s financial network.

Up until the beginning of the 20th century, quite a number of nation-states had developed secure property rights, dependable traditions in defense of contract rights and obligations, methods for ensuring against fraud, dishonesty, and financial malfeasance. But two world wars tore up the old international social contract, and caused the disappearance (in some major nations) of rule of law, together with the appearance of unstable, dictatorial, anti-free-market forms of government. The consequences were hyperinflation, depression, panic, war and social chaos. Only the United States (among major nations) survived the whirlwind, and even it experienced depression, inflation and a general diminishment of property rights.

But the terrible results of the last century’s misadventures are behind us. Payments systems around the world have recovered enough so that, for example, the euro presents some competition to dollar dominance, although the highly imperfect “union” linking the nations of the European Union means, even as the general leadership of the USA is not what it was, that the euro will not supplant the dollar soon, or ever.

On the other hand, China is an example of a unified state. Its population weight is 1.4 billion. How old is it? Its written records go back at least 4,000 years. It has ancient rules, rituals, and regulations controlling economic relationships, that we interpret as a serious version of “rule of law,” or “payments-system rituals” that give business partners a needed sense of security and safety. Among such rites and rules are the following practices, enforced by tradition and social pressure.

Credit transaction: A transaction allowing the client to pay the bill later.

Red note: A bill similar to a voucher today, given to relatives and friends who could purchase commodities with it.

List of gifts: A set of goods packed according to (a standard) convention and sold together.

Commission: The money given to a go-between.

Up door presenting: Door-to-door delivery.

Treating with spring festival wine: A shop manager, together with his apprentice, paid New Year visits to important clients during the Spring Festival, presented his name card, and invited the clients to appreciate the lanterns (and share a drink of wine).

So, what is our policy idea? It will give China a chance to create a deeply rooted payments system, and therefore a “money” that will provide property rights and contract enforcement security to all users, foreign and domestic, now and tomorrow.

Open in order to rise

China should open its investment and ownership rules, giving all comers equal enforcement guarantees for all legitimate payments agreements. An easy way to do this is to allow contract disputes, when they arise over trading arrangements involving both foreigners and domestic players, to be settled, when players so request, in courts and settlement/arbitration panels set up in third-party venues, including places that are legally distinct and separate from China.

Something similar called a “dispute settlement process” is part of the North American Free Trade Agreement. The dispute-settlement panels that are involved do, to an extent, limit the sovereign power of the treaty-linked nations, and that limitation has been the source of some tension. But on the whole, most observers believe the panels have smoothed over disagreements more often than they have aggravated problems.

Yes, applying this model in the “China versus the world” trading environment is a departure from overweening Chinese sovereignty, but such a “rule of law” that is insulated from competing “rules of politics” is what traders need if they are to think (correctly) that they may know and expect just “how the economic game is played.”

In other words, if China desires to play a more significant role in the world’s financial community, it must create institutions that give the rest of the world secure status when international players undertake economic activity connected with Chinese entities, including the Chinese government. Only China knows if the prize is worth the cost.

Source for the above: Traditional Chinese Rites and Rituals by Ge Feng and Zhengming Du.

Tom Velk is a libertarian-leaning American economist who teaches and lives in Montreal, Canada. He is the chairman of the North American studies program at McGill University and a professor in that university's economics department. Jade Xiao is a McGill University graduate.

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