What are the general arguments against
local currency systems,
and how do we respond to them?

Contents:

1.      Parallel currency systems cause a reduction in economic efficiency

2.      Parallel currency systems cause inflation

3.      Parallel currency systems encourage tax evasion

4.      Parallel currency systems abuse the Social Security System

5.      Parallel currency systems are unable to finance investments

6.      Parallel currencies are easily counterfeited

7.      Parallel Currency Systems Lead to an Informalization of the Economy

8.      Bad parallel currency drives out good conventional currency

9.      Local Currencies Cause Confusion Regarding the Basic Functions of Money

 

1.  Parallel currency systems cause a reduction in economic efficiency

Argument:

Since the circulation of a community currency is restricted to a relatively small area, it can be argued that little competition exists between producers of the same goods and services.  Moreover, since producers depend on a much smaller market, they will not be able to achieve the same scale advantages as larger producers.  This may give rise to higher prices for consumers due to the lack of competition-driven efficiency.

Response:

However, rather than replacing the national currency with the parallel currency, consumers generally trade using a portion of the parallel currency in combination with the national currency, therefore producers taking part in the parallel currency systems are not insulated from outside competition.  Because usually only a portion of the purchase is made using the parallel currency, producers are not dependent upon the alternative currency system for their income; it is often only the excess capacity that is sold through this system. By making use of this idle capacity, producers actually see their unit price decrease, thus increasing their efficiency.

Even if a parallel currency system grows in economic importance and consumers and producers become dependent on the system for a large proportion of their needs and income, one can enter the discussion of trade-off between economic efficiency and economic stability: at which point economic efficiency (through specialization) starts to endanger economic dependence.  Adversaries of these systems emphasize the economic efficiency effect of specialization and consider them to be a disguised form of protection, whereas on the other hand proponents of alternative currency systems emphasize the reduced economic dependence and higher self-reliance as result of participating, and see economic dependency as a potential source of not only economical instability, but also political and social unrest.

One of the fundamental principles of neo-classical economics is division of labour through specialization.  Persons, communities, regions and even countries have become increasingly specialized and therefore dependent on external trade.  In a dynamic world market, a comparative advantage today is not a guarantee for the same advantage tomorrow.  Although it is undeniable that globalization has lead to more products available at lower prices, it has also lead to increased inequality of wealth distribution, more income instability and enormous transitions costs for communities that have lost their competitive advantage.  These transition costs include not only a loss of income and employment, but also social costs such as rising crime rates, drug abuse, prostitution etc.  The main form of specialization in developing countries is in agricultural exports.  Local economies are left to the mercy of international markets that are completely out of their control.

A certain degree of specialization is beneficial and community currency systems certainly do not pretend to bring communities back to interdependence with other communities: products which demand a high degree of specialization and in which scale advantages play an important role, are simply not traded within the parallel system.  New computers, cars, and other highly specialized products consist of so many specialized elements, that they cannot possibly be developed at the level of a community unless all the various factors of production are in place at a cost which is competitive with other sources.

Parallel currencies are not intended as an alternative to the national currency.  However as a result of specialization, communities have lost a great deal of their skills diversity, making them more vulnerable to outside shocks.  If skills in such essential areas as agriculture, housing and clothing are lost because many people specialize in tasks that are only of value in the world market, the community degrades from an economically productive unity into a subsidized collection of individual households that have no viability on their own.  A new balance has to be found between the dependence on outside markets and self-reliance at community level.  It is easy to loose a skill; it is much more difficult to acquire one.  Parallel systems can help to employ and retain skills within the community, thus contributing to their very right of existence.

2. Parallel currency systems cause inflation

Argument:

This concern is closely related to the question of whether the new currency system is parallel or alternative to the national currency and the conventional economy.  Do local currencies create new trade or are they rather a substitute for trade formerly handled in the national currency?

If there is a large trade substitution effect, this could mean that prices will rise due to an expansion in the money supply.  This is especially true if the parallel currency is issued as Fiat, in which the money supply is expanded greater than if the parallel currency was issued as partially backed by conventional money or as a mutual credit system.  Fiat parallel currency systems can cause inflation if there is too much money in circulation and if this money can not be removed in time.  However, only in the case of the Salta Bonds in Argentina has the issue of inflation being caused by a fiat parallel currency been raised.  It appears to not be an issue with Hours systems at this stage, however this is one of the reasons behind arguments for what are called "demurrage", "negative-interest" or "depreciating" currencies which terminate after a period of time.

Response:

Trade creation is seen as a way to possibly reduce the effects of expansion in the money supply by providing an expanded range of locally produced goods and services with which to pull excess money out of the local economy.

Another option is to show the methods you have for controlling the money supply, how currency is issued into the economy and how it is removed from the economy.

3.  Parallel currency systems encourage tax evasion

Argument:

In most countries, no taxes are payable on purchases of goods or services unless the income is earned in connection with a business, or amounts to a certain income threshold.  Thus many of the transactions that take place are non-taxable.  If the money comes through a business, it must be recorded as income for the businesses own purposes, as well as for taxation purposes.

Response:

Since the turnover and profits of local businesses may be expected to rise after joining a parallel currency system, an increase of tax revenues may even be expected. Moreover, if transactions are registered (as is common in most mutual credit systems), tax evasion of local currency income is practically impossible, even though the system itself may not divulge this information to a government's Revenue Department.  In this case the parallel currency system actually works in favour of the tax collector because an active economy generates tax revenue.

4.  Parallel currency systems abuse the Social Security System

Argument:

Some issues have raised on the issue of receiving Social Security benefits like welfare and unemployment insurance while earning an income in a parallel currency.  Given that the social security system was never designed for the modern reality of marginal, occasional and temporary employment opportunities, there have been instances of individuals losing their Social Security benefits because of their participation in a parallel currency system.  More and more governments understand that benefit legislation is difficult to apply against individuals who are trying to lift themselves out of welfare dependence by participating in such systems.  Recent efforts in Australia and England are showing signs that federal governments are willing to do whatever is necessary to help people get off of welfare and into work, including allowing people to exempt their local curency income from their Social Security benefits.

Response:

However, governments may experience a drop in tax revenues if sales of certain enterprises fall because people prefer to buy services and products from individual members (who are tax-exempted) using the local currency.  More research would be necessary to examine the importance of this substitution effect and to which degree this tax loss is compensated by overall higher sales elsewhere and decreased expenses on welfare.

In developing countries, the tax evasion argument (and even less the benefit evasion problem) is hardly valid since in many cases such systems do not exist, the incomes earned in the informal sector (one of the main target groups for parallel currency system) are so minimal that it is improbable that they would be taxable.  Thus the issue varies from country to country.

Instead of regarding parallel currency systems as a tax evasion problem, many local and national governments now acknowledge the useful role that such systems can play in reducing the costs of Social Security system, providing income opportunities for people at the lower end of the socio-economic spectrum, and increasing individual well-being and the meeting of needs.  In  Australia, income in local currency is not applied against Social Security benefits; in England, the government has employed civil servants to install systems; in New Zealand people who register as unemployed and looking for work are encouraged to join a system; in the USA income from  Time Dollars are exempted from tax.

In developing countries, where formal social security systems are underdeveloped or even non-existent, government support for parallel currency systems is even more desired.  One possible argument for governments giving preferential treatment to parallel currency systems is that such systems are a financial instrument that reduces the need for government expenditures on income transfers or subsidies, thus liberating public funds for other, truly productive investments such as education and infrastructure.

In short, arguments against parallel currency systems as a way of avoiding taxes are difficult to defend, especially in "developing" countries, and in "developed" countries where governments are going in new directions.  Levying taxes on enterprises that use scarce resources (energy, natural resources, space, environment, waste storage and/or transformation, etc.) are a new direction in which some governments are heading, such as Germany.  This would make labour cheaper and environmentally destructive products more expensive.  Discussions on the introduction of this so-called 'eco-tax' in the European Union are in the final stages.

5.  Parallel currency systems are unable to finance investments

Argument:

At an early stage in the development of modern parallel currency systems, some argued that the zero-interest policy makes it unattractive for the participants to save money, which deprived participants the savings they need to finance investments. 

Response:

At first, parallel currency systems argued that they do not pretend to substitute the conventional currency systems, and that they may even enhance the individuals ability to save money for investment purposes. As explained in earlier, the main function of money is to facilitate transactions, not to accumulate wealth. One of the strong characteristics of parallel currency systems is that accumulation of money is discouraged, thus preventing any interference with the function of money as an exchange medium.

Recent developments are shattering this myth.  The microcredit concept, in which funds may be contributed from outside, or pooled between the participants and lent in turn have won significant mention for their effects in Bangladesh and India.  As will be presented later, joining a parallel currency system to this concept can be very beneficial.

6.  Parallel currencies are easily counterfeited

Argument:

It can be argued that local currencies are easy to falsify, because the high-tech anti-counterfeiting measures taken in the case of national currencies are too expensive for local currencies.

Response:

While this may be true, no exchange medium, whether local or national, is completely safe from counterfeiting.  From the golden coins of previous ages that were shaved or reduced, to fake credit cards: the fact that money is something that can be counterfeited is and will always be an issue of concern.  Nevertheless, the number of cases  of counterfeiting of local currencies is very small (although not nonexistent) for several reasons.

The counterfeiting of local currencies is not very interesting for criminals looking for an easy profit while keeping a low profile. As the circle of people that accepts the local currency is limited, and because it is usually spent in combination with the national currency, the would-be thief would need some money of his own if he wanted to spend the money.  The chance of being caught is considerably higher than in the case of national currency.  Moreover, people within the system are not likely to undermine the system, since they benefit from it.  Finally, it is rare that people spend large amounts of money in a short while within the system.  People who spend large amounts into the system without having earned them first are easily detected.

Several simple and low-tech measures can be take to reduce the risk of counterfeiting:

1.  periodic recall (timed expiration and/or depreciation and new design of the paper money;

2.  use of special colours and/or types of paper, difficult to find or specially made for the purpose;

3.  use of off-set rather than photocopying techniques for reproduction;

4.  serial numbering the notes;

5.  stamping and signing the notes;

6.  making an impression on the note (such as the system's logo) using a special stamp or plier.

Other, more high-tech measures can be used, but they require the financial means available for this purpose and on the technical possibilities locally available.  The investment made in anti-counterfeiting equipment has to be seen not only in the light of reducing the risk of counterfeiting, but also as a confidence building measure, which is especially important during the early stages of the introduction of the currency.  Some community currencies have surpassed some national currencies in their anti-counterfeiting protection.  As Paul Glover, founder of the Ithaca Hours says, "multi-colored HOURS, some printed on locally-made watermarked cattail (marsh reed) paper, or handmade hemp paper, some with non-photocopiable thermal ink, all with serial numbers, are harder to counterfeit than dollars."

Mutual credit systems don't have these problems--they can't be lost, stolen or forged.  Any misuse of the system will appear in the records.

7.  Parallel Currency Systems Lead to an Informalization of the Economy

Argument:

This argument also touches the tax-evasion problem dealt with previously.  If a substitution takes place from activities formerly done by formal enterprises (who pay taxes) to individuals (who do not pay taxes), one can speak of a Informalization of the economy.  This would probably mean that one (taxable) full time job would be lost and replaced by many (untaxed) part-time jobs.  Enterprises can regard this as unfair competition because the individual part-time producers do not carry business overheads such as insurance and rents, nor do they comply with requirements for health, safety and fire regulations, food hygiene laws, public liability insurance etc.

Response:

On the other hand, it is questionable that this Informalization effect exceeds the new employment and income created as a result of better utilization of the excess production capacity of formal enterprises: while some enterprises might have to cut certain jobs, many enterprises will be able to employ more people as a result of increased sales. The overall effect on employment (and thus income tax revenues) might be positive and the job-loss could be considered a readjustment of the local economy.

Secondly, the term Informalization only means that the income is not considered taxable and that it does not figure in the GDP of the country.  It says nothing about the value of that income for the socio-economic well-being of the community.  Paying taxes or contributing to the GDP are no objectives in themselves.  Taxes are paid in order to correct a skewed income distribution and to pay for goods and services that are not produced by the private sector.  If a parallel currency system can redistribute one full time job over many part-time, it contributes to a better income distribution just as taxes do, but in a natural way.  Jobs are not lost; they are redistributed, which reduces the need for corrective socio-economic measures by government, such as welfare.

8.  Bad parallel currency drives out good conventional currency

Argument:

Sir Thomas Gresham, financial agent for Queen Elizabeth I was not the first to recognize the effects of weak currencies driving stronger currencies for circulation, but his elucidation of the principle that "bad money drives out good" became known as Gresham's Law.

When depreciated "bad" money circulates concurrently with "good" money of high value, the good money is hoarded and "driven out" of the market.  This was first noticed when silver and gold were used in coinage--silver was used instead of gold because of its weaker and more unstable value.  Speculators would make purchases of gold using silver, and on the mint market (the rate paid by the mint) silver often fetched a lower price than on the currency market, meaning a profit for the speculator.  "Bimetallism", as it is known, was the method of using Gresham's Law in speculation. 

Although economists rarely make such claims about parallel currencies, it could be argued that parallel currencies, especially fiat currencies circulate in preference to the national currency because they are weaker, driving the national currency from circulation and resulting in monetary problems if the use of the weaker currency becomes widespread.

Response:

Proponents of parallel currencies argue that their currency frees scarce national currency for trade creation through partial substitution of the parallel currency for transactions that formerly took place in the national currency.  By tying the two together in a parallel, rather than alternative system, they argue, Gresham's Law is not entirely applicable.  Instead, it may be better to say that the parallel currency pushes the national currency around with increasing benefit to the economy as a whole.

9.  Local Currencies Cause Confusion Regarding the Basic Functions of Money

Argument:

National currency fulfills three main functions: as a circulating medium of exchange, a divisible and measurable unit of account, and a store of value. Introducing a local currency confuses this by trying to separate the functions of medium of exchange and store of value. 

Response:

National currencies fulfill other functions as well, such as:

A Standard of Deferred Payment:  Because money can be stored, it is convenient for credit operations, the building of capital, and for investment purposes.

A tool for speculative profit: today more than 95% of all currency transactions are motivated by speculation; less than 5% are for trades of goods and services.

A Tool of Empire:  Money is used by powerful countries to undermine the currency of weaker countries to force dependence upon the stronger currency.  The Russian Ruble during the communist era, and the US dollar are examples of this.

Local Currencies seek to separate the function of means of exchange and store of value functions.  To separate the contradictory functions of money as a store of value on external markets and a medium of exchange at the community level.  These systems arise out of a critique of the dominant debt-based economy, and are designed in contrast to it.  The dominant economy is one in which money is owned by Banks, issued as debt to Governments, in scarce supply in order to maintain its value, and which can go anywhere.  As this currency can circulate inside and outside national borders, a contradiction arises:  the currency must be scarce to maintain its value on foreign markets, but there must be enough in the country to facilitate exchange.  In times of economic crisis, this contradiction can reach disastrous proportions.  Thus, community currencies can fill an important role, holding the domestic economy together while the national currency is being battered on international money markets.