The Mechanics of Convertibility

Abstract

Chapters 12–14 consider various mechanical issues relating to the operation of the monetary standard, and we begin in this chapter with the mechanics of a convertible monetary system.¹ We can talk of the convertibility of a monetary system in two different senses. In a weaker and less familiar sense, convertibility involves a commitment by one or more banks of issue to maintain continuously or every so often a pre-announced exchange rate between the MOE they issue and something else (i.e., they peg the latter’s nominal price). For example, they might undertake to peg the nominal price of an ounce of gold throughout each trading day, or on the first day of every month or year. We can also talk about convertibility in a stronger and more familiar sense. ‘Strong’ convertibility involves a similar price-pegging mle, but also includes a supplementary requirement that banks continuously offer an ‘over the counter’ (OTC) service to the general public by which they commit themselves to redeem and sell their liabilities for some medium (or media) of redemption (MOR) at an exchange rate determined by a preannounced formula.² There may be certain conditions attached to the banks’ obligation to buy and sell their liabilities (e.g., members of the public might have to give advance notice to withdraw certain deposits), but in what follows it is easier to abstract from such conditions and implicitly presume that the banks agree to redeem and sell their liabilities on demand without notice.

A large part of this chapter appeared as ‘The Mechanics of Indirect Convertibility’, Journal of Money, Credit and Banking 27(1) (February 1995) pp.67–88.