Competitively-Issued Convertible Bank Notes in a Theory of Finance: Earl Thompson Meets Fischer Black

21 Pages Posted: 17 May 2019 Last revised: 16 Nov 2020

Date Written: March 29, 2019

Abstract

In this paper, I show the validity of and the relationship between two previously unrelated claims in monetary theory. The first claim, made by Earl Thompson, is that privately-issued bank notes pay a positive rate of return in a competitive equilibrium. The second claim, made by Fischer Black, is that it is possible to have a gold standard in which the gold reserves of the central bank are near zero. I first show the validity of Thompson's claim. I then show that a corollary of my result is that Black's claim is correct in a competitive market. The link between these claims is the Black-Scholes equation applied to bank notes. In commodity-based monetary systems, bank notes are perpetual American options. I extend the model to consider the implications of a lack of commitment on the part of the bank and incomplete markets. I show that both arguments break down when banks lack commitment or markets are incomplete. I conclude with implications for macroeconomic theory.

Keywords: bank notes, competitive money supply, commodity money

JEL Classification: E42, E50

Suggested Citation

Hendrickson, Joshua R., Competitively-Issued Convertible Bank Notes in a Theory of Finance: Earl Thompson Meets Fischer Black (March 29, 2019). AIER Sound Money Project Working Paper No. 2020-01, Available at SSRN: https://ssrn.com/abstract=3362350 or http://dx.doi.org/10.2139/ssrn.3362350

Joshua R. Hendrickson (Contact Author)

University of Mississippi ( email )

Oxford, MS 38677
United States

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