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I've been toying around with the idea that the Empire in my flintlock fantasy setting is trying to make sure that the money used in all its territories is the same, as the use of localized currencies has resulted in some problems, especially in terms of counterfeiting. The new currency is largely paper bills. The empire wants to phase out all the old currencies with these new bills. My question is, how much of an effect would this have on inflation? The old paper bills and coins are going to become worthless as the new currency is phased into circulation, so the actual amount of cash isn't changing by that much. You exchange your local currency for an equal value of the new currency. My thinking is that the rate of inflation would not be greatly affected, but I'm not an expert on these things, so I wanted to be sure of that. So, am I right or not?

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    $\begingroup$ Why using the magic tag for a question which is basically about economy? $\endgroup$ – L.Dutch Nov 5 '18 at 20:08
  • $\begingroup$ Just because I find it curious: You are asking about one very specific thing that at least to me, another layman, doesn't have an obvious connection to inflation. I remember when my country traded in our old currency for the Euro and while people complained that things got more expensive, really, inflation went down for several reasons. This is a really complicated topic, so here is my question: Do you usually calculate the rate of inflation based on complicated ideas? If so, how? Calulating the rate is not trivial. If you don't care otherwise, you shouldn't here either $\endgroup$ – Raditz_35 Nov 5 '18 at 20:09
  • $\begingroup$ @L.Dutch I said it was a story set in a flintlock fantasy setting, so I thought the magic tag was appropriate. Also, while I didn't mention it because it seemed irrelevant to the question, the paper bills are made with an ink that's produced using Dragon's blood. $\endgroup$ – Patrick-Leigh Nov 5 '18 at 20:14
  • $\begingroup$ @Raditz_35: Your comment is exactly the sort of feedback I needed, actually. I figured it would work like that, but I wanted to make sure instead of just assuming. It is a complicated matter, but I'm only concerned with how the swapping of an old currency with a new one comes into play. $\endgroup$ – Patrick-Leigh Nov 5 '18 at 20:17
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    $\begingroup$ Inflation is an overall increase in prices over time. If the old-to-new exchange rate is 1 to 1, then prices will stay the same. If the old-to-new exchange rate is <1 to 1(old money worth more), then there will be inflation because every fantasy buck will buy you less than it used to. If the old-to-new exchange rate is >1 to 1, then there will be deflation because every fantasy buck will buy you more than it used to. $\endgroup$ – Giter Nov 5 '18 at 20:17
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The operation will have no effect at all on inflation if done properly, ie. if the total amount of money does not change. This can be achieved by :

  1. replacing the old currency through exchange with the new one (but not the reverse). Usually a progressive operation over months or years.
  2. set the value of former currencies to zero. The value of a money is either related to its material (gold coins have at least the value of their metal), either built by the trust you have that the emitter will be able to garantee it (a bank, a state, a guild). "material value" is hard to deal with and implies devaluating the value of the material (putting large quantities on the market for nearly free), or magically turn it to something cheap, like gold into lead (expect strong reactions from money owners). "trust value" can be managed by political means.

Note that if done wrongly by simply adding new bills and coins, you will indeed inflate the money quantity and reduce its value.

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  • $\begingroup$ As far as coins made of certain materials is concerned, changing gold into lead or vice-versa is possible with magic but prohibitively expensive. I'm thinking that the old coins will be gradually phased out and, once all the old coins are out of circulation, they'll be melted down to make new ones that will be gradually released into circulation. $\endgroup$ – Patrick-Leigh Nov 5 '18 at 21:14
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    $\begingroup$ Be aware there are two totally different types of coins. Some contain actual valuable metals; the others are merely tokens exactly as paper money is merely a token. $\endgroup$ – Fattie Nov 6 '18 at 1:51
  • $\begingroup$ Be aware that confusingly I think OP is asking two totally different things. Please see the edit "A" and "B" in my answer. Here, @Uriel is I believe, like me, answering "A". $\endgroup$ – Fattie Nov 6 '18 at 6:47
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You've asked a question that, technically, you could research on your own. But, to be fair, economics is a subject so complex that it's an oxymoron to describe it with a single, short word.

To begin, you're dealing with something that our real world had been experimenting with for (as I recall) 100-200 years before our flintlock era. You're dealing with fiat money, meaning the money, itself, has no intrinsic value (it's not made of gold, etc.). It's only purpose is to represent value in exchange.

Using fiat money has pros and cons (please remember that I'm simplifying something awful. If anyone notes my oversimplification being reasonably in error, please point it out in a comment.). Fiat money is more flexible, less costly to produce, and has the capability of allowing an economy to grow far beyond the material cost of commodity coinage or commodity-backed scrip.

The cons are that it's counterfeitable, subject to value fluctuation (e.g. inflation and deflation), and must be constantly replaced.

  • The narrator of Ken Burn's The Civil War noted that counterfeit Confederate bills were often detected because they were so much better than actual production scrip. One of the biggest problems with fiat money is that it's cheap and inexpensive to produce. That was circumvented (mostly) in our modern times through the use of complex difficult-to-reproduce printing processes such as the use of Intaglio printing. You won't have that or any of the modern technologies in your flintlock world. Therefore, you will suffer inflation due to (at least) foreign powers trying to destablize your economy by printing fakes. You'll also have inflation by patriotic crooks who are simply looking to put bread on the gold gilt tables their families should be eating at (honestly!).

  • Value fluctuation is amazingly complex (people make careers out of trying to explain it). But, really really really simplistically, if I think my house is worth 10,000 dinero but it's actually only worth 5,000... and some idiot discerning buyer purchases it... the result is inflation. In other words, greed and the desire to make the most money possible will naturally cause inflation. Adding a middle-man to the selling process (oh, call them wholesalers) causes inflation. Passing minimum-wage laws causes inflation. Suddenly running out of Mother Emelda's Amazing Hair Tonic (which everybody has to have!) causes inflation. War (which usually needs Mother Emelda's Amazing Hair Tonic — MEAH — to grease axles) causes inflation. That darn local wizard who happened to figure out how to wave his stinking wand and POOF! whole cart loads of MEAH appear... that causes deflation. You get the picture.

  • Finally, you should not ignore the last issue: paper scrip wears out quickly by today's standards, and we know how to make durable money. It's more than just printing more (inflation!), it's distributing it that's the problem. Now you have a bazzillion distribution points (ok, call them "banks") and you have to get the new scrip to those points and make absolutely sure the old scrip is actually destroyed and doesn't end up lining Uncle Ted's shoes ("But I have a hole in my sole! I just wanted to keep the mud out!") as he trades the scrip. You need guards because the opportunity to steal money went up a thousand-fold. In other words, there's suddenly a whole lot of people getting paid for work that isn't actually producing anything... inflation!

And just to make things worse, you're going to replace the scrip of multiple nations. Yes, Europe did it without a ton of inflation — but that happened today with a lot of high-tech communication and security. How, in your flintlock era, will you determine how much of one nation's money is actually in circulation? Guess too low and the result of the exchange is inflation.

Because you can't just exchange it 1:1. Oh, that would be awful! What if your nation has only 1,000,000 dinero in circulation but your neighbor has 100,000,000 onyx coins in circulation? Are you going to replace them 1:1? Suddenly your neighbor is 100X more wealthy than you are? Is their GDP worth that? Do they have natural resources valued like that? I doubt it. Figuring out that the exchange needed to be 1:100 or, worse, 1:50 because they have 2X the gold mines you do (or something/anything else!)... currency exchange is non-trivial. I love it!

Conclusion

I think inflation would be an entirely believable aspect of the story. I believe the efforts to staunch inflation (if your flintlock society actually understood it) would make for good writing with excellent morals we need to hear today (like "spend what you earn"...). I think the opportunity for inflation is wonderfully complex, which I like to see in stories. And I think your flintlock society is mightily screwed... which makes the best stories of all!

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  • $\begingroup$ You've brought up some great stuff, and I'll be taking it into consideration. Your point about keeping the new money secure while its distributed is actually a key detail to what's going on, in fact. See, my protagonist is going to be foiling an attempted heist where some people try to steal a shipment of the new bills as they're delivered to a branch of the Imperial Bank in one of the port cities in the colonies. I was just wondering what other problems the Empire's "brilliant idea" might cause. I think I'll explore some of the things you brought up in later stories. $\endgroup$ – Patrick-Leigh Nov 5 '18 at 22:02
  • $\begingroup$ "It's only purpose is to represent value in exchange." Fiat currency is government currency (check the definition of "fiat") and it has no value. It is perfectly possible to have paper money which is not fiat currency, i.e. it has actual value (to wit, it can be exchanged for actual money - precious metals), and this was common for centuries. There are a number of classic texts on this if anyoen is interested, example * The Theory of Free Banking: Money Supply under Competitive Note Issue , George A. Selgin* and also the classic Scottish Free Banking. $\endgroup$ – Fattie Nov 6 '18 at 1:54
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This should have very little effect on inflation if done carefully. There are examples of it in the real world - for example replacement of a large group of currencies by the Euro when it was introduced in 1999. The changeover went smoothly with no inflation or panic. A similar thing occurs (admittedly only involving replacement of a single currency) when a nation changes its currency - for example replacement of pound/shilling/pence with dollars/cents in New Zealand in 1967.

A stock-pile of Newnotes is held at each bank. A citizen can deposit 'local' currency but only withdraw NewNotes to the same value. Shops take local currency or NewNotes in transactions but only provide NewNotes as change. A time limit is set beyond which the old currency will cease to be legal-tender (that is - usable for buying and selling). There is usually a longer period of grace set during which old currency can still be swapped for new at a central bank (after the point it has ceased to be legal-tender).

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  • $\begingroup$ This answer is exactly what I needed to know the way the exchange would be done. And it works perfectly for my setting, too, as the Imperial Bank has branches in all its territories and the local banks can get the new money from them as they need it. $\endgroup$ – Patrick-Leigh Nov 5 '18 at 21:04
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    $\begingroup$ It's a great point about the european currencies -> euro "takeover", that seems to be exactly what the OP is getting at! $\endgroup$ – Fattie Nov 6 '18 at 1:56
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It's a great question.

This happens all the time in the real world, and it has no effect on inflation.

Some say it slightly affects the "perceived stability" of the currency/government in question. ("They're forever changing the design of the notes.")

Note that flakey governments do indeed frequently change the design of the notes, there's always some new scheme. And indeed those regimes usually suffer inflation. But there's no cause and effect. If the Swiss change their note designs, it's just a design change, nobody sees it as flakeyness.


Note - OP, it's somewhat unclear if you meant:

There are two totally different issues/questions at hand...

[A] replacing the "currency design" (as happened frequently, see notes above)

[B] eliminating national currencies, to replace with the national currency of a bigger, encompassing nation (examples include when the Euro was introduced, and early US federal money replacing local money)

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  • $\begingroup$ Can you cite an example of a country in the 1700s that instituted fiat currency to replace existing currency in multiple countries with no ill effect (or, at least, no inflation)? If not, "this happens all the time in the real world" is false in that it's out of context. Just because it can happen today without consequence doesn't mean it could happen at all 300 years ago. $\endgroup$ – JBH Nov 6 '18 at 3:32
  • $\begingroup$ Sure, review the classical Scottish Free Banking era (which indeed led to money as we know it today), see my notes under JBH answer - this is the primary studied exemplar of the issue, second is the early US experience. However you're quite right, please see my edit. I was answering only question "A". Thanks for pointing this out. (For me it's not quite clear whether OP is really asking "A" or "B".) Thanks again $\endgroup$ – Fattie Nov 6 '18 at 6:46
  • $\begingroup$ @Fattie: The empire is doing a bit of both. The Crown, the currency used in the head state of the empire, is getting a design change, with the new bank notes being made with an updated ink which makes the bills harder to counterfeit. The territories under the empire are having their currencies phased out. In most places, people have been using the Crown already. For the colonies, this is a welcome change, for the most part, because their currency is getting worn out. Overall, people are welcoming this, except in the places that were recently annexed into the empire. $\endgroup$ – Patrick-Leigh Nov 6 '18 at 16:11
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Inflation ensues when the governing body that prints currency starts to print currency that is not backed by anything; but because people accept the currency (and may be required to accept it by law), the governing body extracts value from the economy without necessarily creating any value.

If I build a bicycle and sell it, I have used my time and energy to create a value that did not exist before. If I just print money and buy things of value produced in the economy, and do not produce anything of value using them, then I am effectively taxing the economy.

Of course the government CAN create something of value with the money, like funding a standing army to defend against invasion, or funding a police force to prevent crime that would otherwise happen. They can build and maintain public roads that have a utility for people and business far beyond their cost. And other utilities as well, that can take advantage of economies of scale to produce power, water, sewage handling and garbage collection much more cheaply and efficiently (and less dangerously and more healthily) than if all citizens were left to their own devices. If the benefit of these to the people is greater than the cost, a value is being created, savings are being experienced, productivity is being increased.

But governments tend to do many things that create much less value than they cost, like funding far more military than would suffice for self-defense, like doing political favors for their friends by over-paying for their products, or entertaining themselves or enriching themselves. They are spending "free money", and the temptations can be boundless.

This can make them parasites on their economy, and this causes inflation, by increasing the amount of currency in the society without providing any service or products that increase the net value of the society. I.e. instead of making life easier, safer and more convenient for the ruled, they are imposing a hardship on the ruled to support a "royal class" because some portion of their labor and productivity is being taken from them without providing them any corresponding benefit.

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