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| Isaac Newton, Master of the Mint |
Beginning in 1717, Isaac Newton, Master of the Royal Mint, put England on a bimetallic standard. Under bimetallism, the pound sterling was defined as a fixed quantity of silver or gold. In other words, where before England's medium of account was a certain quantity of silver, the new medium of account was a certain quantity of both metals. The unit of account through all of this remained pounds. As the market prices of gold and silver varied due to technological advances and new discoveries, the fixed silver-to-gold ratio meant that one or the other would be undervalued relative to its actual market price. As a result, the entire nation's stock of circulating coin would either flip to gold (if gold was overvalued by the mint) or silver (if silver was overvalued). After all, why bring your silver to the Royal Mint in London when you might sell it for more overseas? The overvaluation of gold, which in England's case was accidental and not intended, quickly moved the nation from a mixed standard to a gold based monetary system.
Just as England once fixed the quantity of gold equal to a quantity of silver, the modern Bank of England declares a fixed relationship between a paper pound and an electronic deposit at the Bank. The relationship is 1:1. This fixed relationship causes significant problems at the zero-lower bound. Say interest rates on BoE deposits fall below zero. At this point, the entire nation's stock of circulating pounds will be converted into paper pounds. Why hold a -2% deposit when you can hold cash at 0%? Very quickly, England will have moved from a mixed deposit/currency standard to a straight paper currency standard. It's exactly like the old bimetallic flips of yore.
The way to solve the bimetallic switching problem was to periodically adjust the fixed ratio between gold and silver to approximate actual market rates. That way neither of metals would ever be undervalued and, as a result, England would have been able to stay on a mixed standard with both silver and gold coinage. Miles's proposal is very much the same. If you relax the 1:1 ratio between Bank of England deposits and Bank of England paper currency, then as rates fall you can prevent the flip to paper currency from happening. Say rate on deposits falls to -2%. The Bank can declare that paper currency is now only worth 0.98 of a deposit, nipping at the bud the incentive to switch into paper currency. With neither asset superior to the other, people will choose to hold the same mix of currency and deposits as before.
The other way to solve the switching problem was to simply get rid of bimetallism altogether. Define the pound in terms of only one metal and let the free market take care of dealings in the rest. This is Bill Woolsey's answer to the modern zero-lower problem (here and here). It's similar in nature to Miles's. Have the central bank cease all dealings in paper currency and define the pound only in terms of deposits at the BoE. Private banks will take over the business of issuing 0% paper money. When rates fall to zero, private banks will immediately contract their issues of outstanding paper currency to nothing since maintaining a stock of 0% liabilities when the assets that support them are also paying 0% is not profitable.
In either case, you can get below the zero-lower bound pretty easily. The long gone era of bimetallism isn't as dead as we think. Differentiating between currency and deposits is very much like differentiating between silver and gold.
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