When times get tough and cash is in short supply, local economies sometimes turn to printing their own money to keep things moving.  Local currencies a method of exchange in commerce that is not backed by a national government.

By this definition local currencies are not legal tender.  This would keep them from being considered valid “for all debts public and private” like the US dollar.  However for a currency to be valid in a local economy you need only have enough people and businesses believe in its strength.  This could work in theory, and it is working in practice.  The federal government in the US is the only entity that can coin money, but anyone can print it.  An example is the BerkShare, which not only has been successful in the Berkshires of Massachusetts, but other economies are seeking to create their own currency based on the BerkShare.

The basic idea behind a local currency’s use is that a bank will hold the printed cash and happily exchange the national currency for the local stuff.  This is usually at a 1:1 ratio.  Local businesses can register with the bank to accept the local currency at their business.  This way consumers have a way to spend the money and businesses have a way to exchange it for dollars with they want.

So what is the point?  Think about the “Buy American” initiatives you’ve seen.  Buying American keeps jobs in America.  Now think about the organic movement.  Buy local, not from big agriculture.  Buying local keeps money in the economy.  There is a reason certain cities have tons of money.  On top of attracting money to the area, they also are very good at keeping the money there.  By creating a currency that can only be used locally, the local economy is able to stimulate itself even in down national economies.  This is possible because in a recession the availability of human capital is not diminished.  If anything it increases, but no one is able to use it because they don’t have money to pay for the services or products.

Think about a baker that makes lots of organic bread.  Everyone in town loves the bread but because the local factory closed down they have 12% unemployment.  This has impacted many businesses as well, including the baker.  The baker heads down to the local banks to sign up for a program introducing a new local currency.  To entice people to embrace the currency the notes are sold at a discount.  For example you can purchase 10 BerkShares for $9.50.  Since both have the same purchasing power this gives the user a 5% discount.

So now people interested in saving a few bucks and/or supporting local businesses there is a new currency in town.  Local currencies tend to move through the economy faster than national ones, and this movement stimulates the economy.  The consumer buys bread, the baker buys local flour, the flour maker pays their CPA, and the CPA heads to the bakery for some blueberry muffins.  Had the baker bought the flour at Wal-Mart, that money might be in China by now.  This is why Wal-Mart will never be included in programs like this.  Only local businesses can sign up and participate.

Local currencies are not without their caveats.  For it to work, you have to get a lot of people on board, but not too many.  You need enough for there to be some form of competition for the business but if it gets too big you risk someone gaming the system.  Also even at a 5% discount this stuff still won’t be cheaper than what Wal-Mart has, and therefore some lower income groups may not see any use for the system.  Finally, a local currency can be hoarded increasing the demand for notes; once the hoarde is released hyper-inflation is a possible result.

categories: college of weakonomics, economics