To what extent should “coins” be public to be “stable”?

Abstract
Barthélemy et al. (2025) introduces a general framework to study whether a state can determine the value of the fiat money that it issues by assigning it two roles: official medium of exchange and legal tender. Our results emphasize the key role of the state’s market-making strategy to back the market value of the official money against other stores of value. Comparing the situation of a state with that of the issuer of a private currency such as a stablecoin highlights that the latter private issuer, because it lacks a state’s ability both to tax and to restrict trading, needs the backing of relatively more important real resources in order to credibly peg its currency.

New forms of private monies

To what extent should money be connected to a state to keep a stable value? Is there anything unique that governments do that issuers of private monies cannot? The rise of stablecoins — tokens whose private issuer aims at pegging to a fiat currency or a commodity — challenges the dominant view that private monies are inherently unstable in the absence of public intervention. This view has been shaped by substantial historical evidence suggesting that purely private monies seem subject to occasional self-justified “runs” away from them.

Beyond the three traditional roles of money

While the three textbook roles of money — store of value, medium of exchange, and unit of account — are critical to understand the roles of money inside the private sector, two other important functions of money connect private and public sectors and are often thought to crucially affect in turn the price level in private monetary transactions.

First, taxes must be paid in money, and sovereign debt is repaid in money: Money is legal tender for transfers between public and private sectors. Second, the state purchases goods and services in money, and stands ready to trade money against other assets or currencies — money is the official medium of exchange between the state and the private sector. Through monetary policy in particular, the state acts as a market maker in the exchanges in which money trades for other stores of value.

Economic theory and political science view both roles as instrumental for a state seeking to control the value of the money that it issues. The money demand induced by tax payments is highlighted by Smith (1776), Lerner (1947) or Starr (1974). That sovereign debt repayment may affect money supply is also critical in the fiscal theory of the price level (see Bassetto et al., 2024). Using money as an official medium of exchange affects even more directly the price level. The conduct of monetary policy often takes the form of explicit price targets such as metallic standards; currency pegs or the targeting of some short-term interest rates as is currently widely the case. It is also the keystone of theories of price level determination such as fractional backing (Obstfeld and Rogoff, 1983).

But do these two roles of money — legal tender for taxes and sovereign debt, and official medium of exchange — always suffice to ensure a well-defined price level at which private agents freely trade money for goods?

Mixed lessons from history

Looking back at history, it is noticeable that, despite taxes being paid in money and official trading policies aiming at stabilizing the value of money, states often fail to achieve a clear-cut determination of the value of money.

A telling example is that of currency pegs, which, as documented in, e.g., Reinhart and Rogoff (2004) are routinely associated with the coexistence of active official and unofficial foreign exchange markets with diverging prevailing prices. Similarly, black markets are the natural reaction to price controls for goods. The private agents with privileged access to the official markets are typically the ones who extract rents from such failures of the law of one price.

Metallic standards are not immune to forms of loss of controls on the price level, as debt-deflation spirals (Fisher, 1933) may emerge. Even within the most common current implementation of monetary policy, the targeting of short-term nominal interest rates, there are examples of central banks being unable to control key rates, as currently evidenced by liquidity shocks in US repo markets despite a regime of ample reserves.

A general framework to think about these two official roles of money

Barthélemy et al. (2025) introduces a novel theoretical framework to think about these two roles of money. In this framework, the public sector implements a policy consisting in a trading policy – how much it trades against money and at what price (official medium of exchange) – and a set of monetary transfers – either positive or negative (legal tender). Importantly, the private sector is completely free to trade and set prices, including outside the official trading mechanism. The state is successful at setting the price level in this stylized economy if private agents do not create unofficial markets in which money has a different value from that in the official one.

A key aspect of our framework is that the public sector’s interventions may not necessarily « clear the market » and, thus may ration the private sector. Said differently, the public sector has a free hand both on the quantities and the price at which it trades with the private sector – a feature that we think is consistent with many policies and historical examples in which the public sector never commits to unlimited quantities or quantities at whatever prices. This is, for example, the case of pegs that are limited by the quantities of FX reserves. Central banks do also apply price or quantity restrictions in refinancing operations or quantitative easing.

Finally, it is also consistent with the view that, in contrast with private trades, policies are not decided based on market opportunities but on more general policy objectives.

The emergence of parallel markets

In this framework, we obtain that if the state fixes an official price (e.g., gold standard, currency peg, interest rate target) but does not commit to trade enough goods or assets for its money, parallel markets may emerge. To be concrete, if the state repays creditors in money but limits its supply, some agents buy cheap at the official price and resell at a premium elsewhere. The money anchor slips: Money is exchanged not only at the official price but also, unofficially, at a higher price level. Our theory predicts that it is the agents with privileged access to official markets who may coordinate to create unofficial ones in order to scale up these superior private returns.

Such situations are reminiscent of parallel markets as observed, for example, with currency pegs. In addition to parallel markets, limited backing also leads some agents to hold money even if they would prefer to sell it, a situation of financial repression.

« Dash for cash » and debt deflation

Conversely, private agents who owe more in taxes than they receive from the state (net debtors), may scramble for official money in case of a “dash for cash” whereby all agents run for money, even those who do not need any to repay debts. Shortages occur and parallel markets emerge where money trades at a premium. This situation is reminiscent of the explanation for recessions under a metallic standard, according to which the financial distress of nominally indebted firms, a low-price level and a “dash for cash” amplify each other (Fisher, 1933).

How important is the state to determine the value of money?

In principle, the role of money as official medium of exchange is necessary and sufficient to determine the price level. Yet the government must have sufficient resources and be willing to exchange goods/assets against money (in both directions) to set the price level at its desired level. The value of money ultimately depends on the state’s active engagement in exchanging money for goods and assets, ensuring that official and market prices align.

Interestingly, from this point of view, there is nothing specific about the state: A private issuer should be equally able to control the value of its money, if it has sufficient resources to do so.

This connects with fiercely debated questions around the rise of stablecoins, but also around the US Free Banking era. In these instances of private monies, the backing of money and the ease of access to the primary market in which it can be converted into an external reference asset are central determinants of financial stability.

For stablecoins, both primary and secondary markets are essential to understanding the mechanisms and ultimate success of their price stability. The primary market corresponds to the official market in which the issuer — tasked with maintaining a peg — Intervenes. The secondary market, by contrast, functions as a parallel market where prices more accurately reflect the perceived fundamentals of the stablecoin value, as well as the issuer’s capacity to meet demand for minting, burning, and redeeming coins at par on the primary market.

Importantly, when the peg breaks, arbitrage opportunities arise and intermediaries emerge endogenously, depending on their relative access to the primary market as illustrated, for example, by the role of intermediaries during the Terra–Luna collapse in Liu et al. (2023). Using a different terminology, Ma et al. (2025) highlight a related trade-off between financial stability — that is, the issuer’s ability to withstand runs — and price stability. They argue that the concentration of the institutions that have access to the primary market determines the trade-off.

During the US Free-banking era, imperfect backing relates to wildcat banks, that were unable to redeem their banknotes in specie. The framework in Barthélemy et al. (2025) is well suited to think about situations in which money can be retraded as it is the case with bearer instrument such as banknotes but not to think about « double claims », as dubbed by Gorton (1985), such as deposits which are liabilities of a specific customer at a specific bank.

Our view of money issuers as market makers highlights interesting similarities between public and private issuers. Yet the state can avail itself of tools, taxation and trading restrictions, that private issuers are lacking. In particular, in situations of imperfect backing, the state may use its ability to tax. That private agents pay their taxes in money reduces the amount that they are willing to sell or redeem in the primary market. Future taxes are typically a fixed fraction of future output and thus tax capacity acts as a state’s real net worth that backs its money.

Trade restrictions – the prerogative of the state – ultimately rely on the state’s monopoly over coercion. During the French Revolution, the Terror sentenced to death deviations from the parity of the Assignats and even hoarding assets as noted by Sargent and Velde (1995). In 1933, Executive Order 6102 by President Roosevelt forced US residents to sell most of their holdings of gold to the Federal Reserve at a fixed price — before devaluating the value of the dollar in terms of gold. Trade restrictions are however akin to price controls and, as mentioned above, are not a panacea, as they lead to “leakages” in the form of black markets.

As taxes in money and/or trade restrictions are typically not available to private actors, the latter are unable to rely on mechanisms akin to financial repression to maintain monetary stability. This heightens the importance of sound backing strategies and guaranteed access to central markets for sustaining the price level of private forms of money.