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The one weird trick of good money: be informationally insensitive

The best thing about a dollar is that it’s always worth a dollar.

That may sound tautologically obvious, but it's a surprisingly difficult trick to pull off; it took a century of panics, bank runs, and legal engineering to make it possible. 

Specifically, it took the 101 years between the Panic of 1907 and the Great Financial Crisis of 2008.

In 1907, depositors ran on the Knickerbocker Trust when its “dollars” stopped being accepted at face value by other banks: when a dollar deposited there was suddenly worth less than a dollar deposited at another bank, the entire financial system froze. 

In 1913, the Federal Reserve was created to ensure that wouldn’t happen again — by giving every bank an account at the Fed, where their reserves cleared through a single, risk-free balance sheet, always at par.

For the first time, a dollar at any US bank became interchangeable with a dollar at any other, no questions asked.

This wasn't the Fed’s job to do alone, however. 

In the 1930s, US policymakers introduced deposit insurance and special bankruptcy rules for banks, giving both depositors and lenders confidence that dollars from any bank — even a failing one — would be accepted at par.

In 2008, the circle of trust was expanded when the Fed guaranteed a new kind of money — money market funds — and bailed out the banks to keep their dollars trading at par.

These were unpopular decisions.

We cynically assumed that banks got special treatment only because they lobbied for it; we occupied Wall Street after it was bailed out in 2008; we complained about “socialized risk” when Silicon Valley’s depositors were made whole in 2023. 

But we also expect our dollars to always be worth a dollar, wherever we hold them, without ever having to think about it — and the special treatment banks receive is what makes that happen.

“The fact that most of us do not think about the institutional design of money is itself more or less by design,” Dan Awrey details in Beyond Banks.

FDIC insurance, special bank bankruptcy laws, and government bank bailouts are all aimed at stopping people from thinking about the quality of their dollars. 

Because Gresham’s Law tells us what happens when they do: Bad money drives out good.

If dollars are of varying quality, people will hoard the good ones and spend the bad ones. Knowing many are bad, people become increasingly reluctant to accept the dollars in circulation. With less and less trusted money in circulation, commerce will grind to a halt.

This is why the US financial and legal systems take extraordinary measures to ensure there are no bad dollars.

“Our money is legally engineered so that we can go about our daily lives without caring two cents about what makes our two cents worth two cents,” Awrey explains.

Your bank deposit, my Venmo balance, and a $1 bill are all functionally indistinguishable.

Or, as economists would put it, our dollars are “informationally insensitive contracts” — promises so thoroughly engineered that no one ever need question them.

Dollars are a form of debt, but in a normal debt contract, the value depends on information: how creditworthy the borrower is, how markets are moving, what tomorrow might bring. 

The express purpose of a regulated US bank deposit is to eliminate the need to consider any of that information. 

As Awrey explains, special bankruptcy rules, deposit insurance, and emergency Fed lending “reengineer otherwise risky deposit contracts into paragons of good money.”

This is to everyone’s benefit because making dollars “no questions asked” allows them to flow freely through the economy.

But bank deposits are not the only kind of dollar, and some of the others are a little questionable.

Money exists on a spectrum: from reserves held at the Fed, to FDIC-insured bank deposits, to large, uninsured deposits, to money market funds, to repurchase agreements, to commercial paper, to PayPal and Venmo balances, and even prepaid Starbucks cards.

Importantly, the further a form of dollar moves from the core banking system, the more “informationally sensitive” it becomes — and the more headaches it creates for regulators and the Fed.

“Where the universe of monetary IOUs is constantly expanding,” Awrey writes, “policymakers face the herculean task of attempting to watch a thousand eggs in a thousand different baskets.”

With the recent passage of the Genius Act, policymakers have decided to start watching stablecoins, too.

For now, they probably don’t need to watch them much more closely than they do our Starbucks balances — few people use them as money in the US, so there’s no systemic risk if 1 USDC isn’t always accepted as exactly 1 USD.

That could change, of course, because money is always evolving.

But for stablecoins to catch-on as a medium of exchange, they’ll have to become as informationally insensitive as bank deposits.

There are a few ways that could happen.

There might be a technical solution. Stripe, for instance, says all stablecoins issued on its platform will trade interchangeably: one CASH (the Phantom stablecoin) will always be worth one USDH (the Hyperliquid one).

There could be a TradFi solution. The blockchain platform that SWIFT is building seems likely to make all bank-issued stablecoins exchangeable one-for-one.

Or it could be a UX trick that does it. Payments apps might simply display stablecoin balances as “dollars,” as Nic Carter predicts, which would make people think that’s what they are.

But the most reliable path to becoming informationally insensitive money is still the tried-and-true one: Get too big to fail.

Money market funds were never meant to be equivalent to bank deposits, but in 2008 the Fed guaranteed them as such, because the entire financial system might otherwise have stopped functioning. 

When Silicon Valley Bank failed in 2023, regulators similarly invoked a “systemic risk exception” to guarantee all of the bank's deposits — just so people wouldn’t start questioning the quality of other banks’ deposits.

As a result, money market funds and deposits at big US banks are now informationally insensitive US dollars.

Stablecoins might someday be, too — if they get big enough.

— Byron Gilliam

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