On the Current State of Currency

The Chinese are doing it.

So are the Russians and the Venezuelans.

“Doing what?” you might ask.

Answer: Proposing new international currency standards.

Since everyone seems to be getting in on the act, I thought I’d post my own thoughts on the subject. I’m no economist, but judging by some of the concepts being advanced lately, I feel sure that I can come up with something better than the half-baked ideas being flogged by the world’s political ‘elite’.

First of all, I’d like to address our present de facto standard for international trade: the US Dollar.

The Trek from Bretton Woods
Even before the end of the Second World War, the 44 Allied Nations put together an agreement at Bretton Woods, New Hampshire, which led to the establishment of the International Monetary Fund (IMF) and the World Bank. Subsequently, in 1947, a comprehensive plan was devised to aid Europe in its post-war reconstruction; this was officially called the European Recovery Program (ERP) and popularly called the Marshall Plan in honour of U.S. Secretary of State George Marshall who championed the initiative.

Since the US economy was the strongest and most prolific in the world, it made sense to balance these new financial systems using US dollars, which consequently resulted in all three major international oil markets (Brent Crude, WTI and UAE Dubai Crude) and the world’s two major oil bourses (NYMEX and IPE [later ICE]) being denominated in ‘American’ dollars.

The system worked quite well until the mid-1960s. In 1971, when the United States completely decoupled its currency from the Gold Standard, all signatory nations of the Bretton Woods agreements had to decide between: a) abandoning the security of those financial treaties; or b) accepting the US dollar as their default foreign reserve currency. By early 1976, all major world currencies were “floating”, but the US dollar remained the central pinion around which all other currencies revolved.

Most economists at the time probably agreed that this was far from an ideal solution, but they also seemed to agree that most of the other proposed options were worse.

Bretton Woods, along with its contingent cascade of financial paradigms, should have incorporated provisions for its own evolution. By the mid-1960s, there should already have been a new regime in place; one that could have assured financial stability for both developed and developing countries; and that may even have avoided the clash between OPEC and the United States in the early 1970s.

As unfair as it might seem to some that the US dollar should enjoy such preeminence, the imbalance is also less obviously–but no less practically–unfair to the United States, by having allowed its economy to expand in an unsustainable manner. The recent international economic implosion is an indirect–but inescapable–result of that unbalanced growth, and few countries will be as severely impacted by it as the United States, itself.

Options and Intrigues Abound
Lately, Russia has been mumbling about returning to the Gold Standard and China has been talking up the extended use of SDRs (Special Drawing Rights provided under the aegis of the IMF) as possible means for re-balancing the international currency regime. The Chinese proposal (given some applause by US Treasury Secretary Timothy Geithner) would require that SDRs be denominated across a basket of prominent national currencies, rather than being pegged to the US dollar, as they are now. The Russian notion of returning to the Gold Standard would ultimately favour those nations (like Russia) that have significant (in-vault or in-ground) gold reserves.

Neither of these solutions seem very practical to me, though they are a good deal more viable than the concept put forward by Venezuelan president Hugo Chavez, who would seek to have international foreign reserves denominated in a new petro-dollar; i.e., based on the price of oil. Of course, Venezuela has plenty of oil, and Mr. Chavez has been talking with Iran and other OPEC members in an effort to get them on-side. So far, the only other country that seems to be interested, not surprisingly, is Iran.

Pegging global economic well-being to a single currency or a single commodity would be to invite the same sort of disaster that followed the Great Tulip Collapse of 1673.

To my way of thinking, the Chinese are the closest to an actual solution, but their idea of a “meta-dollar” comprised of a handful of prominent currencies is still prone to some of the same problems we’ve encountered under the current US dollar-centric model.

The CVG System
My idea hinges on the establishment of a relative value index based on Commonly Valued Goods (CVGs) and the promotion of strong national currencies.

Through existing world commodities markets, we know the expected yields of thousands of real products upon which the world collectively depends. This includes foodstuffs like corn, wheat and rice, as well as useful materials such as cotton, gold and petroleum. The relative demands for each of these goods, along with their respective availabilities, determines their price. Individual national and regional markets will vary in their demand for each of these products, but every economy on earth will require access to most of these goods on a regular basis to feed and clothe its population, as well as to drive and energise sustainable economic growth.

Having an international ‘meta-currency’ based on the value of a basket of real goods is reasonably preferable to predicating it on any single commodity (whether oil, gold or tulips) in the same way that increasing the basket of currencies proposed by the Chinese to include the coins of all developed and developing realms (G20±) is preferable to selecting a much smaller sampling of national monies.

By interlinking these baskets of goods and currencies (and adding a logistical means/cost dimension for delivering these goods where and when they are needed) we should be able to arrive at a formula that is grounded in real-world supply and demand, rather than in the more ethereal world of speculation. Think of it as a scale, with a mix of currencies (the coin basket) on one end of the beam, counterbalanced by a mix of commonly valued goods (the bread basket?) on the other.

Under such a regime, FOREX would be need to be removed from market speculation, instead becoming a domain reserved solely for international transactions. National currencies would be shielded from the vagaries of the market and be more reflective of their true, respective measures of GDP/GNP.

As more countries progress from under-developed to developing status, the basket of currencies would expand to include them. Until that time comes, their currencies would be tied to the international currency basket (rather than the US dollar), making them less susceptible to swings in the price of oil, other commodities, or any other “standard” to which their economies may be tied.

In this way, no reserve currency would actually be required as each nation could purchase goods using its own money — or credits extended by the World Bank, in the case of those countries requiring international assistance.

Repatriation of the US Dollar
The trickiest bit of this whole exercise is how to withdraw the US dollar from its current position as the de facto world reserve currency without causing a massive devaluation of the dollar and all the financial drama that such a move would surely entail.

We have all gotten fairly used to the idea of treating debt/credit as money, so that might make it easier to resolve the problem.

China currently holds somewhere in excess of $1 trillion of US foreign debt and has been growing increasingly anxious about its ability to collect on that sum, short of selling it off to third parties at discounted prices and effectively destroying their primary overseas export market. It also has a total foreign reserve cache of nearly $2 trillion (about 70% of which is in US dollars). The US economy, with an accumulated deficit of over $10 trillion, is certainly in no position to buy back its own debt.

So what to do?

Let’s Look to Marshall Again
In the aftermath of the Second World War, the Marshall Plan was largely funded by the United States with US dollars heavily leveraged by US industrial expertise. The goal was the reconstruction of European infrastructure, particularly its manufacturing and transportation systems.

What if we were to take the same sort of approach with respect to Third World infrastructure development with special emphasis on desalination plants, water treatment facilities, crop production, education, disaster preparedness, etc.?

E.g. China would exchange almost $3 trillion worth of foreign currency and foreign IOUs for an equivalent measure of Commonly Valued Goods credits. The US and other nations would accept and repatriate all foreign reserve moneys created under their imprimatur in order to balance their national accounts. Repatriated foreign debt, on the other hand, would be converted to CVG credits and made available for critical development projects in under-developed nations.

If world debt was “magically” converted into a Critical Infrastructure Fund for under-developed nations, just imagine how much better off the world would be. Our baskets (both literal and figurative) would soon be overflowing.

The cure for our economic malaise is not to create an international “super-currency” to save us from ourselves, but to build up and maintain our respective national currencies and economies while strengthening the ties that bind us together in common pursuit of all that is good.

 

© 2009