I was recently sent an article from a friend and asked if it was relevant to John Nash’s idea of a commodity basket based international currency. I immediately wanted to remind my friend Nash’s work doesn’t rely on a such a basket but I did read the article anyways (and the source) and I was quite pleased I was introduced to it.
The article was about a writing by Warren Coats, who worked for the IMF for many years, called a “Real SDR Currency Board” and as it turns out my friend’s observation was astute because the paper perfectly mirrors Nash’s proposal.
Coats explains how pegging national currencies to his internationally issued currency would alleviate the “triffin dilemma”
The weaknesses of the existing system include the asymmetry between the market pressure for deficit countries (other than reserve currency countries) to adjust and the lack of such pressure for surplus countries, and the Triffin dilemma like risk of foreign exchange reserve growth producing an increasingly large foreign holding of reserve currency countries’ debt relative to the size of their economies.
He means to provide stability that our current system, which effectively holds the USD as the global reserve currency, cannot provide:
Pegging domestic currencies to the SDR rather than the dollar or euro would often provide increased real effective exchange rate stability …
This would bring about a universal pricing system without the requirement of a single world currency:
Less often discussed is the fundamental impediment to the free flow of goods and capital globally on the basis of national currencies, whose exchange rates vary dramatically.
…
Wide spread pegging of national currencies to the SDR would promote global trade by removing exchange rate uncertainty thus emulating the openness of the gold standard era
These sentiments are very reminiscent to Nash’s proposal which has the same goal. Nash observes:
There is tremendous value in simply having prices quoted conveniently.
Nash also makes a similar point as Coats in regard to having our monetary systems based on major currencies:
Here Argentina and El Salvador can be mentioned. They are adopting (at least temporarily) expedients that put the value of their domestic money on a fixed relation to the U. S. dollar. And of course Panama has had such a situation for a long time previously. This is not “ideal money” because the U. S. dollar is not an ideal standard for money value. But the countries adopting such expedients thus offer their citizens, at least for as long as they manage to or choose to continue it, a deliverance from a typical past tradition of national currencies of even less stable value than that of the (historically observed) U. S. dollar. But if, for example, all of the countries of the world would base the value for their national currencies on the value of the british currency then this situation would appear singular and unstable, while it was not so singular for a lot of countries to base their currency value on gold.
The Missing Piece
I’ve long wondered why Nash’s argument can’t get any traction in the discussions about bitcoin and I believe that I have found the slight error in my argument (or at least what wasn’t perfectly clear to me) we can start to understand this with Coats explanation:
The recent IMF papers on the SDR have raised the more radical possibility of issuing an international currency unlinked to the SDR basket — “bancor.” Its value would be determined by its supply and demand, possibly supported by some official uses (as is the demand for existing SDRs). An international central bank issuing a fiat currency would enjoy the political protection of needing the agreement of a majority of its international members to expand its supply, but is still very unlikely to enjoy the broad support necessary for its adoption. However, the value of such an SDR/bancor could be linked to that of the Real SDR valuation basket. An international “currency board,” in which the IMF (or a new International Central Bank) would passively buy or sell SDRs (ala the classical gold standard) at the value of a real SDR valuation basket, would raise far fewer risks and potentially attract more political support.
So if I understand correctly Coats means to have an internationally issued settlement unit that is pegged to a basket of currencies (that he will later suggest an international body should decide what the basket should be comprised of) and then the national (or euro etc) currencies should be pegged to the international units. He calls these units “real SDRs”.
I think some will argue that its a stretch to suggest that this is the framework that Nash was speaking to. But it makes sense of some lines that I didn’t perfectly understand before reading Coats:
Now, after some years of thought and observations, I feel that the sort of authority or agency that would be able to establish any version of ideal money (money intrinsically not subject to inflation) would be necessarily comparable to classical “Sovereigns” or “Seigneurs” who have provided practical media for use in traders’ exchanges. We can prepare to appropriately respect the functioning of such an agency (conceivably like the IMF or BIS or ECB) and concede to the effective agency some discretion about the specific form of a guiding index of prices.
In conclusion Coats explains in 4 points what perfectly parallels Nash’s argument (which includes Keynes intention in regard to the Bancor proposal):
a) It would relieve the pressure on the United States to supply dollar assets to satisfy the demands by other countries for international reserves. In the extreme and over time it could replace the U.S. dollar as the unit of account, means of payment and store of value (reserve asset) for international transactions.
b) For countries pegging their own currencies to the Real SDR or using it directly, domestic prices would become more predictable both in the short and long term, thus promoting investment and growth.
c) Moreover, international prices would become much more predictable, facilitating the further extension of the gains from trade. A Real SDR could attract a large number of countries to peg the exchange rates of their currencies to the Real SDR, thus reestablishing a truly global currency for global trade.
d) Global liquidity would automatically become countercyclical and thus stabilizing. “This idea [of a commodity standard], which goes back to Keynes’ Treatise on Money, had interesting countercyclical features: world liquidity would automatically increase during global business downswings, which tended to depress commodity prices, and automatically decreased during business upswings, when commodity prices boomed.”
Barriers
With proper academic form Coats states the possible barriers:
A number of technical issues would need to be addressed, none of which are insurmountable:
Which goods should be put in the valuation basket and in what amounts?
How should their market prices be determined and how frequently?
How frequently should the items in the basket and their weights be adjusted?
Should Real SDRs be issued actively or only passively?
Nash gives similar sentiments:
Here, evidently, politicians in control of the authority behind standards could corrupt the continuity of a good standard, but depending on how things were fundamentally arranged, the probabilities of serious damage through political corruption might becomes as small as the probabilities that the values of the standard meter and kilogram will be corrupted through the actions of politicians.
In Correspondence With Coats
I found an email for Coats and to my delight he responded to a few inquiries. I told him of Nash and he said he met him at an economic conference some years ago. He didn’t know of Nash’s work Ideal Money. I suggested that bitcoin fits as a perfect basis to their arguments and Coats responded (I won’t quote for privacy) that bitcoin can’t qualify because its not a “real” commodity nor a major currency.
Coats linked me two articles he wrote and I must admit they are well informed. However he overlooks a crucial point in his evaluation here:
For bitcoin, so called, miners are given increasingly difficult mathematical problems to solve to establish that the latest blockchain transaction is unique rather than a copy.
He doesn’t seem to understand or acknowledge the significance of the difficulty adjustment algorithm which I have claimed removes the political problem Nash outlines here:
We can see that times could change, especially if a “miracle energy source” were found, and thus if a good ICPI is constructed, it should not be expected to be valid as initially defined for all eternity. It would instead be appropriate for it to be regularly readjusted depending on how the patterns of international trade would actually evolve.
Furthermore in regard to being a “real” commodity I didn’t get any clarification but I would suggest that if bitcoin was used as a money then it would naturally be considered a commodity. I’m not sure what is meant by “real”.
Re-turning to Selgin’s Concept of a “Synthetic” Commodity Money
Under Selgin’s free banking theory a commodity money is the name he gives for the base money of the system. It is meant to mirror the conventionally held definition but also with the implication that it plays the role of the base layer currency of the system.
When bitcoin was birthed there arose a definitional problem since it was possible to conceive of a base layer money that didn’t fit the traditional definition of a commodity money (ie has a non monetary use case/value).
Synthetic commodity money is shown in this graph:
Selgin notes important and relevant drawbacks of traditional commodity money that synthetic commodity money (not necessarily bitcoin but perhaps) has:
Commodity monies have drawbacks of their own, of course. They are vulnerable to supply shocks — that is, to shocks that shift the base-money supply schedule.
Many try to argue that a good money should have alternative non money use cases but Selgin notes that a synthetic commodity money is actually better because it doesn’t:
Changes in the nonmonetary demand for an ordinary commodity can also destabilize a monetary regime based upon that commodity. Had 18th-century England been on a copper standard, for example, it might have been plunged into a deflationary crisis by the British Navy’s discovery of copper’s merits as material for ships’ sheathing, which led to a sharp increase in the nonmonetary demand for that metal, and hence in its relative price.
This point speaks very well to Coats search of the optimal commodities as a basis for his proposed currency board (whereas Coats seems to miss this point):
Because its scarcity though immutable, is nevertheless contrived, that scarcity isn’t subject to changes stemming either from raw-material discoveries or from technological innovations. Because a synthetic commodity money has no alternative, nonmonetary uses, there is no such thing as a varying nonmonetary demand for it that can alter its purchasing power.
Selgin makes the final point that synthetic commodity money would remove the problem of political corruption that each of Nash, Coats, and Keynes observed and meant to solve as well:
Finally, like that of a genuine commodity money but, unlike that of a fiat money, the supply of a synthetic commodity money isn’t subject to politically-motivated or capricious modification.
In Regard to Stable Supply and Demand
Eric Voskuil explains there is a dampening relationship between the supply and demand of (commodity) money:
The stability of a money is not a tendency toward constant prices in all other things, it is a damping relationship between demand for the money and its supply.
He later explains what I think to be a crucial counter point to Coats claims that bitcoin’s nature precludes it from serving as an ideal basis for his proposal:
Gold demand is stabilized by inflation and Bitcoin’s demand is stabilized by fees.
Putting It All Together
Here we can think of the problem a large value player has in regard to using bitcoin as a settlement system today and why a central banking minded person might say bitcoin is a not a money (I certainly use it myself for purchases that traditional payment systems cannot facilitate!).
The problem is that bitcoin isn’t widely accepted as a currency in exchange for a significant variety of goods. From a central banking perspective this means you can’t judge its purchasing power trend and so it has no measurable inflation rate in regard to the stability of its purchasing power. There is no basket of goods to measure its purchasing power trend by since it doesn’t buy many goods directly.
Of course you COULD use its exchange rate but to this regard one needs to cash out of bitcoin and for high value players this can cause fluctuations in the exchange rate (and this act comes with costs!). In this sense bitcoin is a settlement medium but with a comparably lower market cap to something like gold, sdrs, or USD and so it doesn’t yet serve this function well.
We can then think of the transactional type use cases (as opposed to settlement) for bitcoin as either new usecases are found that traditional payment systems can’t serve or usecases that bitcoin can serve at a cheaper cost arise.
This in tandem with the closing of closed loops (ie “kula rings”) or the idea that users won’t need to cash out and one can accept, for example, income in bitcoin and pay rent to a landlord in bitcoin who in turn buys products off of their tenant’s employer in bitcoin etc.
It could be said that new use cases that lead to newly formed kula rings are most beneficial in officially establishing bitcoin as a currency. We can note that bitcoin can still be comparably expensive for traditional transactions and still serve new usecases in a comparably cheaper fashion.
We tend to think in terms of how stable bitcoin might be in comparison to the USD which is seen as very worthy in regard to purchasing power stability. But we can think of what the cost of a hash would be in “satoshis” and ask how this number might change over 100 years and what the contributing factors to that change would be.
Furthermore, it is that nations or alliances such as the euro will naturally look at bitcoin as an impartial line as it doesn’t have the geopolitical barriers that sanctions and capital controls imply on traditional payment systems.
We shouldn’t really expect the demand for bitcoin to differ much around the world (in the medium to long term) except in relation to politically unstable currency regions.
This signal for political strife would be just as pronounced if bitcoin itself (in comparison to its own network/market) was not perfectly or ideally stable in purchasing power.
This is what I think Coats overlooks about his and Nash’s argument in regard to bitcoin.
