How the global monetary standard proposed in
The global monetary unit woud be defined by international treaty. The value of the unit is defined by a basket of diversified global equity shares, represented by an index (see W Engels, 1981). An international currency board would be tasked to hold the value of the monetary unit constant against the basket (index). I call this currency unit the Ikon – i.e. a representation of a respected abstract value.
Governments joining the Ikon standard fix their national currencies, which can keep their familiar denominations, to the unit. Nations opt to join or leave the standard voluntarily at exchange rates of their choosing. Countries continue to abide by the disciplines accompanying fixed exchange rates against the Ikon as they experience benefits that membership of the area bring – or observe others gaining such benefits (this is how the gold standard became the symbol of membership of the global community in the late 19th century). Discipline is enforced by the market.
Central banks lose their monopoly of note issuance, being converted into currency boards. Any authorised bank that meets minimum solvency requirements may issue bank notes and open deposit accounts. They stand ready at all times to convert notes and deposits into a basket of shares at the target (index) value. They define their legal obligation in terms of an index of prices of equity shares.
A bank regulates the value of its notes (i.e. of the share index) either by purchasing shares against notes (i.e. issue notes) or by redeeming notes against sales of shares from their own holdings. It ensures its solvency by maintaining a sufficient “coverage” of its note issue in terms of shares. In contrast to the case of a bank under the gold standard, the larger the proportion of its liabilities “backed” by its investments the higher its income. This is because equity investments earn a yield that will exceed the interest on loans by a risk premium. In other words, the higher its solvency, the larger its income and the higher the interest it can offer on its notes and deposits. Under the gold standard, there is a tension between banking stability – as banks wish to minimise their capital – and monetary stability, which requires struct adherence to the rule of the game. This tension does not exist under the Ikon.
The value of the Ikon currency rises in real (purchasing power) terms with the increase in market capitalisation, or, more generally, with economic progress. As money is fixed in terms of the selected index, this is seen as a decline in the price level over the long term. There may be short-term fluctuations in the value of the money (as measured by CPI, retail prices or the national income deflator), reflecting shifts of optimism and pessimism concerning economic prospects, but so long as economic growth is expected to continue in the long term, the real value of money will be expected to grow.
Given this expectation, market agents will find it profitable to offer (as derivatives) accounts that remain stable in terms of shopping baskets or other price indices – if some clients wish to hold such accounts in place of ikons. Nominal interest rates on risk-free assets are zero for spot and all future terms.
Companies will be financed mainly be equity as there will be no advantage in loan finance. Banks will finance themselves by deposits and equity. The financial system will be reminiscent of that under the classical gold standard. Long-term, equity, cross-border flows will dominate.
Financial historian Alessandro Roselli has drawn attention to an historical precedent:
“Curiously, the closest attempt to establish such an anchor can be historically found in the short experience of the German Rentenbank of 1923-24: thanks to this device, domestic inflation was contained, and confidence in the German monetary system was restored. The anchor was then represented by a mortgage on land and industrial, commercial and banking properties, based on a compulsory assessment of 4 percent of their value. Coherently, this mortgage appeared as the main asset of the Rentenbank balance sheet. One may question whether, in Pringle’s proposal, the currency board should actually purchase, and write on its asset side, a basket of equities while creating Ikons. Or, rather, whether the Ikon would be created on the basis of an index representing equities, not through their actual ownership. The ideas of reform are advanced by Pringle in a tentative form, open to doubt. The author stresses that there is a proposal, as well as a utopia, in his design. If this book contributes to develop a debate on the centrality of money in any possible scheme of financial reform, the author’s goal will be certainly accomplished. “ (Review of “The Money Trap”, published in Aperta Contrada.
- The scheme would be anti-cyclical. When asset valuations rise and the index moves above the target, the currency board and the banks will be obliged to sell shares and cancel money, causing asset prices and economic activity to fall. When asset prices fall below the target, the currency board will buy assets and issue money. The money will reduce the magnitude of business cycle as market interest rates will track equilibrium rates. Calculations of the return on new capital investment will not be affected by uncertainty about the future value of money between the time of the investment and returns.
- A currency defined in this way eliminates the arbitrary and unpredictable shift in wealth between creditors and debtors characteristic of long-term contracts denominated in paper money. Investors in a project can focus on the real prospective return from a project, without worrying about variations in the value of the monetary measuring rod used to forecast cash flow and profit rates.
- The arbitrariness of the unit of measurement characteristic of paper money disappears if one considers the risk facing a group of creditors and of debtors. If one chooses as a unit a commodity with large fluctuations in its real price, then the distributional risk is high. The optimal unit is one in which the distribution risk from the choice of unit becomes zero.
- In such a world, demand for money will be higher than now, loans will decline, companies will be financed through equity issuance, which will be just as cheap as borrowing, and the money multiplier will be very low. Indebtedness will likely exist only in two forms – public debts and mortgages on real estate, where the owner wants an undivided and direct right to the property.
- Banks will be financed exclusively with demand deposits and equity capital. Their assets consist of shares, bonds and mortgages and a small quantity of short-term advances.
- Unlike Hayek’s call for competing currencies, it is necessary for the state to define the standard to ensure economies of scale. But the actual production of money takes place under a regime of Hayekian competition.
- With such a currency, there is no possibility of Keynesian underemployment or savings exceeding ex ante investment. Any underemployment and unemployment would reflect excessive wages. Under the present system, business requires expectation of an additional return from new investment to compensate for uncertainty – especially monetary uncertainty – and pessimism over the outlook – people expect the real value of future output to decline. That is why many commentators say we need to cut real interest rates further. But it can’t be done under the present system; that is another reason we have to reconstruct it.
- All global citizens acquire an equal proportional claim on the world’s workforce skills, productivity growth and capacity growth by acquiring money. This unites peoples across time and space. It binds generations together rather than dividing them as paper money does. It means everybody benefits from productivity growth without requiring the services of expensive investment advisors, unit trusts and the whole paraphernalia of the investment industry.
Based on a proposal by Wolfram Engels in ‘The Optimal Monetary Unit”, Campus Verlag, 1981.