Money is one of those things that’s so ubiquitous, it’s rarely analyzed by most people. We consider money as something that just exists, a necessary part of the exchange of goods or simply a convenient shorthand for value. But in reality, the specific properties of money can significantly contribute to the overall health of an economy and, by extension, our personal finances. As with most things, there’s good and bad money, so thankfully economists agree on the properties that make money good. Good money is usually considered to have six properties: portability, durability, fungibility, divisibility, cognizability, and stability of value. It’s the existence of good (or at least acceptable) money that enables economies to prosper.
While the two most common varieties of money, precious metal and fiat currencies, both do well in satisfying the first five properties, they often fail to possess stability of value. It is perhaps not surprising that the property these currencies often fail to exhibit is also the only property not intrinsic to their design. Gold coins and paper dollars were designed to be easy to transport and to withstand at least normal levels of wear; to be capable of being exchanged or changed into smaller or larger units; and to be thought of as money. One may say that these first five properties are natural to precious metal and fiat currencies.
On the other hand, we realize that neither precious metal nor fiat currencies are naturally stable stores of value. This is because the value of a currency is determined by its ability to purchase goods and services (its purchasing power), which is in turn dependent on supply, relative to demand, of the desired goods or services. To see this, consider what occurred during the Spanish Price Revolution. When countless tons of silver were imported to Spain from its new colonies in America, prices exploded as a result of an expanded currency supply that wasn’t accompanied by a substantial increase of the supply of goods that people wanted to buy. For a more modern example, we can look at the the latest Fortune 500 list and ask, “does the value created by most of these companies have any necessary relationship with the number of dollars in existence?”
The preceding depiction is not meant to imply that precious metal or fiat currencies have zero price stability. As the production of other goods increases, either because of an increased population or technological advances, it is likely that more gold will be mined as well. Moreover, the Federal Reserve exists to ensure the price stability of the US dollar and has an array of powerful tools to accomplish this. Rather than claiming there is no stability in precious metal or fiat currencies, I argue that utilizing these currency designs to achieve price stability is akin to attempting to fill a square peg with a round hole. It may work, but not well and only after a great deal of effort. More specifically, this is because precious metals are largely inelastic in their supply and monetary policy is an extremely difficult and inexact practice, involving a quantity of contrasting opinions as to rival the number of actual economists.
Instead of being content with currency designs that do not naturally exhibit all the properties of good money, I repropose a currency paradigm that succeeds in naturally satisfying all six properties of good money and possesses the additional virtue of being automatically countercyclical.
Time to unpack and explain.
Commodity Basket Currency
A properly designed and implemented commodity basket currency (CBC) naturally achieves the six properties of good money, with the added bonus of being automatically countercyclical. Since I have little expectation that anyone will take my word in support of such a claim, let’s look at why this may be true. We assume for now that the first five properties are trivially solved by employing a system of representative units similar to that of currencies already in existence and will focus on how a CBC may serve as a stable store of value. But first, a few quick points about commodities.
With at least that cursory knowledge of commodities, let’s now consider how a CBC system may function and be a stable store of value.
Above I outlined how a CBC currency system may work but neglected to illustrate the countercyclical nature of the system. To understand this property we need to analyze two undesirable economic scenarios.
First, consider a demand-driven recession, like the one begun by the 2008 Financial Crisis. During the 18 months from late 2007 to early 2009, US household wealth declined by nearly 25%, with an estimated $6 trillion lost in housing prices alone. As a result of such a decline in wealth, consumer expenditures drastically decreased causing further economic damage. In demand-driven recessions, demand for goods falls more quickly than their supply.
Within our proposed CBC system, this decoupling of the supply and demand of goods will have a favorable impact on the currency supply. In times of a demand-driven economic slowdown, the demand for commodities falls substantially more quickly than production. The result in a CBC system will be an increase in the number of circulating currency units (the supply of capital), which would serve to lower the cost of borrowing. A decrease in the cost of borrowing for consumers and businesses will drive new spending, thus helping to reverse the onset of economic recession or depression. This reduction in borrowing costs is exactly the goal of the Federal Reserve during demand-driven slowdowns. The only difference here is that our CBC system accomplishes the desired outcome naturally, without the need for ad hoc and often flawed policy making.
Now let’s consider the impact of the proposed CBC system in a scenario where an economy is overheating. Economic overheating is often caused by the supply of money growing faster than real economic production. In turn, inflation and asset bubbles will almost inevitably emerge to plague future growth and stability. The benefits a CBC in these situations are simpler to notice than in the case of demand-driven slowdown previously described. Since CBCs are created by production, it is impossible for the currency supply to grow more quickly than the underlying production.
While there are several counterarguments and implementation specific questions that I didn’t address here (stay tuned for more to come!), I hope that this was able to serve as an interesting and informative introduction to commodity money. And with any luck, I’ve managed to convince at least some of you that just maybe, good money is natural money.
To learn more about Topl's work developing a commodity-basket currency as part of our mission to create the first truly global investment protocol join us on Slack and Reddit or check out our Github!
