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Commodities as a global currency
By George Athanassakos and Joseph Potvin
The Globe and Mail
November 3, 2009
Central bankers around the globe are itching to diversify out of
U.S. dollars.
Brazil, Russia, India, China and oil producers are looking for
alternatives.
Even World Bank president Robert Zoellick acknowledged this
month thatthe U.S. dollar is losing its status as the dominant
reserve currency.
But what can central bankers diversify into?
Besides gold, the closest thing the world has to a generic unit
of account is
the International Monetary Fund's Special Drawing Rights (SDRs).
But
they're not a currency, just a claim on the currencies of IMF
members.
Diversification to multiple currencies can spread risk, but
ultimately, SDRs
share the same problem that all national currencies have, namely
that theyare all based upon nothing more than the hope that debts
denominated in
those currencies will be repaid.
The last time the world was forced to fundamentally re-think
markets andmoney was during the 1930s and 1940s. In that period,
Benjamin Graham
wrote four books. The best known ones are Security Analysis with
David
Dodd (1934) and The Intelligent Investor (1949), which have
remained
prominent as the foundations of value investing the
identification andpurchase of stocks at a discount to their
intrinsic value.
The two other books that Mr. Graham wrote, however, have
received lessattention. They are Storage and Stability (1937) and
World Commodities and
World Currency (1944). In them, Mr. Graham explored methods to
maintainthe integrity and value of national currencies by linking
currencies to a
basket of commodities in order to maintain and stabilize the
purchasingpower of money. According to Mr. Graham, the currencies
the central and
commercial banks deal in should be genuinely liquid in the sense
of being
reliably convertible into useful physical commodities. So he
proposed a newinternational unit representing a weighted basket of
30 commodities.
In Mr. Graham's design, a federated network of commodity-reserve
banks
would buy and sell standard commodity bundles to maintain the
averageprice of a standard composite commodity unit.
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When the average market price of the basket of commodities
reaches a low
threshold, reflecting a shortfall in demand, the Treasury or
commodity-reserve banks will purchase commodities for storage. They
will purchase in
sufficiently large quantities in order to stop the average price
from fallingfurther, issuing the commodity-reserve currency as
payment.
When the average market price of the basket of commodities
reaches a high
threshold, the Treasury will sell commodities from storage in
exchange forany type of money this, according to Mr. Graham, would
enable replacingunbacked or gold-backed currency with the
commodity-unit-backedcurrency. Such an arrangement would amount
simply to putting the State
in the role of a shrewd long-term operator in basic commodities,
blessedwith an unlimited bankroll.
In Mr. Graham's mind, inventories of useful commodities are the
most liquid
of assets, and therefore the logical basis for a currency.
Instead, the Bretton Woods Conference made other national
currencies
convertible into U.S. dollars and the dollar convertible into
gold at a pricemanaged by the U.S. Federal Reserve.
It did not address commodity price stabilization, nor did their
adopted plan
conform to conservative banking principles of convertibility and
self-liquidation. The gold-only system began to falter in the
1960s, and was
unilaterally abandoned by the U.S. government on Aug. 15,
1971.
It is the 30-commodity version of Mr. Graham's reserve currency
proposalthat Zhou Xiaochuan, governor of the People's Bank of
China, recommended
to the world in March, 2009. He said: Back in the 1940s [it was]
alr eadyproposed to introduce an international currency unit based
on the value of
30 representative commodities. Unfortunately the proposal was
not
accepted. The collapse of the Bretton Woods system indicates
that the [commodities] approach may have been more farsighted.
Mr. Zhou's interest reflects China's long history with
commodity-based
money. Ancient China tied money to the assets of the
ever-normal
granary, to which Mr. Graham referred to as an example. In June,
1949,the new People's Bank of China introduced the parity deposit
unit todenominate retail bank deposits and bonds in four basic
commodities: rice,
wheat flour, cotton cloth and coal.
It has long been common for producers in China to obtain bank
loansmortgaged against commodity reserves. Outright purchase and
storage of
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commodities or control of commodity-producing companies by China
over
the past few years are intriguing when viewed through these
lenses.
Now that the world is again looking for a reliable international
reservecurrency, in light of the major changes under way in the
global economy, it
is time to reconsider Mr. Graham's proposal to reduce
uncertainty about thevalue of money by coupling it with intrinsic
value in the physical economy.
George Athanassakos is a professor of finance and holds the Ben
GrahamChair in Value Investing at the Richard Ivey School of
Business, University ofWestern Ontario. He can be reached
[email protected].
Joseph Potvin is an economist who works for the Canadian
government. The
views expressed are his own. He can be reached
[email protected].
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