Foldvary on Currency
|April 4, 2003||Posted by Fred Foldvary under Archive, Progress Report, The Progress Report|
Currency Boards for Troubled Moneys
by Fred E. Foldvary, Senior Editor
The global economy is suffering from monetary chaos. The currencies of several countries in East Asia suffered a severe devaluation. This drop in the value of a currency relative to other currencies makes imports much more expensive, which is why hungry and angry demonstrators toppled the government in Indonesia. Devaluation makes exports cheaper, but that often does not help much if the banking system has broken down and there is no credit.
It is interesting to note that the Chinese economies have so far not suffered as much. These are China, Taiwan, Hong Kong, and Singapore. What they have in common besides being ethnically Chinese is that these countries did not devalue their currencies. Russia is now experiencing a currency crisis. Investors fear that because of its debts and budget deficits, the government of Russia may devalue its currency. In order to keep foreign funds in the country, the government has raised interest rates to 50, 100, even 150 percent. IMF loans and high interest rates have not restored investor confidence because these only treat the symptoms.
Some economists have proposed a remedy for troubled money: currency boards. These boards would convert a domestic currency into foreign currency at a fixed rate. Several countries have implemented currency boards successfully. Estonia, one of the Baltic countries formerly in the USSR, backs its money with German marks, and exchanges its currency for marks at a fixed rate. All the Estonian money is backed with German money or bonds. Hong Kong has had a currency board instead of a central bank, and so far it has been successful in preserving the Hong Kong dollar.
The global ideal would be a common international currency, which the global economy had prior to World War I when money was gold, and national currencies were convertible into gold at fixed rates. Short of that, a currency board can at least stabilize a national currency. However, if a country’s money is based on the currency of another country, such as the US dollar, the domestic currency is hostage to the currency value and interest rates of the other country. That hurt the East Asian economies when the US dollar gained in value, making the Asian exports more expensive.
What I would recommend to the governments of Russia, Indonesia, and any other country, would be to base their currencies on a basket of four items: the US dollar, the euro, gold, and first-class postage. Suppose Russia issued a new currency, the CB (currency board) rouble. One CB rouble would be worth 25 UC cents plus one quarter of a euro plus one thousandth of an ounce of gold plus one first- class stamp. The euro is the new European Union currency that will replace the ECU and the national currencies of several countries in Europe; it is worth a bit more than one US dollar.
Russia would issue stamps good for domestic first-class postage at the lowest current rate, but with no denomination. They would just be inscribed “first class.” Several countries already issue such stamps; they are good for domestic postage no matter what the postage rate is. These stamps are therefore inflation-proof, and can be part of the backing for money. For the gold, the currency board would issue bars with one ounce, half ounce, a quarter ounce, and a tenth ounce of gold.
With postage around 25c, and 1/000 ounce of gold about 30c, the CB rouble would be worth a bit over one US dollar. The value of the CB rouble would be stable so long as Russia could deliver US dollars, euros, gold, and first-class stamps, on demand. One would be able to bring 100 CB roubles to the currency board and obtain 25 US dollars, 25 euros, 100 first-class stamps, and one-tenth ounce of gold. This mix of currencies and commodities would be more stable than basing the currency only on the dollar, euro, or gold.
To be credible, the CB rouble would have to have 100 percent backing. For every 100 roubles, the board would have to have about $25 in US currency or treasury bills, $25 in German currency or short-term bonds, and $25 in gold. The board would not need to stockpile stamps, since the government could print as many as the public demands (but then be ready to accept them for the service of postage!). This backing would be the wisest use of the billions of dollars of IMF loans Russia is getting.
With such a currency board and asset-backed money, there would be no more devaluations and currency crises. The CB rouble would not fluctuate much, since the variations in the value of the US dollar, euro, and gold would mostly offset one another, and the one quarter of the CB rouble based on postage would not fluctuate.
Currency boards have worked well, and if the backing of money with a mix of assets would provide stability, why do countries still have central banks and fiat money instead? Because central banks that issue fiat money – not backed by anything – allow them to have a monetary policy. They can in the short run print money to cover expenses and try to stimulate growth. In the longer run, they get inflation, which hurts the economy. These government officials just are not going to give up their power over the creation of money even if that is the solution to their currency problems.
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Copyright 1998 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieveal system, without giving full credit to Fred Foldvary and The Progress Report.