Tag: commodity-backed currency

Categories
Economics

[2316] Of would goldbugs support a large diverse monetary union?

I took a long hard look at a one-euro coin in my hand while I was on a train to Versailles from Paris. For a huge monetary policy controversy across the Eurozone, the coin does not look so special. It is a small unassuming bimetal. Not too many would take a second look at it. Everybody here in France uses it for mundane purposes. Yet, its link to Eurozone’s policy is there and is no small matter.

I was focusing on the coin to avoid thinking of somebody that I care a lot about. After awhile, I began to retrace the cause of the controversy with Eurozone and the weaknesses of monetary union in general. A question soon popped in my mind. Would some hard currency advocates — goldbugs and others — support a large monetary union?

A typical weakness of a large monetary union is its inflexible interest rate as set by its central bank.

A large area with diverse parts that economically grow or shrink differently. That demands different monetary policies and specifically, different interest rates to be pursued by different parts of the union. A monetary union prevents these different parts from pursuing individual rate however. There is only one rate by definition.

The politics between members of the union will inevitably decide the union’s single rate. Each representative at the table will promote the interest of the member who they represent.

The more diverse the members of the union, the harder it will be to achieve a consensus. It is hard because the rate cannot accommodate everybody easily, if ever.

The debilitating politics of a diverse monetary union discourages the rate from becoming flexible. It would be hard to change the interest rate at any one time, unless there is to be some kind of systemic shock that would make everybody to agree to some magnitude of rate change on top of individual needs, and unless the composition of the decision-making body is skewed to side that makes the body unrepresentative.

Through this, the central bank effectively loses control of the rate. This, I think, is a close equivalent of having a hard currency because the central bank loses its power to print money arbitrarily.

Given this, I think many advocates of hard currency will likely like the creation of a large and diverse monetary union. Or at least, they would prefer this to a normal fiat currency regime.

Categories
Economics

[2237] Of why I prefer fiat currency to commodity-backed currency

Libertarians generally are in favor of commodity-backed currency. This is largely based on typical libertarian attitude towards the state: do not trust them.

Others who are not quite libertarian share the same idea about trust. They really have trouble believing that a piece of paper worth something when it is only backed by some promise. They rather have a piece of paper that essentially put a claim on some asset. Typically, that asset is gold although it does not have to be gold.

A step beyond the issue of trust is the fear of inflation and the belief that commodity-backed currency is not inflationary. It is a myth that commodity-backed currency is not inflationary however. Theoretically, gold supply can increase to affect the quantity of money in the economy directly and thus, creating an inflationary environment. Admittedly, there is more inflationary risk associated with fiat currency than to commodity-backed currency.

Before we go farther down the road, let me clarify one thing: I do not think highly of commodity-backed currency when it is juxtaposed with fiat currency.

As a libertarian, I need to rationalize my position through libertarian means, especially so when I am going against the libertarian stream. This entry is partly where I do that rationalization.

I would like to address the worry of inflation first because it is more general than specific libertarian concern. I will visit the libertarian concern soon after.

The inflationary concern has been overblown by proponents of commodity-backed currency, and especially by supporters of gold standard. Despite the ”˜distrust-the-government’ mantra, modern monetary institutions these days are good at managing inflation. The occurrence of hyperinflation, which is really the problem, is rare. As long as those institutions are independent under normal everyday circumstances, inflation can be contained, or at least inflation attributable to changes in money supply. Note that not all inflation is due to increase in money supply.

On the issue of libertarian distrust of government, that does not really automatically translate into support for commodity-backed currency or more specifically, for gold standard. Private banks, for instance, can issue fiat currency. The only prerequisite to fiat currency is trust, no matter who the issuer is.

But what about trust in general, be the issuer is the government or some private entities? I would like to argue the use of commodity-currency is a society that suffers from trust deficit. I will save that for another day.

Finally, the practical reasons for fiat currency vis-à-vis commodity-backed one are unrivaled. One of those major reasons is flexibility: I value the flexibility that comes with fiat currency, which commodity-backed currency does not have. The flexibility is this: fiat currency can completely mimic commodity-backed ones while the reverse is untrue.

Flexibility is especially valuable in times of economic crisis. Perhaps, once I find myself in an economic foxhole, I tend to waver on the idea of limited government. But I would like to think that the flexibility of monetary policy allows the use of monetary policy as the first course of action when the other option is fiscal policy. I think this is a practical libertarian justification to the use of fiat currency.

Fiscal policy is more damaging to the idea of laissez-faire than monetary policy. Fiscal policy tend to have real programs associated with it while monetary policy is just, well, about money. Programs associated with fiscal policy often involve active government intervention in multiple fields. Meanwhile, the management of money involves only passive intervention. Between the two evils, I would vote for monetary policy. I am voting for monetary policy.

But that choice is available only when there is flexibility in the monetary policy. Without flexibility, the urge to engage on large fiscal policy can be too great to resist in time of crisis.

People do not like pain. In a democracy, doing nothing may not be viable. The democratic reality is that there is a populist element needs to be tended to, however unfortunate that is. With monetary policy, at least there is an avenue to do something and reduce the pressure for heavy government intervention.

Of course, both policies are not mutually exclusive but with monetary policy, the size of fiscal policy can be managed, compared to a scenario where there is limited monetary policy spectrum to choose from, i.e. when there is only commodity money.

Categories
Economics

[2236] Of Kelantan gold dinar is bound to fail

The idea of the issuance of gold dinar and silver dirham as currency in Kelantan is not new but this week, the northern Malaysian state has decided to go ahead with it finally.[0] This will be a lesson demonstrating the superiority of  fiat currency to that which is backed by commodity: commodity-backed currency simply does not do well alongside fiat currency.

Never mind the legality of the whole thing.

First of all, the dinar and the dirham are pegged to the ringgit.[1] This option eliminates the need to use the new currency vis-a-vis the ringgit, notwithstanding the supposedly Islamic ideal. With wider circulation, why would a person not choose the ringgit over the new currency? Call it the status quo bias but that is the reality.

Furthermore,  the dinar is likely fail to fulfill the double coincidence of wants, which is necessary for any trade to happen between at least two parties. This is the reason why barter trading is not nearly as popular as trading done through a medium of exchange called money.

A far more threatening factor is the prices of metals. Sufficient increase in gold and silver prices vis-à-vis the exchange rate will make the money more valuable as metals than as a medium of exchange. That will create an incentive to sell the dinar and the dirham as metals, thus lowering the quantity of money in circulation. The next time metal prices go through the roof, one may expect the dinar and the dirham as a currency to collapse or at the very least becoming very, very unpopular. It will be hard to see the currency around and in use.

One possible solution to the circulation problem is that the Kelantan government may want to support the currency by printing more of them. That will prove to be a costly policy to carry out in the long run.

Alternatively, the Kelantan government may reevaluate exchange rate between the commodity-backed currency and the fiat ringgit to address rising gold prices. The higher value of the commodity-backed currency compared to the prices of the relevant metals, the more valuable it will be as currency and less as metals.

If reevaluation is the favored policy, it will be a race between the issuer and arbitrageurs: who can act first. There is an handsome profits to be made. Remember, for instance, the painful experience of the European Exchange Rate Mechanism.

Between a state government (along with the issuer) with no experience in monetary policy and countless arbitrageurs, I have a feeling the state government will not fare too well. I doubt Kelantan has sufficient reserve to support a currency, in case of a run. Somebody once said something to this effect in a different but entirely applicable scenario: the government has to win every time but the arbitrageurs need to win only once to induce a collapse of the currency.

Or, the Kelantan government can float the exchange rate. But if it does so, there is a feeling that that policy would make the dinar redundant as a currency to the ringgit, leading us back to the status quo bias.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

[0] — KOTA BAHARU, Aug 12 (Bernama) — Kelantan paved the way to become the first state to introduce the gold dinar and silver dirham currency on Thursday.

Speaking when launching the Syariah currency, Menteri Besar Kelantan Datuk Nik Abdul Aziz Nik Mat said the state would strive to expand the use of gold dinar and silver dirham in all transactions, including paying civil servants’ remuneration. [Kelantan Launches Dinar Gold. Bernama. August 12 2010]

[1] — The exchange rate are RM589 to a dinar and RM13 to a dirham. See World Islamic Mint. Accessed August 13 2010.