The American dollar is beginning to show signs of aging and decline as did the British pound before it and the currencies that climbed to the top of the heap throughout history then fell from grace to be replaced by another currency. And the consequence of the dollar’s demise has been that a number of nations expressed concern about continuing to use it as their reserve currency while organizations such as the United Nations suggested that something be done to find an alternative to the dollar sooner rather than later. But to ask that the nations of the world drop the dollar in favor of another currency is pointless at this stage of the game because what we must do instead is explore different ways to conduct the business of the world without having to rely on the currency of one nation.
But before we do that, let us answer these questions: What is a reserve currency anyway and how does the currency of one nation get to be it? Well, the best way to answer these questions is to take an example and discuss it. Here is one. Suppose a wealthy individual in Turkey decides to have a yacht custom-built for him in Egypt. He finds the company that will build the yacht and discusses with their representative the design he has in mind. Now comes the time to negotiate the price and the mode of payment. The Turk wants to pay the full amount in Turkish new liras when the yacht is delivered but the Egyptian expresses the concern that Turkey went through a period of hyperinflation only recently at which time the old currency was scrapped and replaced with a new one.
Reminding his customer that it will take a number of months to build the yacht during which time the history of the lira may repeat itself, the Egyptian asks to be paid in Egyptian pounds. At this point the Turk voices his own concern about the large amount of foreign direct and indirect investments that pour into Egypt these days, a reality that is combined with the almost weekly discoveries of gold, oil and natural gas made in the country. The Turk says he fears that this will send the pound soaring, and if he agrees to pay in pounds several months from now, the currency translation will cost him a great deal more than he bargained for.
Faced with these difficulties, the two sides decide to conduct the transaction in American dollars which they still regard as a stable currency. Of course, they could have chosen the Euro, the Yen, the Yuan, the Swiss Franc or any another currency they consider stable but they settled on the dollar because it was familiar to them and it is available on demand almost everywhere even now.
Imagine this sort of scene taking place around the globe thousands of times a day and you will see why the people in business and the banks that serve them want to keep an adequate supply of American dollars in their vaults. This answers the question as to why the dollar is the de facto reserve currency of the world but if it looks like the dollar is about to suffer the same fate as the Turkish lira and be devalued, the people who hold large amounts of it begin to worry. Of course, they can dump the dollar but to do so, they will need another currency to take its place, one that will be acceptable to everyone else around the world. After all, those same transnational deals will continue to take place and the people who engage in them will need some kind of currency to complete the transactions. So then, what can replace the dollar?
That same question can also be asked with regard to the money that sovereign governments borrow from time to time. The way things are done now is that a government that decides to borrow money issues a bond denominated in its own currency or, on rare occasions, issues the bond in the currency of another nation such as the American dollar. Of course, a bond is a promise to pay the money back in the denominated currency with interest at a specified date. But to put things in perspective, it should be noted that there was a time when the dollar itself was maintained stable only because it was pegged to gold. The exchange rate was fixed at 35 American dollars per ounce of pure gold, and the other major currencies of the world were pegged to the dollar at a fixed rate also. This arrangement came to an end in 1971 when the French opted out of it and the Americans broke the peg by withdrawing the promise to pay 35 dollars in exchange for an ounce of gold.
And when the financial crisis of 2008 hit -- an event that started in America and went on to create severe problems around the globe -- people realized that solving these problems can only happen at the expense of the American dollar which will have to be devalued. Accordingly, some people suggested that we return to the gold standard, other people suggested that we adopt a system based on a basket of commodities and still other people suggested that we adopt the Special Drawing Rights (SDR), a kind of index now used as virtual money by the International Monetary Fund.
Before we look into each of these suggestions let us see what they are supposed to accomplish in the first place. They are supposed to deliver stability, equity and fairness to the parties who enter into a contract now but do not consummate the deal until later on. This will be the time when the parties will do the actual exchange of goods or services for the agreed upon sum of money in the designated currency. However, the price of those goods or services will most certainly have changed by then and so will the relative value of the currency to pay with, a development that will defeat the principle of stability, equity and fairness. But there is worse; there is embedded in this development a provocative reality. It is this: If everything is in flux and nothing is absolute, the reality is that it will always be impossible to anchor to one thing and achieve the stability, equity and fairness we seek. So then, what do we do?
And this reality is at the core of the criticism leveled against the adoption of the gold standard or the idea of the basket of commodities; it is that their values are in constant flux. What is happening with these commodities is that fundamental and technical forces act on them, forces that even the most experienced of traders can never understand and whose pitfalls they cannot avoid. And there is here another provocative reality to contend with. It is this: For any commodity to have a value there must only be a limited quantity of it, but if the quantity is limited, the value of the commodity will remain vulnerable to the forces that maintain it in flux. It is a vicious cycle that needs to be tamed and one that begs the question: Can there be a way out of this dilemma?
Yes, there can be a way out but only if you anchor your solution to a large basket of commodities, not to one or to a small basket of them. The commodities should be chosen so that when the value of some will tend to rise, the value of the others will tend to fall. This combination will cancel out the individual fluctuations to some extent and thus maintain the basket relatively stable. The idea should apply to all sorts of commodities, be they agricultural products which depend among other things on the weather, or the base metals which depend on the ever changing balance between supply and demand, or the precious metals which are always the object of speculation. And when you give a weight to each item in the basket based on the importance that the item occupies in the economy you create an index such as there are many in use today.
In fact, this is the principle that underlies the composition of the SDR index. However, the time has come to overhaul this index by including in it all the currencies of the world without a single exception. What is included now are the US dollar, the Euro, the Yen and the British pound but it is important to have everyone in the index because, in addition to being an equitable idea, the inclusions will give every country the chance to convert its currency into the reserve currency of the world and vice versa. This way, everybody will be able to participate in world commerce.
But how do we create this reserve currency of the world? We create it by recognizing that natural resources are the building blocks that make an economy, and money is the cement that holds it all together. We combine the index of commodities with the index of currencies to create a super-index; and it is this super-index that will form the sturdy base upon which we can anchor our commercial undertakings thus achieve the near perfect stability we seek. The super-index will represent the world Reserve Currency Unit (RCU) to which the currency of every nation will convert back and forth.
Mindful that from time to time a currency will disappear and a new one appear, the system should be flexible enough to drop the disappearing one, make the new inclusion and readjust the relative weights. The same principle should apply to the other commodities whose importance to shoppers and to industry may change with time. For example, all commodities can be represented by subdividing the index of commodities into several sub-indices each comprising one or two items such as wheat and rice to represent the grains, tomato and zucchini to represent the vegetables, grapes and oranges to represent the fruits, fish and beef to represent the proteins et cetera. In addition, gold and silver could represent the precious metals, petroleum and uranium represent energy, copper and aluminum represent the base metals and so on. But this will change with time as the consumption patterns change.
Some people might argue that it will be too cumbersome to work with thousands of items making up a super-index that must be refreshed every day because prices fluctuate. Not to worry; such exercise may have been cumbersome in the old days when the work was done by hand but will be entirely manageable in this age of the computer and of instant communication. In fact, there exist now more complicated indices operating at all sorts of exchanges such as the stock, currency and commodities exchanges where the values are refreshed not every day but every second or even less. And all these indices work like a charm so to speak.
Let us now go back to the earlier example and see how a transaction would unfold under this new regime. The wealthy Turk and the Egyptian shipbuilder agree on a price in any currency they want be it the lira, the pound, the dollar or anything else. They consult the super-index and convert the price into Reserve Currency Units at the rate indicated by the super-index on that day, and this value is written into the contract. When the yacht is delivered, the Turk writes a check in RCU as per the contract at which time the shipbuilder takes it to his bank and has it redeemed not in RCU which is virtual money but in the currency of his choice such as the Egyptian pound. To do this, the bank looks up the conversion rate for this day in the super-index and may add the usual commission to pay for the risk inherent to conversions.
That same approach can be used with regard to corporate and to sovereign bonds, all of which can be written in RCU but then bought, sold and redeemed in any real currency according to the conversion rate indicated on the day that each transaction is made.
Thus, regardless as to how much the price of commodities, currencies or commercial papers change between the time that a contract is negotiated and the check is cashed, the intended value of the transaction is kept stable and the sense of equity and fairness is maintained.