Two-level currency system
As the discourse on De-dollarisation gains traction, we need to understand the functions of currency systems and what could be an ideal solution.
Let me first confess that a few decades ago, I was a proponent of a single global currency system. The quantum of trades in FX was so huge that I thought it must serve no important purpose, as the cost indicates. However, when I wrote my book Subverting Capitalism and Democracy, my view moved towards a two-level currency system.
Two functions of currency
A currency system needs to have two critical functions. First, it should reliably communicate price information. Second, it should facilitate the transactions in the economy and not hinder it. Given these two functions, a high or loose money supply distorts price information but allows enough money for transactions. A constrained money supply does not allow transactions to happen, thus possibly limiting growth. Thus, the increase in money supply should account for the following:
The increase in the economic value being created in the economy. The higher money supply should support the exchange of these new goods, new services, etc. (Simplistically, let us assume 3 units of growth was achieved)
The decrease (or increase) in the need for money because of efficiency in transactions, thus creating additional velocity. This refers to a structural increase in velocity rather than cyclical changes (let us assume velocity grew, accounting for 2 units increase in money supply)
The increase in money inventory (locked up money) as activity increases (let us say 1 unit)
So, the net increase in the money supply should be +3-2+1 = 2 units. Now, each of these is difficult to determine as it is. So, I think Milton Friedman implied that the actual increase in the money supply should be a little higher than 2, say 2.2 units. This leads to inflation, but that is better than deflation (separate debate).Â
Further, we need reliable mechanisms to measure each of the three. If we do not have confidence in the measurement, we do not have a monetary policy. This is the problem with the Euro. Fudging of sovereign balance sheets and finances has impaled confidence in the monetary system.
Two-level currency system
An ideal system, I think, maybe a two-level currency system. A currency at the national level should signal the relative prices of goods and services in the economy. An international currency should signal confidence in the judgement exercised in a national currency. The international currency, therefore, decides the relative prices of currencies and, thus, of everything.
In the pre-Bretton-Woods era, gold was an international currency, while Bretton-Woods established the US Dollar in that role. The system, however, leaves the world vulnerable to US monetary policy misgivings. The world does not have a mechanism to communicate confidence in US monetary policy.
In sum
When we evaluate US monetary policy, I believe we should do so in relation to world GDP growth and interest rates rather than simply to US growth and interest rates.
A currency without the legal charter to measure other economic variables does not make sense. Thus, community-level currencies (some experiments are being conducted in the UK) do not make sense unless they are deflationary by design.
We need an extra-national currency to signal confidence in national monetary policies. In this case, the money supply of this extra-national currency should grow at the pace of world growth. This is also closer to Keynes’ proposal in the Bretton Woods meeting.