Failed monetary technology

Archaic and ignored monetary technologies can be very interesting, especially when they teach us about newer attempts to update our monetary system. I recently stumbled on a neat monetary innovation from the bimetallic debate of the late 1800s, Nicholas Veeder's Republic of Eutopia coin:

During the bimetallic debates of the late 1800s, one of the more interesting compromises put forward was Nicolas Veeder's cometallic standard. His model 'Republic of Eutopia' coins (1866) had a plug with 12.9 grains of gold and ring with 206¼ grains of silver. A good idea or no? pic.twitter.com/6eZN2YAq6o

— JP Koning (@jp_koning) May 28, 2018

If you've read this blog for a while, you'll know that I like to talk about monetary technology. Unlike financial technology, monetary tech involves a technological or sociological upgrade to the monetary system itself. And since we are all unavoidably users of the monetary system—we all think and calculate in terms of our nations unit of account—each of us is immediately affected by the change.

Veeder's Eutopia coin is an old monetary technology that was never adopted. More recent examples of unadopted (or as-yet not adopted) montech include Fedcoin, NGDP futures targeting, or Miles Kimball's technique for evading the zero-lower bound, which would decouple the value of paper money from electronic money. Examples of recent monetary tech that went on to be adopted include the switch from paper to plastic banknotes, the replacement of older end-of-day clearing systems to real time gross settlement systems, and inflation targeting.

Fintech is more limited in scope than monetary tech. Only that portion of the population that uses these innovations is affected—everyone else's financial habits continues on as before. Recent examples include bitcoin, p2p lending, and roboadvisors. (If bitcoin ever became the standard unit of account, it would have made the trek over to becoming monetary technology, and not just fintech.)

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To make sense of Veeder's Republic of Eutopia coin, we need to understand the problem that his monetary innovation was meant to solve. Most nations were on a gold standard by the 1870s, and with the price of gold rising, the world price level was generally falling. This development provided an unexpected boost to the creditor class, who were owed gold, while hurting the debtor class, who owed gold. A higher price for the yellow metal meant that the loan contract to which a debtor had signed their name now required them to work that much harder to pay it off.

In that context, a broad popular movement for the remonetization of silver emerged. Prior to being on gold standards, nations were generally on a pure silver standard or a bimetallic standard. On a gold standard the debtor class had only one way to settle the debt, by providing the proper amount of gold coins. But if silver coinage was reintroduced at the old rate of sixteen-to-one, debtors could instead sell their labour to buy cheap silver, have it minted into legal tender silver coins, and use those silver coins to pay off the debt. Paying their debts with silver rather than gold meant they'd have a bigger amount of wealth remaining in their pocket.

The movement to restore bimetallism wasn't purely a populist one. The smartest economists of the time--folks like Irving Fisher, Leon Walras, and Alfred Marshall--also preferred bimetallism. A bimetallic standard recruits more monetary material into service than a gold standard. This is advantageous because, as Fisher put it, it "spreads the effect of any single fluctuation over the combined gold and silver markets." In other words, the evolution of the price level under a bimetallic system should be more stable—and thus more fair—than under a monometallic system, since it can absorb larger shocks.

The problem with bimetallism is that it very quickly runs smack into Gresham's law. The traditional way to bring the two metals into service as monetary material was to offer to mint both high denomination gold coins and lower denomination silver coins. So if a merchant needed £20 worth of coins, he could bring either a chunk of raw gold to the mint, or an even bigger chunk of pure silver, and the mint would convert either chunk into £20 for him. The specified amounts of raw silver or raw gold that were required to get a certain number of £-denominated coins constituted the mint's official gold-to-silver exchange rate.

Inevitably the market's gold-to-silver exchange rate would diverge from the mint's official exchange rate, effectively over- or undervaluing one of the two metals. In this situation, no one would bring any of the overvalued metal to the mint to be turned into coins. After all, why bother minting a chunk of gold (assuming the yellow metal was the overvalued one) into £20 worth of coins if that same amount of gold has far more purchasing power overseas? The overvalued metal would thus disappear as it was hoarded and exported, leaving only the undervalued metal in circulation. A monometallic standard had accidentally emerged, and all the benefits of bimetallism were for not.

To prevent Gresham's law from being engaged, the mint had to constantly adjust its official rate so that it stayed in-line with the ever-evolving market rate. Not only would these changes have been politically costly, but they would required an expensive series of recoinages in order to ensure that coins always had the proper amount of silver or gold in them.

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Enter Veeder's Eutopia coin. Nicholas Veeder was no economist, but an executive at C.G. Hussey, a copper rolling mill in Pittsburgh. In 1885, he published a pamphlet with the wordy title Cometallism: A Plan for Combining Gold and Silver in Coinage, for Uniting and Blending their Values in Paper Money and For Establishing a Composite Single Standard Dollar of Account.

Rather than defining a dollar as simultaneously a fixed amount of gold OR a fixed amount of silver, Veeder's pamphlet suggested defining it as a fusion of the two together. Specifically, Veeder's dollar was to contain 12.9 grains of gold AND 206.25 grains of silver. It's worth noting that under a proposed cometallic standard, paper dollars needn't be redeemed with actual Eutopia coins, but could be converted into separate silver and gold bars or coins. The important rule was that each dollar's worth of debt had to be discharged with 12.9 grains of gold and 206.25 grain of silver.

A model of a cometallic gold certificate, from page 60 of Veeder's pamphlet on cometallism

Veeder's cometallic scheme was a neat way to keep all the benefits of bimetallism with none of its drawbacks. Cometallism would draw on the combined supplies of the gold and silver markets, so that the system would be much more elastic than a pure gold standard, and thus fairer to both creditors and debtors. At the same time, Gresham's law would be avoided. Under traditional bimetallic coin systems, the mint established an exchange rate between the two metals. This rate inevitably became the system's undoing when it diverged from the true rate.

But a mint that was operating under a cometallic standard would only accept fixed quantities of silver AND gold before it would mint a $1 coin, and so it would no longer be setting an exchange rate between the two precious metals. The undervaluation of one of the metals, a key ingredient for Gresham's law, could never emerge under cometallism.

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A year after Veeder published his pamphlet, Alfred Marshall—one of the world's leading economists—described a remarkably similar system. Here is part of his response to the Royal Commission on the Depression in Trade and Industry in 1886, which had been convened to address the Long Depression:

"I propose that currency should be exchangeable at the Mint or Issue Department not for gold, but for gold and silver, at the rate of not £1 for 113 grains of gold, but £1 for 56^ grains of gold, together with, say, twenty times as many grains of silver. I would make up the gold and silver bars in gramme weights, so as to be useful for international trade. A gold bar of 100 grammes, together with a silver bar, say, twenty * times as heavy, would be exchangeable at the Issue Department for an amount of the currency which would be calcalated and fixed once for all when the scheme was introduced. (It would be about .€28 or .€30 according to the basis of calculation)."

Marshall's proposal was later dubbed symmetallism. (I wrote about it here.) If you study monetary systems, you'll run into the gold & silver basket idea sooner or later. The concept is invariably refereed to as symmetallism (and not cometallism) and attributed to Marshall (not Veeder). In the 1800s academics were not required to provide references, and from what I understand plagiarism was rampant. Did Marshall develop his idea separately from Veeder, or did he rip it off? Whatever the case, Veeder was an unknown executive at a small manufacturing concern, whereas Marshall a world famous academic. Celebrity carried the day.

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Interestingly, Veeder himself probably borrowed the idea, or at least part of it, from someone else. Almost a decade earlier, William Wheeler Hubbell had tried to get the U.S. congress to adopt the so-called "goloid dollar," a coin containing silver and gold alloyed together.

Another proposed fix was William Hubbell's "goloid" metric dollar (1878). This specimen is 1 part gold, 16.1 parts silver, and 1.9 parts copper. Whereas Vedeer's dollars kept the metals apart, Hubbel's intermingled them. https://t.co/qXpE7EbQrk pic.twitter.com/csNahz1Hhq

— JP Koning (@jp_koning) May 29, 2018

Hubbell owned the patent to the goloid alloy, so he would have made a good profit if the goloid dollar had been adopted by the U.S. Treasury. Unlike Veeder, Hubbell doesn't seem to have been a very good monetary economist, and the case he makes for goloid misses much of nuances of the benefits of bimetallism and the hazards of Gresham's law. He lists a number of advantages for his proposed coin, including: superior durability to gold and silver coins; not susceptible to oxidization (unlike silver); a goloid dollar was smaller than a silver dollar and thus more convenient for consumers to carry around; the mint would be able to make more goloid dollars than silver dollars with its existing capacity; and goloid coins could not be easily melted down for usage in the arts as was the case with gold and silver coins.

Hubbell's idea foundered on the fact that a goloid coin, despite containing gold, has almost the exact same colour as a silver coin. Hubbell's critics believed this set the coin up to be widely counterfeited. A counterfeiter could make a replica with lower gold content, this alteration unlikely to be noticed by the public since the colour of a genuine goloid coin and the fake would be the same.

The difficulties that Hubbell experienced alloying gold and silver were not lost on Veeder. In has pamphlet he mentions that "my first approach, as with many other persons, was to combine the two metals as an alloy for coinage, but, owing to certain difficulties... this idea was soon considered impracticable and abandoned." To avoid Hubbell's color problem, Veeder ended up mechanically wedding the two metals rather than chemically combining them, the Eutopia coin being comprised of a ring of silver and a gold plug embedded inside.

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The topic of goloid and Eutopia dollars seem a bit obscure, but the issues of stability and fairness that concerned monetary technologists in the late 1800s remain relevant today.

Today, most western central banks define the national currency in terms of a basket of consumer goods and services rather than a fixed amount of gold (gold monometallism) or a basket of gold & silver (cometallism, symmetallism). This makes a lot of sense. If we want to create a stable monetary standard, one that provides creditors and debtors with an even playing field, better to use a broad basket of stuff that regular people buy than a narrow basket of metals. That way all parties to a contract know many years ahead of time exactly how much consumer goods they will get (if they are creditors) or give up (if they are debtors). Knowing how much gold and silver baskets they will owe or be owed is less relevant to the average person, since gold and silver are a very small part of most people's day-to-day consumption profiles.

There is an important debate going on today about whether to continue defining national currencies in terms of a consumer goods & services basket, or whether to move to something more fluid like a nominal gross domestic product (NGDP), or output. One problem with using a consumer goods basket is that, in the event of a large economic shock that leads to significant loss of jobs, debtors take on all the macroeconomic risk. After all, they owe just as many CPI baskets as before, but have less capacity to meet that obligation because they might not have a job. This doesn't seem like a fair splitting up of risks and rewards.

The nice thing about defining the national currency in terms of NGDP, or output, is that the risk of a large shock, and the associated loss of jobs, is shared between creditors and debtors. This is because if a recession occurs, debtors will owe a smaller amount of real wealth to creditors than they otherwise would. And during a boom, when the job offers are rolling in, creditors will owe more.

Cometallism was never adopted. Perhaps it was a bit too fancy. NGDP is a bit exotic too, but then again so were many forms of monetary technology, until they were actually adopted and became part of the background. We'll have to see what happens.

From ancient electrum to modern currency baskets (with a quick detour through symmetallism)

Electrum coins [source]

First proposed by economist Alfred Marshall in the late 19th century as an alternative metallic standard to the gold, silver and bimetallic standards, symmetallism was widely debated at the time but never adopted. Marshall's idea amounted to fusing together fixed quantities of silver and gold in the same coin rather than striking separate gold and/or silver coins. Symmetallism is actually one of the world's oldest monetary standards. In the seventh century B.C., the kingdom of Lydia struck the first coins out of electrum, a naturally occurring mix of gold and silver. Electrum coins are captured in the above photo.

While symmetallism is an archaic concept, it has at least some relevance to today's world. Modern currencies that are pegged to the dollar (like the Hong Kong dollar) act very much like currencies on a gold standard, the dollar filling in for the role of gold. A shift from a dollar peg to one involving a basket of other currencies amounts to the adoption of a modern version of Marshall's symmetallic standard, the euro/yen/etc playing the role of electrum.

The most recent of these shifts has occurred with China, which late last year said it would be measuring the renminbi against a trade-weighted basket of 13 currencies rather than just the U.S. dollar. Thus many of the same issues that were at stake back at the turn of the 19th century when Marshall dreamt up the idea of symmetallism are relevant today.

So what exactly is symmetallism? In the late 1800s, the dominant monetary debate concerned the relative merits of the gold standard and its alternatives, the best known of which was a bimetallic standard. The western world, which was mostly on a gold standard back then, had experienced a steady deflation in prices since 1875. This "cross of gold" was damaging to debtors; they had to settle with a higher real quantity of currency. The reintroduction of silver as legal tender would mean that debts could be paid off with a lower real amount of resources. No wonder the debtor class was a strong proponent of bimetallism.

There was more to the debate than mere class interests. As long as prices and wages were rigid, insufficient supplies of gold in the face of strong gold demand might aggravate business cycle downturns. For this reason, leading economists of the day like Alfred Marshall, Leon Walras, and Irving Fisher mostly agreed that a bimetallic standard was superior to either a silver standard or a gold standard. (And a hundred or so years later, Milton Friedman would come to the same conclusion.)

The advantage of a bimetallic standard is that the price level is held hostage to not just one precious metal but two; silver and gold. This means that bimetallism is likely to be less fickle than a monometallic standard. As Irving Fisher said: "Bimetallism spreads the effect of any single fluctuation over the combined gold and silver markets."  Thus if the late 1800s standard had been moved from a gold basis to a bimetallic one, the stock of monetary material would have grown to include silver, thus 'venting' deflationary pressures.

Despite these benefits, everyone admitted that classical bimetallism had a major weakness; eventually it ran into Gresham's law. Under bimetallism, the mint advertised how many coins that it would fabricate out of pound of silver or gold, in effect setting a rate between the two metals. If the mint's rate differed too much from the market rate, no one would bring the undervalued metal (say silver) to the mint, preferring to hoard it or export it overseas where it was properly valued. The result would be small denomination silver coin shortages, which complicated trade. What had started out as a bimetallic standard thus degenerated into an unofficial gold standard (or a silver one) so that once again the nation's price level was held hostage to just one metal.

The genius of Alfred Marshall's symmetallic standard was that it salvaged the benefits of a bimetallic standard from Gresham's law. Instead of defining the pound as either a fixed quantity of gold or silver, the pound was to be defined as a fixed quantity of gold twinned with a fixed quantity of silver, or as electrum. Thus a £1 note or token coin would be exchangeable at the Bank of England not for, say, 113 grains of gold, but for 56 grains of gold together with twenty or so times as many grains of silver. The number of silver and gold grains in each pound would be fixed indefinitely when the standard was introduced.

Because symmetallism fuses gold and silver into super-commodity, the monetary authority no longer sets the price ratio between the two metals. Gresham's law, which afflicts any bimetallic system when one of the two metals is artificially undervalued, was no longer free to operate. At the same time, the quantity of metal recruited into monetary purposes was much larger and more diverse than under a monometallic standard, thus reducing the effect of fluctuations in the precious metals market on aggregate demand.

While symmetallism was an elegant solution, Alfred Marshall was lukewarm to his own idea, noting that "it is with great diffidence that I suggest an alternative bimetallic scheme." To achieve a stable price level, Marshall preferred a complete separation of the unit of account, the pound, from the media of exchange, notes and coins. This was called a tabular standard, a system earlier proposed by William Stanley Jevons. The idea went nowhere, however; the only nation I know that has implemented such a standard is Chile. As for Fisher, he proposed his own compensated dollar standard plan, which I described here.

The urgency to adopt a new standard diminished as gold discoveries in South Africa and the Yukon spurred production higher, thus reducing deflationary pressures. None of these exotic plans—Marshall's symmetallism, Jevons tabular standard, or Fisher's compensated dollar—would ever be adopted. Rather, the world kept on limping forward under various forms of the gold standard. This standard would be progressively modified through the years in order to conserve on the necessity for gold, first by removing gold coin from circulation and substituting convertibility into gold bars (a gold bullion standard) and then having one (or two) nations take on the task of maintaining gold convertibility while the remaining nations pegged to that nation's currency (a gold exchange standard).

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Let's bring this back to the present. In the same way that conditions in the gold market caused deflation among gold standard countries in the late 1800s, the huge rise in the U.S. dollar over the last few years has tightened monetary conditions in all those nations that peg their currency to the dollar. To cope, many of these countries have devalued their currencies, a development that Lars Christensen has called an 'unraveling of the dollar bloc.'

A more lasting alternative to re-rating a U.S. dollar peg might be to create a fiat version of electrum; mix the U.S. dollar with other currencies like the euro and yen to create a currency basket and peg to this basket. China, which has been the most important member of the dollar bloc, has turned to the modern version of symmetallism by placing less emphasis on pegging to the U.S. dollar and more emphasis on measuring the yuan against a trade-weighted basket of currencies. This means that where before China had a strictly made-in-the U.S. monetary policy, its price level is now determined by more diverse forces. Better to put your eggs in two or three baskets than just one.

Bahrain, Oman, Qatar, Saudi Arabia and United Arab Emirates are also members of the dollar bloc. Kuwait, however, links its dinar to a basket of currencies, a policy it adopted in 2007 to cope with the inflationary fallout from the weakening U.S. dollar. In an FT article from April entitled Kuwaiti currency basket yield benefits, the point is made that Kuwait has enjoyed a more flexible monetary policy than its neighbours over the recent period of U.S. dollar strength. Look for the other GCC countries to mull over Kuwaiti-style electrum if the U.S. dollar, currently in holding pattern, starts to rise again.

Modern day electrum can get downright exotic. Jeffrey Frankel, for instance, has suggested including commodities among the basket of fiat currencies, specifically oil in the case of the GCC nations. Such a basket would allow oil producing countries to better weather commodity shocks than if they remained on their dollar pegs. If you want to pursue these ideas further, wander over to Lars Christensen's blog where Frankel's peg the export price plan is a regular subject of conversation.