Article I: Currencies

In economic terms, currency is normally described as a store of value, a unit of account, and a medium of exchange. Inherently durable and scarce, gold has been almost universally identified with ‘real’ money for thousands of years, a status reinforced by long tradition. For practical reasons the actual medium of exchange soon evolved into representational money, with the underlying asset symbolically traded through lesser coins, paper, and other records. Such accounts were nevertheless liable to ‘settlement’ with the real thing, although an institution might – and often did – anticipate that only a fraction of the total would be required for settlement at any given time, reducing its reserves accordingly.

Although simple and resilient, gold is a rather arbitrary basis for a monetary system. Its supply is naturally limited, and distributed, in a way that has little to do with the actual requirement for money. As a store of value and unit of account, its value is only indirectly related to the totality of economic activity and opportunity that it represents. Perhaps more seriously, state-sponsored gold currencies suffer from a historical precedent that, having been established, is difficult to forget: fractional reserves will tend to decline and may reach zero without much warning. Government promises to redeem gold for paper, in other words, are now known to be worth nothing.

Currencies that do not promise to redeem any underlying asset are fiat money, having value literally by decree. Exactly how much value is essentially a system effect; a given unit is worth whatever range of goods and services is expected to be available in exchange for it. This in turn depends upon the expectations that others are expected to hold, and what they expect others to expect, ad infinitum (or less kindly, ad absurdum). These are faith-based monetary systems, anchored to the real economy only through assumptions about the integrity of the issuing authority and the collective, self-referential assumptions of the user base. With a large enough system some kind of equilibrium tends to be established, but its stability is as dubious as its basis is intangible.

Fiat currencies are in some ways a convenient medium of exchange. Their underlying assets are essentially immaterial and can be issued or restricted at will by governments; but there are many governments in the world, and on an international level the utility of currencies is limited by uncertainty in conversion between them. Fiat currencies are poor stores of value and units of account; they are subject to unpredictable variations in relative value, and it is generally accepted that they will gradually depreciate by an unknowable amount in real terms. It is impossible to know what actual wealth a given unit represents across countries and through time.

A more recent development in the history of money has involved the realisation that any secure representation of value can be used as currency, regardless of government sponsorship or even the involvement of the established financial system. Cryptocurrencies rely more on the structure of their programming and the distributed system of users it entails than on any given institution. That said, most ‘conventional’ currency is in effect digital, enjoying many of the same advantages, and the cryptocurrencies still depend upon various individuals and institutions to provide services while the system itself is normally administered by something best described as community politics. Whether this really does result in less centralised and more responsible management is not yet clear. It is also not clear that trust is better placed in the new cryptocurrency participants rather than established and more openly regulated financial institutions, that the system will remain viable when regulation does arrive, or that the integrity of the underlying technology will survive contact with future developments designed to undermine it.

The most prominent cryptocurrency is Bitcoin, but the amount of genuine commerce that it supports has always been negligible. Bitcoins have value as a speculative asset on the assumption that the system will eventually be adopted on a large scale for its utility as a currency, and that a considerable amount of real wealth will be transferred to early adopters in recognition of their pioneering efforts. Unfortunately, Bitcoins fluctuate so wildly in price that they serve almost no purpose as a store of value or unit of account, while the uncertainty and difficulty of operations outside the financial system make them an impractical medium of exchange. It is always tempting to become fascinated by the flashing lights of new technology and lose sight of the fundamentals. As a currency, the fundamentals of Bitcoin are poor.

The cryptocurrencies have at least demonstrated that our existing national currencies are contingent facts of history rather than the necessary way of things. The modest success enjoyed by even a system as flawed as Bitcoin shows that there is strong demand for almost any alternative. The world of money that we have inherited from the twentieth century has started to look a little old, even if the new world has not yet been discovered.

A better currency would provide a global alternative to local sovereign currencies, remaining independent of government control; but unlike the cryptocurrencies, it would have to integrate easily with the established financial system. The reliability and convenience of existing arrangements will only be matched by a currency that functions in line with normal processes and regulations.

A better currency would also provide an internationally relevant and stable unit of account, while representing a store of value that is financially neutral through time and across countries. Such a unit would have to replicate the global economic opportunity cost – an extremely diversified international investment portfolio – so that it describes a constant real financial value from year to year, regardless of exchange rates. Properties of this kind imply some form of tangible asset base, rather than a balance of managed or programmed supply against variable demand. Fortunately, some fairly recent financial developments, and the declining relevance of physical cash, have made the creation and deployment of such a currency quite feasible.