A constant unit of account.

• Author: Rahn, Richard W.
• Position: Essay

F. A. Hayek, in his classic Denationalisation of Money, argued the case for competitive nongovernmental currencies. As Hayek ([1976] 1990: 130) wrote,

The abolition of the government monopoly of money was conceived to prevent the bouts of acute inflation and deflation which have plagued the world for the past 60 years. It proves on examination to be also the much needed cure for a more deep-seated disease; the recurrent waves of depression and unemployment that have been represented as an inherent and deadly defect of capitalism. Over the past several decades, I have been a professional economist, government advisor, financial regulator, and have also engaged in international business. After this variety of experience, I am now more than ever convinced that Hayek was absolutely correct in how the government monopoly of the issuance of money leads to a never-ending cycle of economic crises. A decade ago, I was hopeful that the ability of private parties to create their own digital currency might be our salvation, and that led me to write a book, The End of Money and the Struggle for Financial Privacy (Rahn 1999). At the time, Milton Friedman told me that I was much too optimistic about how long it would take. Friedman was right, as usual, and we still seem decades away from this ideal.

Many have struggled with this problem. Warren Coats, who studied under Friedman and served on the IMF staff for many years (and served with me on the board of the Cayman Islands Monetary Authority), wrote an important study on the subject, In Search of a Monetary Anchor (Coats 1994), where he both reviewed the history of the effort and made significant recommendations for creating a global monetary standard.

In this article, my goal is far less ambitious, and that is to lay out a very practical and politically doable, and even simple, way to define a global monetary unit of account that is closer to a monetary constant than other alternatives now available, such as gold or commodity baskets. As Hayek and many other authors have noted over the decades, inflation, deflation, and wide swings in relative exchange rates cause huge problems for business people, investors, policymakers, and, of course, economists in trying to understand what is happening. The result of the risks and uncertainties of holding or contracting any government-issued money has reduced productive investment, productivity growth, and job creation--making us all unnecessarily poorer.

Overview

In an ideal world, there would be one global currency subject to neither inflation nor deflation, nor political manipulation by any one or group of countries. In such a world, transaction and exchange costs, and investment costs and risks would be greatly reduced, but it is not going to happen in the foreseeable future. That does not mean, however, no improvements can be made in the functioning of the existing monetary order. This article presents a practical proposal for creating a "constant unit of account" that could result in substantial economic benefits to the global financial system.

Money is traditionally defined as a medium of exchange, a unit of account, and a store of value. The goal of this article is to deal only with the unit of account, which facilitates the valuation and calculation function of money. The idea is that, by providing a better global unit of account whose definition is widely accepted, it will enable others to devise ways to make it a medium of exchange and a store of value.

There has been rising dissatisfaction with the U.S. dollar as the primary global reserve currency and the unit of account for much of world trade and commodity prices, most importantly oil. The problem is there are, at the moment, no obviously superior alternatives. There has been some discussion about trying to turn the SDR (Special Drawing Right issued by the IMF) into a global currency. The SDR does serve both as a unit of account and a medium of exchange, but for many reasons, including practical and political, it is unlikely to become a world currency in the near future, if ever. (1) The United States and the European Union enjoy the profits they obtain from selling their currencies to the citizens of the world. And the United States, in particular, is most unlikely to give up its monetary sovereignty to a group of international bureaucrats representing countries, many of whom are not necessarily friendly to U.S. interests. In fact, the Founders of the American Republic explicitly provided in the Constitution that the Congress shall have the power "to coin money and regulate the value thereof." Thus, it may not even be constitutional for the U.S. government to delegate this power to some international organization.

Nobel laureate economist Robert Mundell, a principal architect of the euro, noted in an article written almost a half century ago that there are optimal currency areas (Mundell 1961). Some economists dispute whether the eurozone is truly an optimal currency area. Nevertheless, one could argue that as trade and investment are increasingly globalized, the entire world may become an optimum currency area. The huge swings in currency exchange rates (the U.S. dollar has ranged from 80 cents to $1.60 for one euro in just the past seven years) have caused costly problems for everyone--from international tourists to major international traders and investors. Current mechanisms for currency hedging and forward trading can partially mitigate some of, but far from all, exchange rate risks, and they are often costly.

Banks and other financial institutions do provide some private specialized currency baskets, but these are of limited use. As noted above, proponents of the expanded use of SDRs correctly note that the SDR can serve as a unit of account, a means of payment, and even a store of value, but the definition and value is determined by a group of international bureaucrats and...