Friday, May 27, 2016

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).


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.


  1. The trend appears to be moving away from pegs to a clean floating FX system, and also away from a reserve currency at all...

  2. "The urgency to adopt a new standard diminished as discoveries in South Africa and the Yukon spurred gold production higher, thus reducing deflationary pressures."

    This quote contains a barely discernible thread into the relationship between "standards", price level, and time (of labor needed to mine gold). Standards are peculiar things because they are always "relative" to something.

    The value of time-of-labor is one of the most difficult things to measure that we find in macroeconomics. It is even hard to define what the goal of measurement might be, but I will make an opening gambit.

    I would like to measure my time in terms of future value. It would be nice if I could work one hour tomorrow and then save that hours work for future spending without worry that I would lose that hours work due to inflation.

    That was periodically a reasonable expectation using gold coins as the time-of-labor storage vehicle, but gold coins have the limitation that they are subject to hording. Holders have the macro-ability to universally stop trading, which causes instant paralysis in a gold based monetary economy. This is obviously a major flaw in the use of gold as a time-of-labor-storage-vehicle.

    So what-in-the-world could our standard be that would (world wide) measure and preserve the value of time-of-labor?