Money is a yardstick we use to measure the value of things. It is also a lubricant that eases the exchange of goods and services. Additionally, money is a way to store wealth, particularly in the short term.
We tend to think of money as something issued by a government, or as some like to say, “backed by the full faith and credit of the government,” for whatever that is worth. But from prehistoric times and continuing into the present day, people have adopted and used systems of money that have no government backing. In many places and times, people have even preferred other forms of payment instead of the official government-approved money.
Government-issued money has never been very stable due to the constant temptation of debasement, and since the world abandoned the gold standard, debasement has become as easy as punching a few digits into a computer. With the government controlling the money supply, those who stand to gain the most from debasement (government officials) are those who are given the power to debase the money, while those who stand to suffer most from debasement (the working poor) have little say in the matter.
Cryptocurrencies are becoming popular. People are, quite reasonably, leery of the stability of government-issued money and of the invasion-of-privacy inherent in most electronic payment systems. However cryptocurrencies are inconvenient, have been suffering massive losses due to security issues, and do not really solve the invasion-of-privacy issue. Fiat currencies, including cryptocurrencies, have no inherent value and therefore are potentially subject to unlimited swings in value.
One can stabilize the value of a currency by tying it to something real, such as a commodity. Many today call for the value of the U. S. Dollar to be tied to the value of gold. Gold was historically a convenient form of money, at least for the wealthy, because it is physically stable and relatively rare. A small amount of gold coin could be easily carried and physically exchanged for a large amount of goods and services. Silver and copper coins were carried and physically exchanged by those who could not afford gold. In a world where most transactions are recorded electronically with no physical transfer of currency, gold has little advantage over other stable commodities as a monetary standard. (I will suggest iron as a standard for reasons that will be addressed later.)
A system is needed to maintain the link between a commodity-based currency and its commodity. This link has traditionally been enforced by the same governments that both define and issue the currency. This is what is colloquially knows as having the fox guard the chicken coop.
One traditional problem with commodity-based money, as with fiat money, has been debasement. For commodity based money, the issuing organization, typically a government, either reduces the amount of valuable metal in coins or reduces the quantity of commodity pledged to back each monetary unit. For fiat money, the issuing organization simply spends more money than it receives. Debasement results in an increase in the money supply (inflation) and an eventual decrease in the market value of the money as the additional money enters the market. The organization that debases the money gains an advantage by spending the debased money immediately before its market value decreases. The working classes tend to suffer a resulting loss as the additional money trickles down to them only after prices have already risen.
To reduce incentives for debasement and keep people honest, the organization that prescribes the commodity-value of a monetary unit should be completely independent of the organization authorized to issue currency designated in that unit. Audits should be conducted by a third independent organization.
People all over the world stand to benefit from access to a stable monetary unit that can be used for both local and international transactions. Those who stand to benefit the most are those living in smaller, poorer countries where the local currency is not generally recognized or accepted beyond their borders. By working together, these smaller countries could establish an international standard defining a commodity-based monetary unit, including creation of the money, independent auditing, and enforcement. No one country would individually control the process, but people from all countries could benefit from using the standard.
The International Organization for Standardization (ISO) has issued standards for other economic processes that contain unit definitions, procedures, auditing standards, etc. analogous to those that would be be required to establish an international standard for creation of commodity-based money. ISO seems an appropriate place to document a new international monetary standard. ISO standards are voluntary. Enforcement of the standard could be mainly reputation based, with everything, including audit results, transparently documented on a public blockchain. Enforcement by reputation could be supplemented by lawsuits or fraud-prosecutions in countries with reliable legal systems.
The standard will need to define the unit of money in terms of some commodity. It will need to establish procedures that must be followed by the organizations that create the money. It will need procedures for auditing those organizations to verify that the currency they issue is backed by an adequate quantity of the stated commodity and was created following the procedures in the standard. It will need procedures for establishing the blockchain and for publishing all transactions and audits to the blockchain. And it will need to identify how the standard may be enforced and by whom.
A commodity unit such as a kilogram of iron could be used as the basis for a monetary unit which I will call a “kiron,” though other commodities would do. A kiron might be defined to contain at least 98% metallic iron, up to 2% carbon, and up to 0.5% other metals, with some limit on impurities. Many businesses that produce iron or iron-containing products keep iron products meeting these specifications in stock. They can lease their stocks to banks which can use the stocks as a basis for issuing the money. As the business storing the metal moves materials in and out of stock, the quantities leased to the bank will fluctuate as will the amount of money the bank may create based on those stocks. A brief time-lag allowance will be needed for the bank to adjust.
As banks lend out the kirons, borrowers will spend them and they will come back to the banks, where they can be lent back out to others, thus increasing the money supply as needed beyond the initial amount of commodity iron. Banks should be required to inform depositors what percent of deposits they keep in reserve and information about their outstanding loans to help depositors understand the risks they are taking. Of course, all of that information should be on the blockchain. Banks or depositors may purchase private insurance to protect deposits from loss due to bad loans or fraud.
The information on the blockchain will help people identify and avoid weak banks and questionable auditors, while providing incentive to banks and auditors to comply with the standards. Additionally, for a bank to issue kirons in violation of the standard or an auditor to falsify an audit could be prosecuted as fraud in most countries.
The messiest part is keeping the value of the kiron or other monetary unit connected to the underlying market value of the commodity. Suggestions in this regard will be appreciated. The normal way is through procedures that allow people to challenge the system, either to demand delivery of the commodity at a price close to its official monetary value or to demand delivery of the official amount of monetary units for a specified amount of the commodity. This can be messy because iron is not just iron; there are ingots, plates, sheets, bars, etc. in various grades and quantities, and their relative prices fluctuate with supply and demand. Other commodities are stored in various forms, grades, and quantities as well. Arranging physical transfer of the commodity can be complicated. Additionally, there must be sufficient incentives for parties to accept these challenges.
When a holder of kirons challenges a bank demanding metal, the bank will not have tons of iron sitting there in a vault. The bank will need to have a contractual arrangement with a business that can supply the iron, and will charge the challenger a fee for assisting with the arrangements. The supplier of the metal will charge the challenger a handling fee and will arrange a location and time period wherein the challenger can pick up the metal at his/her own expense. The supplier may specify the units in which the iron is available, such as 100,000 kilogram ingots, and the challenger will need to accept those units and pay for them at the official rate. In the unlikely event of a bank run with people demanding more metal than is immediately available there may be a delay of some months producing and providing all of the metal demanded.
What would happen if a holder of metal wanted to exchange it for the official quantity of kirons? It would not be practical to allow any random individual with a chunk of iron to demand to be paid for it. As explained above, a bank that creates money based on stored iron, will have a contract in place with a metal supplier. That contracted supplier could challenge the bank to buy its iron at the official rate. In this case, the seller would pay the bank for acting as its agent to find a buyer for the metal, and would pay to ship the metal to a location specified by the bank. If the bank were to resell the metal for above or below the official price, then the bank would take the resulting profit or loss.
This system of challenges would be inconvenient and costly, discouraging anyone from challenging the system unless the market value of the kiron was substantially above or below its official price. But the possibility of challenges would incentivize banks to keep the market value of the kiron close to the commodity value of its base.
Iron provides the bones that support the rest of our society. It is produced and used in large quantities around the world, and even nations without iron ore can recycle their iron and steel. About 95% of all metal produced in the world is iron and steel. (Steel is just iron with a little bit of carbon added.) Due to the large supply and demand of iron, its value is affected more by actual supply and demand than by speculation. It would be difficult for anyone to manipulate or corner the market on iron. When the economy is growing, the demand for and value of iron tends to increase and the reverse happens when the economy declines. Therefore, using iron as the monetary base would naturally tend to dampen economic cycles without the need for outside intervention.
Another large-volume, widely-used, stable commodity such as copper could work about as well, and copper has traditionally been used as money. Both iron and copper are readily recycled. Consumable commodities such as oil or wheat would not work well because available quantities fluctuate widely, as do their market values compared with other goods.
The legal implications of fraud were addressed above, but not its effect on the money supply. It could be disruptive to have money suddenly disappear when it was found to have been created fraudulently. The plan assumes that money created by a bank based on iron supplies will be lent out immediately, as the bank gains nothing by paying rent on iron while not earning interest on the resulting money. If the bank has not lent the money, then there is no problem letting that money disappear instantly. If the bank has lent the money, the loan payments, principal and interest, should go toward retiring the fraudulent money until all of the fraudulent money has been removed from the system.
Posted 2022/05/29
2022/09/14 Comment: A reader with experience in computer network security says blockchain has security issues and there are better ways to maintain a publicly-verifiable financial record.