The Parallel Currency Option

The Parallel Currency Option
June 10, 2012

(This item originally appeared in Forbes.com on June 10, 2012.)

http://www.forbes.com/sites/nathanlewis/2012/06/10/if-the-gold-standard-scares-you-how-about-a-parallel-currency-option/

A friend asked me: “What country today, besides the United States, could transition to a gold standard system?”

The technical answer is: any of them. However, that is not what she meant. What she meant is: what country could do so, without causing unacceptable levels of economic turmoil?

That is a more difficult question. The basic problem facing a country like Nicaragua, Pakistan, Cambodia — or China — is that the major international currencies, such as the dollar, euro, pound and yen, are highly variable compared to gold.

You can argue – correctly, I would say – that this represents the unsteady value of these floating currencies, while gold itself is relatively inert, a constant of stable value. Gold has served this role for centuries. It’s not gold that is “volatile,” but rather these chaotic bits of fiat paper.

That may be true, but in practical terms, most other countries can’t put up with this kind of exchange rate volatility on an extended basis. The turmoil imposed on the conditions of trade would be too much to bear.

There are a few exceptions: localities for which the “terms of trade” are not particularly relevant. I would include the oil-producing states, such as the Gulf States or Brunei. Also, the financial havens like the Cayman Islands would probably be OK. These countries, due to the nature of their economies, have a great opportunity to adopt gold standard systems, where other states cannot easily do so.

Most countries in the world have some sort of currency link, formal or informal, with major international currencies, to maintain stable trade conditions. This link might be a fixed system, like Hong Kong’s currency board, or it might be a more casual arrangement, such as Russia’s unofficial policy of maintaining the ruble in a stable band compared to the dollar or euro.

However, if the dollar or euro’s future is not a particularly happy one, then this currency link will tend to suck these other countries down the devaluation hole as well. This is what happened when the world’s premier international currency, the British pound, was devalued in September 1931. It happened again when the premier international currency, the U.S. dollar, was devalued in August 1971.

If you look at the performance of currencies around the world compared to gold over the last decade, you can see that it is happening again.

One option for these countries is to introduce a parallel, gold-linked currency. Most countries in the world have an effective “dual currency” system already. Business is conducted both in the local currency – typically some sort of unreliable junk – and also in some major international currency, such as the dollar or euro. U.S. tourists have found for decades that they can spend their dollars in shops around the world. When these countries have one of their usual bouts of currency turmoil, business tends to migrate more towards the international currency.

In a similar fashion, a government could introduce an alternative gold-linked currency within their own borders – or, at the very least, allow a private organization to do so. If the U.S. dollar or euro, and the domestic currencies linked to them, become unreliable, then business would naturally migrate to the gold-linked currency. This would be relatively painless, because each person would make the switch when it was to their advantage to do so. Rather than causing problems, the parallel currency would offer a solution.

Several U.S. states, beginning with Utah, have already begun to lay the legal groundwork for gold-linked secondary currencies in the U.S. However, I think there is a great opportunity for something we haven’t seen before: a state-sponsored major international gold-linked parallel currency.

Let’s say that the Russian government, with all the support of the Russian state, issued a gold-linked parallel currency. The existing, casually dollar-linked ruble would remain, but the government would also issue and allow the use of a gold-linked ruble. Perhaps they could call it a “gold chervonet,” in honor of the gold-linked currency Russia first introduced in 1701. (One chervonet was worth 3.47 grams of gold.)

However, this could also be an international currency. Let’s say that a corporation wished to issue bonds denominated in gold chervonets. Why? Because there would be many ready buyers for such a bond, and thus the corporation could raise a large amount of capital at excellent rates. This is why most large corporations around the world raise capital with bonds denominated in dollars or euros, instead of their low-quality local currencies.

Where would they issue such bonds? In Moscow of course. Thus, Moscow would become the financial center for all issuance and secondary trading of debt and equity denominated in gold chervonets. (Reliability of contract law and political stability would be a prerequisite for Moscow to become such a financial center, however.)

In this way, Russia could provide a path to a world monetary system based on the gold chervonet, rather than the fiat U.S. dollar, but without the disruption that would be caused by transitioning the ruble to gold directly. The existing dollar-centric monetary system would continue, but Russia would also provide an alternative for anyone who wished to use it – not only for its own citizens, but for people around the world.

There would be no official “day of transition.” People would decide, one by one, when the time had come for them to stop doing business in U.S. dollars – and other fiat currencies within the dollar-centric system – and start doing business in gold chervonets, or some other gold-linked alternative.

Probably, there would come a “tipping point,” when the majority of business worldwide is done in gold-linked currencies, and there is no longer any reason at all to use Ben Bernanke’s funny money. When that point would come is hard to say: maybe in a few months, maybe after ten years or more.

The point is: nobody has to decide when that time comes. It would happen naturally and painlessly, as the collective decision of people around the world. Which is the way it should happen, don’t you think?

Russia has done this before: in 1922, the gold chervonet was re-introduced by the Russian government, as a parallel option to the floating fiat ruble. Both currencies circulated side-by-side. By 1947, the ruble was pegged to gold at a rate of ten rubles to one chervonet. This eliminated any need for two parallel currencies, and the chervonet was retired. It had done its job well.