Friedman, the Blockchain, and the Coming Monetary Revolution
How distributed ledgers hold the key to better money
In my last post, I argued that it’s possible to design a currency which naturally exhibits all the properties of good money. If you haven’t seen it yet, you can find the post here (TL;DR, a currency backed by a basket of commodities will be a stable store of value while not requiring ad hoc monetary policy). The core proposal in my post for a commodity basket currency (CBC) was not original and has been the subject of considerable debate among leading economists including John Maynard Keynes, Friedrich Hayek, and Milton Friedman.
A quick survey of the world’s monies (or even just what’s in your wallet or purse) is all that’s necessary to realize that those against commodity basket currencies, the vast majority of the world’s financial titans and policy makers, won the debate. I argue here that the points against commodity money are either unfounded or can be now be overcome.
In his paper, “Commodity-Reserve Currency”, Nobel laureate Milton Friedman put forth his argument against commodity backed currencies. In line with many other economists, Friedman argued that while the theoretical benefits of commodity money, including price stability and a natural countercyclical tendency, were significant, the practical considerations and costs negated any potential benefit.
A currency that works countercyclically will work to increase economic growth in times of recession or depression and will slow growth when an economy may be expanding at an unsustainable rate.
In Friedman’s view, the first point against the feasibility of commodity money concerns the ability of such a currency to capture a sufficient portion of the economy. This is a major concern because the countercyclical and price stable properties of commodity money largely rely on it being backed by goods from as many different sectors of the economy as possible. Aware of this potential pitfall, advocates for commodity backed currency often included at least three of the major commodity groups — energy, food staples, and metals — in their proposed baskets. Arguing against such currency schemes, Friedman looked at what he believed to be the feasibility of storing each type of commodity, arriving at the following conclusions:
- With respect to energy goods, the problem Friedman encountered was a technological one. At the time of his writing, energy sources such as crude oil, natural gas, and coal were not regularly stored for extended periods due to the difficulty and cost of doing so.
- Regarding food staples, such as grains, corn, and soy, Friedman noted a potential moral hazard in using these goods for monetary purposes. He considered what may happen if a poor growing season were to occur coincident with the need for an increased supply of money. If we are dealing with (as Friedman was) a commodity currency that required fixed amounts of each commodity in its basket, then the monetary usage of food staples could severely exacerbate any existing or potential food shortage as it would be more profitable for farmers to sell their goods for monetary purposes than for consumption.
- As a group, metals (both precious and industrial) are the only commodities that Friedman deems suitable for monetary use. This inclusion is perhaps not surprising given the historical use of metals in monetary functions. Despite this acceptance, Friedman is quick to note that even the inclusion of additional metals (copper, steel, aluminum, etc) fails to provide a potential commodity currency with sufficient economic breadth.
First, regarding energy goods, Friedman’s concern does not require much consideration, as it stemmed entirely from now outdated technical limitations. Storing energy sources is now a common and economical practice. On the other hand, the monetary use of food staples presents the same potential moral hazard today as when it was first suggested. Luckily, this problem can be solved if we redefine how the basket of commodities supporting our currency is composed. In prior proposals for a commodity currency, the commodity basket was fixed in the physical amount of each commodity. And it is this property that creates the potential for exacerbated food shortages. If we instead define the composition of our basket with respect to the value of each commodity, then we avoid this quandary. Now, when the price of a food staple rises, the amount required by each unit of currency will decrease.
Friedman’s second point against commodity money is his claim that the need to store a sufficient amount of commodity stuffs would make the entire system infeasible and wasteful. On the surface, it does seem as though locking away useful commodities just to be used as money would be a massive waste of production. However, looking at how commodities are actually handled, one realizes that the additional cost is not as high as this critique would indicate.
The key here is that commodities are already stored for non-monetary purposes. The production and exchange of commodities is a major logistical challenge, requiring thousands of warehouse and storage sites just to match supply with demand across time and geography. The consequence of these logistical needs is illustrated in the table below. At any time, we can expect between $150 and $200 billion worth of energy goods, food staples, and metals to be held in storage just for US based exchange and contract fulfillment.
Although it’s a strong start, the $170 billion worth of commodities shown here does not come close to the at least $500 billion monetary base required by an economy as large as that of the US.
Where can we find $330 billion?
In order to fully rebut Friedman’s claim that a commodity currency brings with it wasteful storage of otherwise useful goods, we must discover a way to create $500 billion worth of commodity backed money without devoting substantial resources to storage or holding useful goods idle. Let’s assume that we begin to construct our commodity basket using the $170 billion in commodities that are already sitting in storage waiting to be bought and sold. This leaves us to address a $330 billion shortfall. Looking first at commodities in storage (table above), we see that we are rather light on precious metals. Given that the storage of precious metals could hardly constitute waste (since being held is an essential function of precious metals), we decide to add $110 billion to our gold, silver, platinum, and palladium holdings, which will give us a final basket consisting of about 25% precious metals. We’re now up to $280 billion, only $220 billion left to go!
Typically, we tend to think about commodities as discrete goods like those we have already discussed here — energy goods, food staples, and metals. But what about utilities? Utilities such as electricity, water, and even computing power and storage, all meet the core criterion for a commodity, fungibility. One kW-h is equivalent to any other kW-h and clean water is clean water. Historically, the problem with treating utilities as commodities is the fact that utilities are consumed as they are produced and not stored for extended periods of time as with other commodities. Because they cannot be owned (only purchased and consumed), utilities themselves are not capable of underpinning a currency. However, the means of utility production can be owned.
The combination of blockchain and smart devices (IoT) means that the ownership of utility production can now be easily bought and sold (more on this in a future post). Including the means of utility production in our basket of commodities allows us to more than cover the $220 billion gap between the value of traditional commodities and the required size of our monetary base, all without devoting resources to the wasteful storage of commodities for monetary use.
Now that we’ve managed to overcome the previously fatal flaws of a commodity-basket currency, we are faced with one final dilemma — even if people agree that commodity money is better than the fiat money we use today there is a great deal of inertia and investment in the status quo. Before the release of Bitcoin in 2008, the creation of a viable alternative to national currency regimes would have seemed absurd. Today, the collective value of all cryptocurrencies exceeds $100 billion and is showing no signs of slowing down. Even if none of the cryptocurrencies introduced so far are ultimately successful, something far more important has already happened, the idea of competition has been reintroduced to the world of currency.
At Topl, it’s our expectation and hope that the reemergence of competition between currencies, which had been all but lost in the post-WWII financial order, will reignite the active exploration for the best possible money. To learn more about our work developing a commodity-basket currency as part of our mission to create the first truly global investment protocol, follow our blog, join us on Slack and Reddit, or check out our Github!