2.3 Synthetic Commodity Money

The search for an "ideal" base money has long preoccupied monetary economists, and in 2015 George Selgin published a particularly relevant article in the Journal of Financial Stability titled Synthetic Commodity Money.

He was investigating the possible use of current-generation cryptocurrencies for monetary reform, and noted that base-monies conventionally fall into one of two categories: "commodity" money and "fiat" money.

Selgin observed that cryptocurrencies like Bitcoin, break this conventional dichotomy resembling both "fiat" and "commodity" monies. Specifically, these digital assets:

  • Resemble fiat-money in having no non-monetary use
  • Resemble commodity-money in being absolutely scarce

Finally he concluded that the categorization to-date excludes a class of potential base-monies with characteristics that can make them especially capable of supplying the foundation for monetary regimes that are both macro-economically stable and constitutionally robust.

For this reason, Selgin introduced a new classification: Synthetic Commodity Money.

>> Amples are a synthetic commodity-money

Below we'll talk about the advantages and disadvantages of both fiat and commodities as base-monies, and then discuss synthetic commodity-monies in context.

Fiat Money

"Money is too important to be left to the central bankers." - Friedman (1962)

Fiat money is generally understood to consist of paper notes, or central bank deposits readily convertible into paper notes, that are useful only as a media of exchange.

Since paper monies command value far exceeding their marginal cost of production (ie: the cost of the underlying ink and paper itself) it follows that the scarcity of fiat money is not a "natural" scarcity, but one that is contrived.

As Friedman observed, because the marginal cost of producing say a $1000 bank note is no higher than that of producing a $1 bank note, “it is not clear that there is any finite price level” that will constitute an equilibrium and competition would tend to drive its value to zero.

For this reason, fiat money does not lend itself to competition, and its value needs to be sustained by "monopolistic provision."

The advantage of fiat money is that because it's so inexpensive to manufacture it can be managed—not only to preserve its purchasing power over time—but also to achieve the greatest possible degree of overall macroeconomic stability.

The disadvantage of fiat money relative to commodity money as a base-money, is that its scarcity is contingent (ie: a matter of deliberate policy only). There is no guarantee that it will be properly managed, and market forces (distinct from political ones) offer no check against mismanagement.

Commodity Money

"Money is too important to be sacrificed to the operation of blind forces." - Keynes (1936)

Commodity-monies—being naturally scarce and politically-independent—are resistant to mismanagement. But they are not without drawbacks of their own. In particular, they are vulnerable to supply shocks.

In the case of metallic moneys such shocks might consist either in the discovery of new relatively high-yield ore or of lower-cost means for extracting minerals from known sources.

In the absence of positive innovations to supply, on the other hand, the wearing-down of outstanding coins and rising marginal extraction costs will, in a growing economy, result in secular deflation. Changes in the nonmonetary demand for an ordinary commodity can also destabilize a monetary regime based upon that commodity.

Finally, commodity-monies are costly. Friedman regarded the fact that a commodity standard “requires real resources to add to the stock of money” as the “fundamental defect” of such a standard.

Synthetic Commodity Money

According to Selgin, the distinguishing characteristic of synthetic commodity money, relative to other kinds of base-monies, is that by resorting to it, we can avoid leaving the management of money either to central-bankers or blind forces of nature.

1. Like fiat, a synthetic commodity standard is free from the cost disadvantages of a commodity standard.

2. Because synthetic commodities enforce absolute scarcity, they are not subject to supply-distortions stemming from either from raw-material discoveries or technical innovations.

3. Because synthetic commodities have no alternative non-monetary uses, like fiat they are not subject to price distortions from non-monetary demand.

4. Like that of genuine commodity-money, the supply of a synthetic commodity-money is not subject to politically motivated changes.

General Remarks

Selgin reiterates that there's no reason to believe that fixed-supply synthetic commodity monies like Bitcoin would be free from the deflationary problems affecting genuine commodity-standards.

However, he states that these "shortcomings of a Bitcoin standard raise the intriguing possibility that one might create a synthetic commodity money based upon a more macro-economically friendly production protocol—one that might achieve outcomes similar to those that might also be achieved by a perfectly enforced monetary rule. Such a money might, for example, bear a perfectly elastic supply schedule, so as to preserve a stable purchasing power." (Selgin 2015)

Ampleforth

As stated above Amples are a synthetic commodity-money; however unlike Bitcoin, Amples take advantage of low production costs, expanding and contracting in response to demand to be macroeconomically friendly.

External References

  • G. Selgin (2015), Synthetic Commodity Money, Journal of Financial Stability.
  • M. Friedman (1962), In Search of a Monetary Constitution, Harvard University Press.
  • J.M. Keynes (1936), The General Theory of Employment, Interest, and Money.

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