Inescapable Role of Real Currency Convertibility

Introduction

In the previous chapter, three different approaches for replacing the role of the US dollar were discussed. From the point-of-view of users, whether individuals, companies, government organisations or others, the single most valuable feature of a currency is that its real value should be reliably stable – just as the definition of physical and engineering units such as second, litre or volt do not vary. Although it is easy to agree with this, it is not so easy to define “stable” in this context. This is because the prices of the innumerable goods and services available in a modern economy change continually, and so the value of a currency measured in terms of any one of them also varies continually. Nowadays governments and economic services continually collect data on a small number of representative goods and services and calculate an index number to show the average value of their currency. The rates of inflation or deflation that are announced periodically are calculated from movements in these price indices. Due to political pressure to make optimistic announcements, there is continual controversy over the relative accuracy and honesty of these calculations and alternative measures. Governments generally try to keep the rate of inflation, that is the rate of decline in the real value of their currency to a low figure such as less than 2%, as measured by these indices. However, even at 2% per year inflation, savings lose more than half their value over a working life of 40 years: something better is needed to provide a new, firmer foundation for the world economic system.

6.1 Currency Convertibility

Among the proposals for what is to replace the US dollar, Internet-based “crypto-currencies” are expected to play a major role, despite the problem that a breakdown of either the Internet or of the electricity supply system would make them unusable – possibly forever. This risk makes crypto-currencies at their present state of development truly a “unique” category of assets.

So far, the value of crypto-currencies is generally stated in terms of existing currencies. This is logical, since potential users need to purchase them, and to know how much they need to use in order to make a payment in an existing currency. But this means that cryptos are still dependent on existing fiat currencies. A major threat today is the danger of accelerating inflation, as measured by price indices, resulting from the huge expansion in the money supplies of OECD countries that has been made in 2020 and 2021. History shows that there is now a serious threat of “hyper-inflation” occurring, whereby existing currencies may lose much or all of their value. In this case, how will the value of crypto-currencies be defined? That is, we can imagine the prices of different cryptos rising faster and faster as inflation accelerates, thereby preserving the value of people’s savings better than holding cash. But when the use of hyper-inflated fiat currencies literally ends – as has happened many times throughout history – what will the value of cryptos be? Or, put another way, how should their values be defined in order to preserve their value over the long-term, independent of the fate of existing fiat currencies, which they are supposed by their supporters to replace – even if they continue to be vulnerable to electric power outages? The rapid rise in price of many cryptos has been a major reason for their rapid adoption. However, although a rise in price is attractive to holders, this encourages hoarding. A rise in price of a crypto may be compatible with its use for making short-term payments, but it is not ideal for business: long-term investment is encouraged by stable and predictable currency values.