The Other Side of Convertibility: Commodity Price Stabilization

Introduction

The discussion of commodity-based currency convertibility brings us to a key issue concerning the potential importance of this subject: guaranteeing the convertibility of a currency into a commodity necessitates announcing prices at which the body implementing convertibility will exchange the commodity for currency. Ipso facto this guarantee keeps the price of the specified commodity between the prices at which convertibility is guaranteed. That is, implementing convertibility of a currency into a real commodity is ipso facto to stabilize the price of the commodity in terms of that currency. In “mainstream” economics the subject of commodity price stabilization is typically treated as a separate subject from currency convertibility, which is part of the separate field of monetary policy, although they are in reality inextricably interconnected – indeed, literally the same phenomenon.

The topic of commodity price stabilization is itself the subject of an immense and wide-ranging literature, accumulated over decades, involving detailed analysis of many different policies and plans such as domestic agriculture support policies, ways of stabilizing farm incomes, subsidies or tax-relief for increased stockpiling, and other related topics. Another major sub-topic on which there is a very extensive literature is how to stabilize the notoriously unstable prices in international commodity markets – as in the discussion by Keynes and Hayek described in the previous chapter. Unfortunately, the great majority of the work on this topic has been done under the influence of an idee fixe: namely that a solution to the problem can be achieved only through international negotiations. Although this idea sounds logical, it has in fact failed to produce a solution to the problem despite discussions continuing for more than a century to date.

Hayek’s paper quoted above was titled “A Commodity Reserve Currency”, which refers specifically to Benjamin Graham’s 1937 proposal for the establishment of a system to maintain prices of a range of primary commodities above a “floor price” by buying market surpluses as required, and below a “ceiling price” by selling sufficient reserves at times of shortage. This basic idea is easy to understand and it or similar proposals have been supported by many others, including Keynes, his successor Nikolas Kaldor, and others. However, even if the principle is accepted, the precise details of realization are of extreme importance in order to confirm that the policy would be truly beneficial. This is because the idea of interfering with market prices is itself almost taboo among many economists, because long experience has shown that it is very easy for government intervention in a market to cause greater costs than the initial instability, disrupting markets and thereby actually aggravating the perceived problem. It is a sign of how important Hayek considered the stabilization of trade fluctuations that he supported what would have constituted major interference with the commodity market price mechanism.

Hayek’s support for this idea proposed by Graham also attracted the criticism that it would expose governments to an open-ended liability, by promising to buy up any amount of commodities at the guaranteed floor price, and to supply any amount of the commodity at or below its guaranteed ceiling price. This is indeed the Achilles heel of this proposal. Moreover, as well as representing an open-ended commitment for the governments involved, it is inevitable that forcing commodity prices to remain within a fixed price-range would at times severely distort market prices, causing problems both for supply and for demand.

Nevertheless, due to the widely recognized importance of the objective of reducing the depth of cyclical trade fluctuations, emphasized by both Keynes and Hayek, discussion of different aspects of the problem continue to the present day. Roughly speaking, proposed means of implementing the plan comprise three different approaches: “buffer-stocks”, some versions of which include a “commodity-basket”, and “virtual systems”. All of these ideas face serious problems, as discussed next.