12/01/2019 No. 148
 
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Where Does the Supranational International Currency of Constant Value Come from? --New Concept and Framework of the World Currency Primary
By Charley Fei (Shuiyu Fei) and Zhongjia Pang Translator Sheng-Wei Wang
September 1, 2009


Excerpt: The strong catalytic influence of the current financial crisis has strengthened the cry for world monetary reform and turned it into a big issue that can no longer be ignored by the international financial world.

At present, given the reality of sovereign currencies used independently by different countries, no borderless “single world currency” can be instituted at one stroke.

The authors of this article advocate the new concept of using the fixed credit currency value, which is based on the international purchasing power parity indicator, as the benchmark for a supranational international currency of constant value called World Currency Primary, WCP. They devise a framework and a realistic roadmap for its practical implementation.

The authors propose that this supranational World Currency Primary be complementary to the various existing sovereign currencies, and that it serves as the vehicle for international payments. Once implemented, the world will no longer expect to be subject to currency hegemony and seigniorage privilege by any single country. Foreign reserves and arbitrage of exchange will be things of the past, while problems due to international exchange rates will disappear completely. The now-familiar turbulence in the global financial markets will be eliminated and globalization will become more transparent, fair, healthy and effective. This would accomplish the realization of a harmonious world, which is the grand goal of reforming the world monetary system. 

Introduction

The current round of financial crisis strongly underscores the irrationality and non-sustainability of the U.S. dollar supremacy being an illogical system in today’s world monetary system.

Crisis is an opportunity for the birth of change. With the financial crisis having gone through its most dangerous period, the market bailout begun to pay off and the regulatory reform started, now is precisely the moment to respond to the call of the historical mission to establish a “supranational currency” on the highest level agenda of the world to avoid wasting time.

At the first finance ministers’ meeting among the BRIC countries (Brazil, Russia, India and China) on November 7, 2008, the four countries called for reform of the international financial system. On March 11, 2009, during the Euro-Asia Economic Forum, President Nazarbayev of Kazakhstan proposed the creation of a new world monetary system using a unified currency for trade settlements. On March 16, 2009, Russia on the official website of the Russian presidential press service proposed to establish a supranational super-reserve currency and give the International Monetary Fund (IMF) or the new international financial organization the status of the issuance authority.

On April 2, 2009, the second round of the G20 (group of 20) financial summit opened in London. After Chinese Premier Wen Jiabao expressed for the first time his concern over the risk of China's large-scale investment in the United States and Vice Premier Wang Qishan called for reforming the international financial system, the March 24 issue of the website of the People’s Bank of China published a long article authored by the Bank President Zhou Xiaochuan entitled "Thoughts on the Reform of the International Monetary System."

Zhou Xiaochuan’s article pointed out that the international reserve currency should first of all have a stable base and clear rules of issuance to ensure an orderly supply; second, the total supply should also be allowed to increase or decrease in a timely and flexible manner in accordance with changes in demand; third, this adjustment must be detached from the economic situation and interests of any single country. The present use of a sovereign credit currency as the major international reserve currency is a rare exception in history. The current crisis warns us again that we must creatively reform and perfect the existing international monetary system to promote the international reserve currency in the direction of perfecting a stable currency, an orderly supply and an adjustable volume in order to fundamentally safeguard the stability of the global economy and the financial markets.

Zhou’s article expressed that the outbreak of the financial crisis and its rapid global spread reflected the inherent defects and systematic risks in the current international monetary system. Therefore, the ideal target of the reform of the international monetary system should be to create an international reserve currency that is detached from sovereign states and is able to maintain a long-term stability of its value so as to avoid the inherent defects of the use of sovereign credit currency as the reserve currency.

Zhou Xiaochuan believes that the reconstruction of a new reserve currency that has a stable baseline value and is acceptable to different countries may be a goal that will take long time to achieve. The establishment of an international monetary unit envisaged by Keynes is furthermore a bold idea of humankind, and requires politicians from all nations to come up with extraordinary visions and courage. In the short term, the international community, particularly the monetary foundations, should at least recognize and face up to the risks caused by the existing system and perform continuous monitoring, assessment and early warning. At the same time, they should also provide special considerations to the full play of the special drawing rights (SDRs) role. The SDR has the characteristics and potential of a super-sovereign reserve currency.

Zhou’s article has drawn great attention from the international community. Several countries in Asia, as well as Brazil, Argentina and Russia immediately expressed support for Zhou’s proposal; the IMF, those responsible for the advisory missions to the United Nations (UN) financial and economic reform, as well as global politicians, economists and all sectors of the community echoed this reaction. In this particular critical juncture, this article has played a historic role in promoting the initiation of a reform of the world monetary system.


U.S. President Obama, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner as well as leaders of some developed countries quickly expressed objections by reiterating their confidence in the U.S. dollar as the global center currency and by stressing that at present only maintaining the status quo would work.  However, Geithner said to the Council on Foreign Relations that on this issue the U.S. has a very open attitude and is willing to discuss this proposal by China.

They were obviously worried that a serious discussion of this issue at the present time might shake the confidence of the outside world against the U.S. dollar, drag down its exchange rate and make other currencies appreciate sharply, resulting in more complications for the global recovery process. Concerning its immediate interests, the United States does not want to see the kind of changes in the world financial market that will replace the privileged status of the U.S. dollar as the world center currency. But a just, healthy and sustainable international monetary system that does not rely on any single power is not only what a bright future of globalization should rely upon, but is also fundamentally consistent with the long-term U.S. national interests. The United States eventually will have to keep pace with and support the inevitable trend of history.

 

It is true that today's crisis is a financial and economic crisis, not a global currency crisis. It has not reached the level where it would shake the United States’ status as the dollar-hegemony empire. Thus the reform of the world monetary system will not be a chaotic movement of national salvation or unnecessarily take a radical approach. But it is possible that under the controlled situation where the U.S. dollar is still the center currency, all stakeholders, including the crisis starter i.e. the United States, can together conclude lessons learned. With peace and rationality, they can orderly and calmly embark on the reform path in a gradual and progressive manner. This implies starting the inevitable process of a great epoch-making change with the least chaos, or, borrowing a thermodynamic term, with the least entropy increase.

On April 2, after the closing ceremony of the second round of the G20 financial summit, British Prime Minister Brown explained to reporters the proposal of establishing a super-sovereign international currency. Since the participating countries failed to achieve a concrete consensus, the subject was arranged for further discussions at the third round of the G20 financial summit to be held in September 2009, at Pittsburgh in the United States. That means that this reform has reached the critical moment when it must embark on its start.

Today, we not only need extraordinary visions and courage from national policy makers and practitioners, but there should also be a practical alternative and at least some preliminary conceptual programs available for studying. Otherwise we would stay with plain talks that become long-drawn-out, far-fetched, blurred, or a fantasy.

The SDR has been shelved for 30 years and has not yet grown out of its infancy. In essence, it is still a composite that depends on the U.S. dollar and the currencies of several sovereign states. It cannot escape from the dilemma of "The Triffin Paradox," and remains as paper gold incapable of actually flowing as a currency. Is it not possible to advance with the times with imagination and breakthrough to make an invention out of a historical and global vision by using scientific and logical reasoning?

Before the world reaches a universal brotherhood and while national sovereignty is still in force today, each of the world’s 200-odd countries and regions uses its different sovereign currency. Owing to the huge differences in politics, economy and culture, there is no likelihood to reach the borderless "single world currency" or World Currency (WC) in one step.

 

What is needed in reality is similar to a prelude to the Wagner Opera. We need to first establish a transitional linkage mechanism to create a world reserve currency for an early stage --- the World Currency Primary (WCP), which is separated from state sovereignty. It specializes in pricing as well as settlement of accounts and serves as a reserve in international trade. The WCP would work in cooperation with other sovereign currencies. It will eliminate the natural irrationality of using the credit currency of a sovereign state as a world currency and fundamentally correct the long-standing chronic disease of a strong national currency dominating the world within this illogical system. It will achieve the initial realization of the goal of reforming the world monetary system into a harmonious world.

Only if such a reform road map can be produced for use, can we set up a world consensus that is worth putting into practice.

To that end, this paper tries to submit a preliminary and complete answer.

Realizing that the past is not recoverable, but the future is worth pursuing, we take the liberty of being the first to air this model on a trial basis. We strive to perfect this model and welcome discussions and comments.

1. No Off-the-shelf Model for the World Currency Primary

 

In this world, there are nearly 200 countries and regions using about 200 sovereign currencies in varied ways.

The growing international trade and investment activities in this globalized age can not continue even for a single day without a common currency. If there are no longer a single or even a few sovereign currencies belonging to a few strong nations as world currencies, then how can we create such a world currency out of nothing?

This article will not consider the gold standard system that has been abandoned by history or the credit currency in the gold exchange standard system.

The euro, the SDR and the unused bancor are the three most typical and important international currencies of the non-sovereign model that of course can help to inspire the idea of a world currency. But they all have strong limitations and not enough advantages to become ready-made models for the WCP.

The euro zone, by virtue of uniformity in many areas like politics, economy, and culture, has abolished the sovereignty of the individual currencies and implemented a single regional monetary system. Over 10 years, the results have been successful and the coverage has been expanding. But there still exist non-reconcilable contradictions between political independence and currency unification. In this much diversified world of today it is clearly not possible to apply the unique experience of the euro area.

The currency unit in the pre-euro era was a composite currency produced by a weighted-average calculation of a basket of currencies. It can be regarded as a liquidation tool, but, in essence, it is in contradiction with the nature of using currency as the monetary measure of value for commodities. Any commodity can have a unified value in the field of commodities only if it can show its relative exchange value to a certain commodity that is regarded as the "general equivalent commodity"(currency). This enables us to express the relative exchange values of all the commodities with each other and through the exchange of the same currency medium to achieve the exchange of different commodities. A conceptual currency made from a composite currency for the purpose of making calculations cannot actually become a currency to be used as such an exchange medium; it is incapable of possessing the functionality of the same value scale. 

The SDR of the IMF is also a composite currency consists of a basket of currencies from various countries. It was a response to the proliferation of the American dollar and the frequent dollar crisis. After repeated negotiations, it was set up in 1968 as a supplement to the reserve assets. It existed on the books as an asset to make up for the lack of liquidity of foreign countries, rather than an actual currency in circulation. The relative value of the SDR and the dollar is artificial, not a market-oriented exchange rate and it is difficult to truly regulate its market behavior. The exchange rate system therefore becomes more complicated. For practical use it must be exchanged into the U.S. dollar or other currency through other designated Member States of the IMF and cannot be directly used for trade or non-trade payments. It can only be used for government clearing between the Member States.

The expansion of the SDR application will undoubtedly contribute to the suppression of dollar dominated seigniorage privilege and alleviate the problems of the U.S. dollar fluctuations. It can be used as the pilot for creating a super-sovereign international currency. But the U.S. dollar will continue to maintain the highest proportion (currently 44%) in the SDR.  In a system of floating exchange rates, as long as the circulation of the sovereign currencies of different countries is not eliminated, all the ills of the U.S. dollar as an international currency will exist in the SDR.

After the collapse of the Bretton Woods system, the international community had high expectations for the SDR, and even hoped that it would eventually replace the dollar. But after more than 30 years, its proportion is still insignificant, whether it is used as a currency of settlement, denomination, or reserve asset. In the total amount of international reserve assets, the highest percentage of SDR has not been more than 5%. The SDR not being able to climb on stage can be attributed to many reasons. Apart from the lack of interest of the United States, its inherent flaws are a decisive factor.

The IMF is not an institution for issuing currency. The issuance of the SDR does not have the support of the real economy. So the amount of the SDR is not very large. If it is expanded and once these foreign currency assets are invested in the international financial markets, it will not change the condition of the issuance flood of the U.S. reserve currency.

 

At present, any kind of international currency uses the credit of its nation (or region) to support its international credit. Whether the IMF can support the international credit of such a supranational reserve currency is questionable.

Of course, the value determination, distribution, issuance and management methods of the SDR can be improved. But this implies a big operation, just like starting all over again.

Toward the end of World War II, the well-known British economist John Maynard Keynes proposed a world currency named "bancor". The bancor would mainly be used for international trade settlement and co-exist with the sovereign currencies of different countries rather than replacing the circulation of the national currencies.

The Keynes program proposed to set up an international settlement or monetary union abbreviated as theInternational Clearing Union” playing the role of the World Central Bank and issuing the bancor. It took 30 kinds of representative commodities (food, petroleum, copper, etc.) as a basket of determined currency value, which included gold, to facilitate the stabilization of the currency. The World Central Bank would take the pre-war 3-year average of import and export trade of the Member States as the shares for the initial distribution, but would not require the Member States to pay gold or foreign exchange, which was just like giving free gifts. Later, the increases in share reserves to different countries were made in accordance with the profits of the World Central Bank or by credit expansion. Countries with a trade deficit could borrow money from the Union, and countries with a trade surplus should deposit the surplus money into the account of the Union or purchase commodities from countries with a trade deficit.

Keynes required the central bank of each nation to use their own bancors as a base to ensure that their national currency maintained a firm exchange rate with the bancor; each country should work with its own currency to maintain a firm, however adjustable exchange rate with the bancor.

 

In the Keynes program, all the international trades used the bancor for pricing. The exporters received income in bancors, and the importers made payments in bancors. If a country could maintain a good trade balance, that country’s trade account in the Clearing Union should maintain a very small balance in bancors or even zero. He hoped that this monetary system could promote the trade balance between different countries. All countries with more exports than imports were known as the “creditor nations” and received a gain from trade surplus; on the other hand, all countries with more imports than exports were referred to as the “debtor nations” because of the loss caused by the trade deficit.

In order to solve the problem of the excessive surplus of the creditor nations, Keynes proposed that countries with savings paid interest to the Union, if the savings exceeded a certain level. This would push the creditors and debtors to actively cooperate to deal with excessive surplus or excessive deficit. Finally, if the debtor countries ran out of credit lines, it went without saying that they could face trade controls or currency devaluation. Therefore the British economist R. F. Harrod pointed out to Keynes that "In the long run, the Clearing Union does not provide an automatic mechanism to restore balance. If all the debtors have exhausted their quotas, the creditors will accumulate huge balances.  Then we are back to the starting point. “

Many problems are yet to be clarified within the Keynesian program. Among them, the biggest doubt may be: what does the credibility of the bancor, as a global credit currency, guarantee?

In fact, behind the Keynesian program existed a strong political intent in favor of the interests of the United Kingdom rather than the interests of the United States.

In the Keynes program, what did the Clearing Union rely on for issuing the bancor? Under the circumstances at that time, this could only be carried out with an overdraft, namely an overdraft to the United States. This meant that the United States would pay a huge amount of material wealth, and then receive a lot of bancors. But these bancors could not buy anything from the post-war countries, which were then almost in ruins. Therefore, the United States would have to bear a huge obligation of adjusting its huge surplus.

By contrast, the post-war debt-ridden United Kingdom did not need to pay gold or foreign currencies, according to its economic record of the past. Taking its pre-war 3-year average of import and export trades, it would receive a large share out of thin air and a great amount of money, which could account for its 16 percent share in the bancor, and the whole British Commonwealth could account for 35%. Wouldn’t this be a great fortune knocking on the door?

In accordance with the Keynes program, the United States on the one hand had to take on an unprecedented large-scale overdraft obligation, and at the same time, its massive amount of gold would become just like ordinary commodities such as iron, steel and coal, no longer functioning as an international currency. As a result the United States would lose its dominance in international finance.

After the Roosevelt administration well understood the wishful thinking of Master Keynes, the Keynesian program was doomed and replaced by the White program of the United States.

The 3 above models all have significant limitations as well as problems of applicability. In fact, in today’s world there does not exist an off-the-shelf supranational WCP. The following section will start from the baseline value, the fundamental element of the WCP, to seek a breakthrough on the basic concepts in order to maximize the principles of optimizing the design requirements of the WCP.

2.  The Purchasing Power Parity Revelation


In a global economy that has about 200 crisscrossing sovereign currencies, there must be a baseline value, known as a fixed "anchor", for the world's common currency. This anchor should not be a sovereign currency or precious metals like gold and silver. From the original definition of the currency, the original meaning of the anchor currency should be equivalent with an adequate representation of the currency --- a basket of commodities, including goods and services.

This basket of commodities is not only a representation of the primary commodities that meet the basic needs of people's livelihood. It should not only be limited to the little more than 30 kinds of commodities in the Keynes program, but should also cover a wide range of categories that are sufficient to reflect the overall integrity of the purchasing power of the entire society, and are weighted with appropriate proportions.

This ideal requirement seems very difficult to achieve. But today, the emergence of the international purchasing power parity (PPP) index and the electronic and information technologies make this possible.

In 1922, the Swedish economist Gustav Cassel (1866-1945) put forward the theory of purchasing power parity and explained it in full in his book Monetary and Foreign Exchange after 1914. The theory is essentially the most basic theory of deciding the exchange rate. From its birth, that theory has aroused a great deal of interest. Today it has not only received practical application, but also continued development and innovation.

Cassel believed that the drawbacks of using market-based exchange rates for comparing economic levels of different countries were obvious, because market exchange rates were built on the basis of short-term factors. They often distorted the truth due to non-reciprocal trade restrictions, excessive speculation on the foreign exchange market, long-term capital flows and the impact of such factors as government intervention. Therefore using market exchange rates to transform the gross domestic product (GDP) often could not reflect the true gaps of the actual levels of economic and social developments between different countries.

The main reasons that market exchange rates are difficult to accurately reflect the true ratio of real purchasing power of currencies in different countries are:

1. The market exchange rate and its fluctuation of course are related to the purchasing power of the currency and the price level, but are mainly affected by the international market and may be out of line with the real situation of the domestic market.

2. The formation of the market exchange rates and its fluctuations not only depend on the international market conditions, but also to a large extent are affected by the economic policies and the impact of people's expectations. For example, in today's world, trade barriers and foreign exchange restrictions are abundant, especially in some countries where a system of non-trade official exchange rates exists: their currency exchange rates are a far cry from the real purchasing powers.

3. International economic exchanges are not limited to commodity trading; they also include capital transactions of international credits in the international financial markets and national investments, etc. The situations of the latter have significant impacts on the formation and fluctuations in exchange rates, but do not belong to the scope of the purchasing power of money. Therefore, only part of the formation of the exchange rate has something to do with the purchasing power of money and cannot accurately reflect the actual differences between currencies of different countries in their purchasing power.

In today’s economic globalization, countries often need to carry out international comparisons of economic strength. The results of the comparison measured by traditional market exchange rates increasingly cannot truly reflect the actual gaps between the GDPs of different countries. Therefore there is a need to find a more effective method. Starting in the latter half of the 1960s, the UN Statistics Division, the World Bank, and the University of Pennsylvania have learned results from years of research and proposed a method to calculate the PPP. The UN Statistical Commission decided to adopt this approach and gradually developed comparisons of international productions and total revenue expenditures, and hence raised the curtain of the International Comparison Program (ICP).

In the ICP, the purchasing power parity is used. That is, in a country, through survey and data collection, we can estimate the country's representative commodities (goods and services) in the price of the local currency and compare it with the price to buy the same variety and quantity of commodities in the basis country (generally, it is the United States) to derive the actual ratio between the purchasing power of currencies of different countries. Namely we can use the PPP to replace the traditional market exchange rate, hence protect against the impact of exchange rate distortions and achieve rationalization of international comparisons. Based on this, the GDPs of different countries can be amended and compared on the basis of the PPP.

The ICP has gone through a development process from bilateral to multilateral comparisons, and then to sub-regional comparisons (multilateral comparisons within a region and then into global comparisons by joining the results). The basic idea of their research was to use the GDP calculated through the price survey and expenditure method as the basis to measure the true ratio of the PPP between different countries (the PPP is used as the conversion factor for the currency) to replace the traditional market exchange rate. The GDP of a country is converted into a GDP based on a base currency or an international currency.


In order to explain the concept of the purchasing power parity in layman terms, British The Economist magazine in September 1986 launched a Big Mac index.

The premise of the purchasing power parity is a “law of one price”: The exchange rate of two currencies will be naturally adjusted to a level such that it will cost the same to buy the identical “basket” of commodities with different currencies. The Big Mac index refers the “basket of commodities" to a large hamburger---the Big Mac---sold in the fast-food McDonald’s franchises. The reason for choosing the Big Mac is that it is sold in many countries, that it uses the same production specifications in different places and that the local McDonald’s is responsible for bargaining the material price. These factors make this index capable of a meaningful comparison of the purchasing power of different currencies.

The Big Mac index is not a formal economic indicator, but only uses a well-known commodity to measure whether the exchange rate of two currencies is reasonable in theory. Since then, the magazine has published a renewed index once a year. This index led to the Burgernomics (burger economy) term in the English-speaking countries.

 

The calculation method of the Big Mac PPP exchange rate is the use of the country's Big Mac price in local currency divided by another country’s Big Mac price in that country’s local currency. According to the PPP theory, the quotient can be compared with the actual exchange rate. If the quotient is lower than the traditional exchange rate, this indicates that the currency exchange rate of the first nation was underestimated; on the other hand, if the quotient is higher than the exchange rate, then the currency exchange rate of the first nation was overvalued.

 

This index has compared the selling prices of the Big Mac in the McDonald’s franchises in different countries. Assuming a Big Mac in the United States is sold for $2.50 and in the United Kingdom for £2.00, then the PPP exchange rate of the latter is 2.50/2.00 = 1.25.

If a dollar can buy £0.55 (equivalent to £1 = $1.82), then in terms of the selling prices of the two Big Macs, the traditional British pound against the U.S. dollar exchange rate has been overestimated by (1.82-1.25) / 1.25 = 45.6%. According to purchasing power parity theory, in the future the real exchange rate will approach closer to the PPP exchange rate.

In January 2004, The Economist launched a "Tall Latte index" (milk-in-coffee index). The calculation principle is the same as above, but replaces the Big Mac by the global popular Starbucks coffee.

Clearly, measuring the PPP with a hamburger has its limitations; for example, local taxes, business competitiveness and import duties on the hamburger materials may not be able to represent the overall economic situation of that country. In many countries, it is more expensive to eat at international fast food restaurants such as McDonald’s than at local restaurants. Besides, different countries may not have the same demand for the Big Mac. For example, in the United States, low-income families may eat at McDonald’s several times a week, but in African villages, low-income people may never eat a Big Mac. Nevertheless, the Big Mac Index is widely quoted by economists.

In order to facilitate the extraction of the new concept on the WCP in the text below, let us now use the overall commodities in the McDonald’s fast-food chain as an example again. We want to show the PPP of a wide range of commodities in a basket as follows:

Assume that McDonald's products sold in all countries have the same specifications and with full comparability. We then elect 20 kinds of representative products from them. In accordance with the level of their sales, we can determine their accepted fair weights. For example, the most commonly eaten Big Mac has a weight of 1. We can list: fish fillets 0.55, seafood salad 0.32, chicken pieces 0.26, French fries (medium) 3.8, coffee (medium) 1.9, etc.

In one country, to buy this basket of 20 products would cost R yuan in that country’s currency.  R is calculated by the following formula:

R = M1 x Q1 + M2 x Q2 + M3 x Q3 + …… + M20 x Q20 =
Σ Mi x Qi

 

Here M is the price for each unit of McDonald's products in that country’s currency, Q is its fair weight, and i is the sequence of different commodities, in this case i runs from 1 through 2, 3, etc. until 20, and Σ sums the results of Mi x Qi for i running from 1 to 20.

If the R value in China is 220 yuan, in the United States is 40 U.S. dollars; the McDonald's PPP exchange rate of RMB against the U.S. dollar is 220/40 = 5.5.

Please note that if we create a currency W with its baseline value based on a rigid standard and define that every W1.0 can buy a basket of these McDonald’s products, then this purchasing power becomes fixed and becomes a rigid index. The above-mentioned price of buying this basket in a certain currency becomes the PPP exchange rate of that currency with respect to W. In accordance with the above example, the PPP exchange rate of the U.S. dollar is equivalent to 40, the PPP exchange rate of the RMB is equivalent to 220; the RMB PPP exchange rate against the U.S. dollar is 5.5.


When the purchasing power of a currency changes, such as when the inflation rate is not equal to 1, the purchasing power parity exchange rate with respect to W should be amended.

 

Example

At present, in comparison with the base period,
the U.S. inflation rate is 6%. If in the base period, W1.0 was equivalent to 40 U.S. dollars, now W1.0 will be corrected as (1+6%) x 40 = $42.4.

This means that during the base period, 40
U.S. dollars could be exchanged for W1.0 to buy a McDonald’s basket which contained a representation of the above-mentioned 20 kinds of products, while now it requires 42.4 U.S. dollars in exchange for W1.0 to buy the same McDonald’s basket.

This common currency W that has a rigid baseline value is the prototype of the new concept of the “world currency primary”, WCP, to be proposed in this article. The text below has further explanations.


In 2002, the World Bank established the Global Office for the International Comparison Program, ICP, in charge of the global ICP operations and set up accordingly a specialized agency, Technical Advisory Group (TAG), in order to provide technical advice.  It established Regional Offices in five regions of the world, namely Africa, Asia, the Pacific, the Commonwealth of Independent States, Latin America and West Asia. The Eurostat and the Organization for Economic Cooperation and Development (OECD) formed by developed countries have incorporated the ICP operations into their day-to-day statistical work and regularly collected data, made measurements and published the PPP statistics. The results from the international comparisons are made an integral part of the statistics of national accounts. Most of the participating countries have National Coordinating Offices responsible for the ICP data (national statistics, prices and wages, etc.) being collected, assessed and entered into the database.

The classification method used in the ICP is based on the System of National Accounts (SNA) formulated together by the UN and other international statistical organizations and only partially adjusted.  For example, the portion of government spending on health, education, cultural services and social welfare for residents is transferred as the final consumption of the residents. Finally, goods and services are divided into five major categories of expenditure: final consumption expenditure of the residents, final consumption expenditure of the society, formation of fixed assets, liquid assets increased and net exports, and then each expenditure category is subdivided into 163 smaller categories. These categories include more than 2000 kinds of representative commodities (goods and services) needed by people in all countries.

In determining these representative goods and services, it is necessary to follow the same principle of goods homogeneity, comparability and identical representation, and also to take into account the consumption habits and structures of different countries. The homogeneity and comparability of the goods require that goods specifications, hierarchical models, packaging, materials, designs and sale conditions in nations or regions that are being compared should basically be the same and comparable.
The principle of representative goods requires that the specified goods being investigated between countries or regions should have a high representation, and that the national-averaged price should be obtained by investigation, data searching, and estimation. By using the method of weighted average we can find out the real purchasing power (real value) of different currencies in their countries, and then use these values (rather than the market exchange rates) to convert their gross domestic products into U.S. dollars.

The following table is an excerpt of the ICP measurement norms taking food as an example.

Table 1. ICP Measurement Norms --- Extracted from Food and Non-alcoholic Beverages

110100     Food and non-alcoholic beverages
110110     Food
110111     Bread and cereals
110111.1  Rice
110111.2  Other cereals, flour and other cereal products
110111.3  Bread
110111.4  Other bakery products
110111.5  Pasta products
110112     Meat
110112.1  Beef and Veal
110112.2  Pork
110112.3  Lamb, mutton and goat
110112.4  Poultry
110112.5  Other meats and meat preparations
110113     Fish
110113.1  Fresh, chilled or frozen fish and seafood
110113.2  Preserved or processed fish and seafood
110114     Milk, cheese and eggs
110114.1  Fresh milk
110114.2  Preserved milk and other milk products
110114.3  Cheese
110114.4  Eggs and egg-based products
110115     Oils and fats
110115.1  Butter and margarine
110115.3  Other edible oils and fats
110116     Fruit
110116.1  Fresh or chilled fruit
110116.2  Frozen, preserved or processed fruit and fruit-based products
110117     Vegetables
110117.1  Fresh or chilled vegetables other than potatoes
110117.2  Fresh or chilled potatoes
110117.3  Frozen, preserved or processed vegetables and vegetable-based products
110118     Sugar, jam, honey, chocolate and confectionery
110118.1  Sugar
110118.2  Jams, marmalades and honey
110118.3  Confectionery, chocolate and ice cream
110119     Food products n. e. c.
110119.1  Food products n. e. c.
110120     Non-alcoholic beverages
110121     Coffee, tea and cocoa
110122     Mineral waters, soft drinks, fruit and vegetable juices

For those categories whose price information cannot be collected in a country, the ICP measurement norms allow another appropriate and similar category to be used for the calculation. For example, the PPP of package holidays, available transportation, and hotel and restaurant services can be used as alternatives.


Ever since the
ICP’s official launch in 1968 over 40 years ago, it has become the largest international agency for data collection throughout the world with participating countries reaching 150, including the Euro zone and the 43 OECD countries. It has completed the comparison report of six stages.

Despite the fact that the PPP method still needs further improvement, its theoretical framework and concrete scientific computing have received recognition by the international statistical community and economic academics. 

Currently, the GDPs obtained by using the PPP are higher than those derived from using the market-based exchange rate conversion method of the U.S. dollar. This is because the market exchange rates often underestimate the purchasing power of the less developed countries. In the table shown below for the 2005 GDPs according to the PPP method, India’s global share was over 4%, but only 2% according to the market exchange rate. As a comparison, according to the market exchange rate GDP, the United States accounted for 28%. When using the PPP method it was reduced to 23%.

Table 2. 2005 GDP Global Share (%) by Different Methods

Country

PPP Method

Market Exchange Rate

United States

23

28

China

10

5

Japan

7

10

Germany

5

6

India

4

2

United Kingdom

3

5

France

3

5

Russia

3

2

Italy

3

4

Brazil

3

2

 

This situation was still clearly seen in the 2008 GDP report.

 

Table 3. 2008 GDP Global Share (%) by Different Methods

 

Country

PPP Method

Market Exchange Rate

United States

21

24

China

11

7

Japan

6

8

Germany

4

6

India

5

2

United Kingdom

3

4

France

3

5

Russia

3

3

Italy

3

4

Brazil

3

3


Table 4. 2008 Top 10 GDPs (in Million U.S. Dollars) Using the Market Exchange Rate

Global

60,689,812

European Union

18,394,115

1. United States

14,264,600

2. Japan

4,923,761

3. China

4,401,614

4. Germany

3,667,513

5. France

2,865,737

6. United Kingdom

2,674,085

7. Italy

2,313,893

8. Russia

1,676,586

9. Spain

1,611,767

10.Brazil

1,572,839

Source: IMF


Table 5. 2008 Top 10 GDPs (in Million U.S. Dollars) Using the PPP

Global

68,996,849

European Union

15,247,163

1. United States

14,264,600

2. China

7,916,429

3. Japan

4,354,368

4. India

3,288,345

5. Germany

2,910,490

6. France

2,865,737

7. Russia

2,260,907

8. United Kingdom

2,230,549

9. France

2,130,383

10. Brazil

1,981,207

Source: IMF

Since China’s open-door reform, its rapid and stable economic growth has drawn international organizations and economic experts to make calculations on China’s economic scale. In 1992, the World Bank’s leading economist Lawrence Henry
Summers said that China’s GDP calculated by the PPP method already reached as high as 45% of that of the U.S. In 1994, the U.S. formally pronounced that China was not a developing nation. This made it impossible for China to enter the World Trade Organization (WTO) prior to converting its tariff and trade agreement in compliance with the WTO. In 2002, the World Bank announced that China’s GDP measured using the PPP was 5732 billion U.S. dollars, thus ranking the second in the world and only next to the U.S. These public opinions have made China realize the need of understanding and researching the methods used in international comparisons in order to correctly estimate economic indicators and clearly recognize its realistic national condition. 

China joined the ICP starting in 1996 and has 11 cities participating in the work.  They are Beijing, Shanghai, Chongqing, Harbin, Wuhan, Guangzhou, Xian, Dalian, Ningbo, Xiamen, and Qingdao. At present, they are at the stage of making trial surveys and the results are mainly used for research in policy making.

 

The PPP theory starts directly from the basic functionality (the purchasing power) of the currency. It has a strong logic that is easily understood and expressed. But due to the high-level complexities of the world finance, the PPP theory still has many difficulties and inadequacies. It is not a perfect exchange rate theory. The relationship between exchange rate and price has not been explained with sufficient clarity and there still exist many controversies.

 

Critics think that as an important index for evaluating the economic development level of a nation, the PPP is not able to reflect many factors such as the effects of people’s income, the migration of international capital, production costs, trade conditions, as well as political and economical conditions on the exchange rate fluctuations. It also neglects the counter reaction of exchange rates on purchasing power. 

For example, the domestic price can vary due to shipping costs, tariffs and the inability of commodities to migrate completely, as well as due to changes of production structure and technical progress making the “law of one price” inconsistent with reality unless proper modifications are made. But this will make the calculations even more complicated.

The theory encounters many difficulties while calculating realistic exchange rates, mainly in making the choice of the consumer price index. It is difficult to decide whether to use as indicators the prices of the traded commodities in international exchange or all the domestic commodity prices, namely the ordinary commodity prices. Besides, people in different countries can give a different price to the same commodity. For example, a luxury item in one country may only be a daily necessity of life in another country. But the PPP cannot distinguish these situations.

At present, the main problems of the application of PPP are:

1. It May Overestimate the Purchasing Power of Developing Countries

On the one hand, developing countries are right at the point of economic transformation. Their level of openness to the outside world is relatively low and construction materials and services which are the core components of the non-trade commodities take fairly large shares. In addition, the quality of these non-trade commodities is relatively poorer and the prices are also correspondingly lower than the international prices. If this portion of non-trade commodities is compared with the high-quality goods and services in the international markets, the purchasing power of the developing countries must be overestimated. On the other hand, the developed level of market economy in developing countries is relatively lower than the developed countries and their governments provide different degrees of subsidies in education, medical care, rent, and wages and so on; their pricing mechanisms are not adequate and pricing distortions are more serious. The prices of a substantial portion of goods and services are shifted lower. This can also overestimate the purchasing power of the developing countries. 

2. It Is Difficult to Guarantee the Representativeness of the Commodity

 

Due to the existence of relatively larger differences between economic development levels, consumption levels and consumption habits, there are huge variances in the commodity qualities of different countries. It is almost impossible to choose absolutely identical goods and services in different countries. Besides, it is also difficult to guarantee the representativeness of the commodity. A commodity that is representative in one country may not be representative in another country.

3. Developed Countries Influence the Weight Determination

In the world economy, the developed countries have most shares of the total economic production and hold leading positions. As long as the value indicator is used in the comparison as the basis for the weight calculation, the influence of the developed countries becomes unavoidable. Despite the fact that the ICP has made many efforts to eliminate the influence of the developed countries on the weights, the developed countries still play decisive roles in determining the weights. 

4. There Is a Substantial Flexibility in Collecting and Working with the Price Information

It is difficult to set strict and unified rules for the collection of price information in different countries. This has made the calculation of the average price in different countries to have a high variability. For example the selection of sample cities and the averaging methods allow huge adjustments. A country can start with a certain purpose and artificially raise or lower the average price of that country and create a non-truthful picture.

In today’s actual applications, due to different approaches and adjustment factors there are many methods to make price calculations.

The calculation method should be applied at two levels to show distinctions between binary and multilateral comparisons. In terms of the binary comparison, we can use the methods of the Laspeyres Index, the Paasche Index and the Idealized Index. First, we should define the products to be compared and then obtain the expense ratio of purchasing the same final composite products in the two countries of interest. Normally this requires that the results for a given pair of countries be independent of the choice of the base country (this is also called the base-country invariance) and pass the factor reversal test.  For the multilateral comparisons, in addition to the above requirements, there are requirements of passing the transitivity test. The present devised methods include the star system method, the country-product-dummy (CPD) method, the Elteto, Koves and Szulc (EKS) method, and the Geary-Khamis (GK) method. (See 2005 International Comparison Program, Preliminary Results, December 2007, Methodology, page 47. International Bank for Reconstruction and Development/The World Bank).

The PPP method used for the GDP calculation or for evaluating the level of the economic development by the ICP still cannot completely replace the results of the traditional market exchange rate method. Scholars are continuing the development and modification of the PPP theory in order to better match reality.  But they have established a global universal PPP calculation norm (the big basket), which provides a useful resource for the base value of the supranational international currency of constant value.

 

3. New Concept of the World Currency Primary

In the following text, we take the big basket defined by the global universal accounting norms of the ICP as the base value. From it, we propose a kind of world currency primary that has the characteristic of the supranational international currency of constant value. 

Assume that the world currency primary, abbreviated as WCP, is represented by the symbol W
.

In the previous section, the example of the giant basket of commodities of the fast-food chain McDonald, has referred to the rigid fixed base value of the embryonic form of the concept of a common currency W.

Let us now expand the basket to represent the whole country's purchasing power parity value, which contains more than 2000 kinds of combined representative commodities (goods and services) according to their determined weight compositions, which in turn belong to standardized ICP categories (currently 163 sub-mesh under 5 major categories) at all levels in the Global Office of the ICP. As long as the types and weight percentages of the commodities in the basket are in line with the above norms, the total size can be artificially made large or small and determined freely without affecting the comparison of the purchasing powers of various currencies.

For the sake of convenience, we set one unit of the currency W equal to the rigid purchasing power of such a fixed basket of commodities. Any one currency required to purchase the basket has to use R units, then the exchange rate of that currency to the WCP is E = R / 1 = R.

For convenience, we shall use the present international sovereign currency U.S. dollar, now commonly employed to describe and set the initial total size of this basket.

Assume that in a base period (subscript o for each indicator), the value of the overall size of the basket is 1 U.S. dollar, that is, Roa = 1 (The subscript a means America, a = America).

Then in the base period, the initial exchange rate of the U.S. dollar to the WCP is Eoa = Roa / 1 = 1
so W1 = $1.

In another example, if in the base period it is necessary to spend Roc = 6.8 (c means China, c = China) in renminbi (RMB) to buy the same basket, then at this time the RMB exchange rate to the original WCP for Eoc = Roc / 1 = 6.8.

Thus, in the base period, the original PPP parity exchange rate of the RMB against the U.S. dollar is Eoca = Eoc / Eoa = 6.8 / 1 = 6.8.

In practice, an amendment is required to the original exchange rate in the base period according to purchasing power changes of the currency, by multiplying it with the relevant correction factor so as to arrive at the actual PPP exchange rate:

 

1. Inflation Correction Factor α

At any time after the base period, the purchasing power of any sovereign currency will change, but the purchasing power of the WCP is rigidly fixed, so the original exchange rate in the base period requires a corresponding amendment.


2. Tax Correction Factor β

When purchasing goods from a country, tariffs and other taxes (or charges) are equivalent to increased prices and reduced purchasing power, so the original exchange rate in the base period requires amendment.

3. Other Correction Factor γ

Factors other than inflation and tax consideration including reasons used for adjustment as a buffer based on historical factors also require amendment of the purchasing power.

For example, in order to take care of maintaining the level of exports prior to a reform, it is necessary to adjust upward the PPP exchange rate (depression) of a currency relative to W, which means
γ1; otherwise, taking care of maintaining the strong position of a currency (appreciation) means γ1.

Finally, the real exchange rate of a currency relative to the WCP equals the multiplication product of the original rate in the base period with the three correction factors.

The actual PPP exchange rate of the currency is therefore E = α x β x γ x Eo, where Eo is the PPP exchange rate of the currency in the base period.
 
Following the above example, we give another example to explain the application of the correction factor:

 

If the inflation rate of the U.S. dollar is 6% in comparison with the base period, then αa = 1 + 6% = 1.06. If βa = 1.08γa = 0.93 and if the PPP exchange rate in the base period was Eoa = 1, then the actual  PPP exchange rate of the U.S. dollars with respect to W becomes  Ea = 1.06 x 1.08 x 0.98 x 1 = 1.12hence W1.0 = $1.12.

At the same time, if the RMB inflation rate is 4%, then αc = 1 + 4% = 1.04. If βc = 1.07
γc = 1.1, and the PPP exchange rate in the base period was Eoc = 6.8, then the actual PPP exchange rate of the RMB with respect to W becomes Ec = 1.04 x 1.05 x 1.02 x 6.8 = 7.57hence W1.0 =
7.57.

At this point, the PPP exchange rate of the RMB against the U.S. dollar is Eca = Ec / Ea = 7.57/1.12 = 6.76.

 

And so on.

Strictly speaking, the amendment to the original exchange rate should be made on an intensive and regular basis for each relevant commodity. But in fact it is not currently possible to get timely access to these data in a short cycle (e.g. monthly) and the comprehensive report of the statistics can only be accomplished in the yearly report on the PPP. To this end, at the beginning of the practice, we can use the approximate comprehensive correction factor accepted publicly, such as the use of the monthly Consumer Price Index (CPI), as the inflation index for obtaining the inflation correction factor and then make an accurate amendment after obtaining the annual PPP index.

Here, the WCP unit is equivalent to the base value of a large basket of commodities. This is a kind of relationship identical to "I am the basket" or "The basket is me".

Here the WCP unit is directly equivalent to the world unified basket of comparable commodities. It has a more rigid value base than the gold standard or the gold exchange standard system. It ensures the same purchasing power anywhere in the world and at any time.

The gold-expressed commodity prices are floating with a wide range, or even artificially, but the WCP is beyond this kind of non-rationality and limitation.

The WCP derived from this definition is independent of all sovereign currencies, and eliminates the embarrassments caused by the two hats worn by the U.S. dollar in the Bretton Woods system. The Triffin Paradox no longer exists.

Using the unified WCP for international trade will no longer cause problems with the exchange rates nor have the need to stockpile foreign reserves. People are equal vis-à-vis the currencies. No one will suffer or take advantage of the seigniorage. The numerous age-old abuses and long-standing problems caused by using the sovereign currencies of strong powers as the world currencies will be wiped out completely.

If the application of the WCP is expanded into people’s livelihood, this implies that people can hold more reliable valued-preserved assets than gold or diamond in their hands with unchanged purchasing power wherever and whenever they are.

The WCP defined this way is still a conceptual symbol, which does not have any credit payment protection; in other words, when you offer a unit of W to buy the goods in this basket, why should the supplier accept that your W indeed has this purchasing power? Therefore, the WCP cannot exist independently nor circulate. The WCP will have credit payment protection to validate its exchange value and becomes an effective international common currency only when it jointly operates with all sovereign currencies.
 

Realistically speaking, when a country decides to use the WCP, this country has to exchange its total currency amount into W using the PPP exchange rate. For example, if country A wants to receive W200 million, it has to use the PPP exchange rate such as 3.75 of currency A to get the corresponding amount 3.75 x 200 million = 7.5 million in currency A and use it to get W200 million from the WCP issuer.

After that, at a certain inspection time, if country A still keeps W200 million, and the PPP exchange rate of currency A changes to 3.93, country A has to send in (3.93 – 3.75
x 2 million = 0.18 x 2 million = 36 million in currency A to the WCP issuer. This is to maintain the principle of constant value in W and ensure that W can purchase at any time the originally established basket of commodities in the market of that country.

If all the countries that participate in the WCP system can follow these rules, then at all times the purchasing power of W in all these countries remains unchanged and becomes a supranational common currency of constant value.   

The new concept of the WCP can be regarded as a transformed type of U.S. dollar in the Bretton Woods system after its role is rationally decomposed and updated. The reason for its applicability is that today’s PPP method of the ICP provides a rationalized benchmark valuation of the resources; in addition, modern information technology provides the needed technical means for the actual operation.  These are very favorable conditions dreamed about but not achievable by people with lofty ideals in the Keynesian era.

Once the WCP is activated, it will automatically cover many of the features pursued by the regional monetary cooperation, which are similar and complementary to each other and reinforce each other, thus speeding up the achievement of the goal of the regional monetary cooperation.

Although this benchmark system of constant base value is still not perfect, and many problems need to be further explored and resolved, it has become a publicly approved feasible method of the ICP. It is put in practical applications under the auspices of the UN. Today, by using it in constructing the WCP, it can provide the maximum relative rationality. With the rapid development and progress of the PPP under the ICP, the foundation of the base value of the WCP will also improve correspondingly.

The new concept of the WCP is a favorably combined idea and can be interpreted with the Confucius philosophy of the “Doctrine of the Mean”: it stands in the global center and abides by the principle of creating harmony, being agreeable but different, being adaptable to changing circumstances, and seeking automatic maintenance of a balanced condition. Based on this, we derive the following design outlines as the framework of a workable proposal for execution.

4. Proposal for the Framework of the World Currency Primary

1. Organization in Charge

One of the purposes of the UN is to form a center for harmonizing the actions of nations in order to achieve international cooperation. The common purpose is to solve issues of an economic, social, cultural or humanitarian character for the international community. The 55th and 59th articles of Chapter 9 of the UN Charter propose the United Nations to accept to establish a preliminary embryonic world currency by the Member States and to pass a resolution to establish the Union of World Currency, abbreviated as UWC. The purpose is to set up regulations in charge of issuance, settlement, coordination, supervision, in order to bring into play the function as the managing center.  

Under the UWC, functional institutions, such as the World Currency Board, the Bank of International Settlement (BIS) and other financial institutions, should be established. The BIS is equivalent to the central bank of the WCP.

The existing relevant UN specialized agencies, like the International Monetary Fund as well as the World Bank Group (referring to the World Bank and its subsidiary bodies, namely, the International Development Association and the International Finance Corporation), may merge with the UWC. The merger will result in an appropriate simplification, enrichment, substantial restructuring, and will establish a United Nations Committee on Monetary Cooperation.

2. Nomenclatures and Symbols

The English name of the world dollar is the World Currency, WC.

The English name of the world primary currency is the World Currency Primary, WCP.

The currency symbol of the WCP is W.

3. Member States of the Union of World Currency

By agreeing to use the WCP in the field of international payment as a prerequisite, countries and regions all over the world can apply to become Member States (including countries and regions) of the UWC according to their own circumstances and timetables. Member States are free to quit only with a prior written notice and by making an appropriate financial settlement.

The UWC does not interfere in the domestic monetary policies of the member countries, but requires their implementation of UWC’s management rules: the inflation rate, fiscal deficit, trade deficit, government debt, bond interest rates, exchange rate fluctuations and other economic indicators are to meet the required standards. If some indicators have not yet met the requirements, while the gap is acceptable, countries may already join under the condition that a number of stages are set out to meet the specific schedule of the set targets.

Member States should promise to accept UWC’s oversight on the volume of currency issued and UWC’s audit and supervision on the commodity price in order to balance import and export trade and fulfill the international obligation of promoting global economic development.

The major decisions of the UWC are voted on by the Member States. The right to vote of the Member States is distributed according to their GDP levels and international trade in global shares, which are adjusted once every 5 years.

If Member States make a serious breach of the rules or do not meet the provisions of the economic indicators, the UWC may take appropriate disciplinary measures, up to the suspension of their memberships.

4. Value Base of the WCP and the Exchange Rate

The WCP takes ICP’s definition of global accounting norms that use the big basket as the base value to determine the original exchange rate of the WCP and revises it for inflation and tax rate to become the practical exchange rate.

This is a rigid ICP-pegged value base, and only needs to change when the ICP modifies its PPP value based basket. At this point, the value of the basket before and after the adjustment can be set equal (according to the composite currency of the weighted average of all the sovereign currencies) in order to maintain the continuity of the value base system.


5. Basic Functions of the WCP

The WCP as an embryo world currency is not a replacement of the existing sovereign currencies in all countries and regions nor an attempt to implement a single currency in the world. Instead, it is an international currency set up to have special functions based on the local sovereign currencies internally circulated in the Member States.
 
The WCP is used uniquely for the purpose of a unified circulation as international market liquidity, rather than the domestic currencies in circulation.

For those who join the UWC as members, the accounting and settlement of their foreign trade and economic exchange are made by the WCP through the unified use of the BIS.

With growing experience and increasing perfection, the use of the WCP can be gradually extended to commercial banks and financial markets for settlement in WCP denominated international deposits, bonds, traveler checks, credit cards and other basic financial services, international investments, as well as virtual economic transactions.

The WCP is mainly electronic money, but can also exist in the form of cash notes.

In any countries and regions, the WCP in the form of cash notes cannot be used for the internal markets. They must be converted into local currency in banks or specialized agencies according to the applicable currency exchange rate before they are allowed to enter the circulation.

6. The Issuance of the WCP

 

The BIS, which belongs to the members of the UWC of the UN, is responsible for the issuance of the WCP to the Member States.

The UWC, according to the needs of the Member States, issues and distributes to them the working capital reserve amount* in the WCP. Each Member State, in accordance with the WCP exchange rate, pays the BIS an equal value in its local currency to the proceeds of the WCP amount as collateral. They should make payments to the BIS by adjusting periodically their local currencies in accordance to the changes in the WCP exchange rate.

The BIS that receives the above-mentioned local currency should deposit it back to the government (Ministry of Finance or the Central Bank) of that country and collect interest payable at a fixed interest rate.

This interchange relationship between the governments of the Member States and the BIS is in a sense similar to the relationship between the U.S. federal government and the Federal Reserve by issuing bonds in exchange for Fed's currency. The difference is that there is a unique mechanism to mutually protect the purchasing power in order to maintain the WCP purchasing power constant. **

*  To measure the needed WCP amount of working capital for the Member States, please refer to the current standards of adequate foreign exchange reserves. The Triffin principles that were popular between
1960 and 1990 were concerned with the import payment and based on the belief that the foreign reserve should satisfy the need for three-months of imports. But after the 1970s and 1980s, following the opening of the capital accounts of many countries and the frequent occurrences of world financial crises in the 1990s, the Triffin rules were no longer able to maintain the international liquidity and resist external financial crises. Therefore different countries generally raised their execution standards: in 2004 the number of months for foreign reserves of different countries to reach their import amount were: 10 months in Asia, 8 months in Africa and 6 months for Western countries.  

According to the foreign reserves exchange adequacy standards proposed by Guidott & Greenspan (1999) and the IMF (2000-2001), the reserve should be more than the sum of the government external debt and short-term foreign debt listed on the one-year debt settlement table and should satisfy the reserve liquidity needed for a one-year management of the external assets. 

Taking China as an example, if China’s imports were 1133.1 billion dollars in 2008, it should have 566.55 billion dollars to pay for its six-month import needs.
 If the Guidott-Greenspan-IMF rule is applied, China's foreign debt at the end of 2007 amounted to 373.6 billion dollars and the foreign debt which needed to be paid within one year was 220.1 billion dollars (including the trade credit balance of 133.1 billion dollars). Taken together, the two give 566.55 + 220.1 = 786.65 billion, which should not be more than 800 billion dollars.


** The United States Government does not have the right to issue currency. The U.S. dollar is a Federal Reserve Certificate issued by the Federal Reserve System. In theory the Fed injects in base currency on the basis of three sources:  buying
U.S. government bonds, rediscounting loans, and issuing special drawing rights. However, since the formation of the U.S. Federal Reserve System, the purchase of U.S. government bonds has been the most important delivery channel for base currency. As of January 30, 2008, the Federal Reserve System had injected a total base currency of 814.3 billion dollars into the market, of which government bond assets formed about 718.4 billion dollars, accounting for 88.2%.



7. Credit Payment Protection of the WCP

The WCP is issued with no reserves. It does not have any asset-backing.

The credit payment protection of the WCP, as a special credit currency, comes from the purchasing power of the equal-value local currencies turned in by the Member States.  The exchange of the local currency with the WCP is not a one-time deal, but rather a collateral relationship as a protection of the purchasing power and requires keeping an equivalent value with the purchasing power at any time. To this end, in accordance with the change of the purchasing power of the local currency, it must add or subtract local currency in order to maintain beyond any doubt a WCP unit that has a constant purchasing power in any global Member State.

At present, the ICP provides complete comparison reports annually. It is not able to publish numerical data needed for computing the WCP exchange rate on a monthly basis. In order to timely amend the equivalent-value relationship between the currencies of the Member States with the WCP, the Consumer Price Index (CPI) * published monthly by different countries can be used for amending the collateral amount of the local currency. At the time of annual clearing, this amount can undergo modifications according to the PPP to match the actual WCP exchange rate.    

* The ICP is a kind of space index. Every item under comparison must be the same comparable item in all Member States.  The CPI is a time index. It compares identical items within the period of the index. Besides, the commodities in the ICP basket are far broader than in the CPI. In many countries, the CPI only gathers prices in provincial capitals, but the ICP encourages a comprehensive price collection in the whole country including villages and cities. Experts are striving hard to help some countries, especially the developing ones, to raise their ability to gather statistics in order to strengthen the CPI representative. 



8. Taking Care of the WCP in the Transition Period

In this reform, developed countries with varying degrees of seigniorage privileges have to give up their vested interests in this regard. The emerging economies inevitably will suffer losses in the exchange rate revaluation. Countries that hold large foreign exchange reserves will face difficulties in dealing with their reserves. So the difficulties and importance of reaching a consensus at the early stage of the consultation are self-evident. In order to alleviate the various aspects of a conflict of interest, during the transition period in the implementation of the WCP program, we may make special and caring amendment to the WCP exchange rate. That is to use the 3rd amendment mentioned in section 3 of this article by setting an acceptable correction buffer factor γ to the exchange rate of different countries to make up for the losses of a certain period of time.  To be specific, during the transition period, the United States can provide a correction factor conducive to maintaining the strength of the U.S. dollar exchange rate; for China, there should be a correction factor conducive to supporting an exchange rate that is favorable to its export competitiveness; and so on.

9. Dealing with the Foreign Reserves of the UWC Member States

Now only the United States does not need foreign exchange reserves for international trade, as the U.S. currency is recognized as the world's main reserve currency. When the WCP system is put into operation, all UWC Member States can use their local currencies in exchange for the WCP as an international currency. This means that they, like the United States, can bid farewell to the era of international trade in foreign exchange reserves while at the same time eliminating the traditional market exchange rate problems and effectively preventing speculative attacks from foreign exchange speculators.

In addition to the needs of issuing the reserve currencies of their own countries, much of the existing foreign exchange reserves need no longer be retained and can be used step by step for international trade, international investment, or conversion of assets to more effective forms. The UWC will assist countries in dealing with their foreign exchange reserves.

Taking China as an example, its current foreign reserves reach as high as more than 2 trillion U.S. dollars, in excess of the adequacy standard by over 100% (see item 6 of this section as reference). Once the implementation of the WCP system starts, these huge foreign exchange reserves basically do not have to be retained. Ways to deal with this include:

 

1). The BIS can accept a portion of the foreign exchange reserves and convert them into a day-to-day working capital requirement of the WCP. The BIS that receives these foreign exchanges will deposit them into the governments (the Ministries of Finance or the Central Banks) that issue such foreign currencies to collect interest. But after that the adjustments in the renminbi exchange rate with the WCP should be cleared by the Chinese side in RMB.

2). It is recommended that the remaining portion should still be used as much as possible for making purchase or investment in the country that issues that form of the foreign exchange currency or be spent in other countries after converting it into the WCP.  We propose to consider some areas that need much focus but have not yet been self-sufficient: for example, the field of energy and mineral resources, bulk commodities, international blue chip companies or shares in the global top 500 enterprises (designed to obtain income but not necessarily requiring stock holding), significant import technology, investment projects of equipments, strategic petroleum, natural gas, nuclear fuel and basic infrastructures.

3). At present, the main channel for China's base currency injection is foreign exchange reserves. The seigniorage income from issuing currency is far from adequately converting into the financial expenditure that can improve the welfare of the people. At the same time, the huge one-way growth in foreign exchange reserves results in the passive injection of the base currency, and also tends to distort the structure of the economy. Therefore, the reform of China's money supply mechanism of the base currency is the inevitable choice of its monetary policy in the future.

10. Balance Account Management of the Member States

The Member States have accounts with the clearing banks of the UWC. Importers make payments in reserved WCP from the trading accounts; exporters receive income in WCP and make deposits into the trading accounts. If a country in a certain cycle can maintain a good trade balance, the surplus in its trade account should be maintained as a small number or even zero.

 

Countries that have larger deficits will pay the bank of settlement more local currencies in exchange for the WCP in support of their import trade. These currencies will be deposited back to the countries' central banks resulting in corresponding increases in the interest payments of these countries. This will urge them to adopt appropriate domestic policies (such as currency devaluation) to strengthen exports and recover the expenditure in the WCP paid for import in order to achieve trade balance.

If a country has a larger surplus and shows a large amount of trade surplus in the trade account of the bank of settlement above a certain share, a cost will be levied. The purpose is to drive such countries to try to spend the WCP surplus and gradually eliminate their trade surplus, so that it flows back to the deficit countries.

This fee is not a severe punishment, but a mild manifestation of a feedback mechanism aimed at maintaining the balance of trade and establishing a sustainable mode of economic operation.

11. Funding for the Union of the World Currency

 

The UWC is a non-profit organization. Its start-up cost is allocated by the UN. It can receive interest income in local currency that the BIS deposits into the central banks of the Member States. In addition, it can collect fees from the countries that have too large a trade surplus. Apart from its operating expenses, the rest of all the revenue will be used to support research and development for the basic world monetary theory and method of practice, setting the benchmark surveys and related management services, as well as rewarding the model management agencies of countries that maintain regular trade balance.

12. International Monetary Safeguards Agreement

In order to ensure that under the auspices of the UN, the WCP system can deal with all kinds of unexpected special difficulties, major countries of the permanent members of the Security Council will form a core (it may be the G20 or a wider group) that signs the International Monetary Safeguards Agreement. The contracting Member
States will be required to provide funds and take actions under obligation upon the request of the UWC to play a major role in global governance, problem solving, crisis management, and protecting the long-term stability and continuing normal operation of the WCP.


5. How Can the WCP Spread Freely to the World?
--- Examples: Personal Consumption and International Trade Clearing Operations

The benefits of the WCP have been repeatedly explained as above.  Once implemented, the long-standing chronic problems caused by the hegemony of the strong sovereign currencies in today's world monetary system will be swept away. This heralds the beginning of a new era that makes everyone equal before the currency.

The WCP is the international common currency and is coordinated with the use of the domestic sovereign currencies of different countries. If you do not deal with foreign countries, of course, you do not need an international currency.  But in the tide of globalization, our world has almost become a Global Village. It may not be an exaggeration to say that everyone has something to do with the WCP.

The WCP brings to the world not only ethical and economic rationality, but also convenience.

Under the WCP system, how do personal lives and business operations in different countries of the world make concrete applications of the WCP in international activities? We employ two cases below as illustrations.

1. Personal Consumption Abroad as an Example

Chinese citizen Mr. Zhang who lives in Shanghai wants to travel around the world. To whichever countries he is going, as long as they are Member States of the WCP, he does not have to carry dollars, euros, RMBs or the currency of any country. It is just fine to have the WCP in paper money or electronic money. Of course, the latter is particularly convenient.

Mr. Zhang can buy in advance an appropriate amount of WCP notes from the China International Bank in Shanghai with the RMB exchange rate at the time to carry abroad with him. He can also freely convert the WCP into the local currency according to the exchange rate at that time at the international bank of any Member State of the WCP for the consumption in that country. The unused local currencies can be converted back into the WCP for consumption in another Member State. The WCP that he holds will have a constant purchasing power at all times and places and with universal access, however it cannot be used for direct consumption as the local currency.

Alternatively, it is even simpler for Mr. Zhang to get an international universal WCP bank account card (credit card) from the China International Bank in Shanghai. This card should have enough balance in RMB (or credit). Say Mr. Chang shops at Tiffany’s jewelry store on Fifth Avenue in New York to buy a diamond ring for his fiancée with a total purchase price of $8000 (including tax). After Tiffany’s teller scans the card, the global electronic accounting system immediately operates the following steps: 

Assumptions:

The dollar exchange rate with respect to the WCP dollar is 1.25 ($1.25 for W1.0), so the value of this ring in WCP is 8000/1.25 = W6400.

 

The RMB exchange rate with respect to the WCP is 6.5 (6.5 exchanges W1.0), then the value of this ring in the renminbi-denominated currency is 6400 x 6.5 = 41600.

 

The globally connected electronic accounting system in accordance with Zhang’s and Tiffany's purchase agreement issues these operating instructions: First of all, 1) China and the United States are both Member States of the WCP, and can proceed with the WCP clearing operation; 2) The Chinese international bank has enough WCP line to pay for W6400; 3) Mr. Zhang’s balance in RMB (or credit) in his account at the Chinese international bank is sufficient to cover 41600. Then, 1) China's international bank collects RMB 41600 from Mr. Zhang’s account; 2) The Chinese international bank extracts W6400 balance from the WCP owned by China to pay it to the international bank of the United States and identifies it as the purchase money that Zhang has to pay to Tiffany’s; 3) The international bank of the United States takes W6400 as income, converts it into $8000 and deposits it into Tiffany’s account; 4) The record of the world clearing bank account shows that the WCP balance of China is reduced by W6400 whereas that of the United States is increased by W6400.

 

The liquidation process of Mr. Zhang purchasing a diamond ring at Tiffany’s is completed at this point (omitting the service charges that may occur and are dealt with).

 

In this process, Mr. Zhang’s shopping in New York is as easy as shopping in Shanghai by scanning the card and not even being aware of any difference. All the pricing and payment procedures including the WCP transfer between the two countries are liquidated in accordance with the BIS general program and automatically completed in an instant.

2. WCP Clearing of Import and Export Trade

Say an American Company D decides to import 20000 pairs of shoes from Company C in China based on the free-on-board (FOB) price to pay
1.35 million in RMB.

Assumptions:

The RMB exchange rate with respect to the WCP is 6.5 (6.5
exchanges W1.0), then the value of the shoes in WCP is 1350000/6.5 = W200000.

 

The U.S. dollar exchange rate with respect to the WCP is 1.25 ($1.25 can exchange W1.0), then the value of the shoes in U.S. dollars is 200000 x 1.25 = $250000.

 

Thus, the globally connected electronic accounting system issues operating instructions in accordance with Company D's purchase agreement:

First of all,

1. Both China and the United States are Member States of the WCP and can take WCP clearing operations;

 

2. The U.S. international bank has enough WCP line to pay W200000;

3. The account of Company D in the US international bank has a dollar balance (or credit) sufficient to cover $250000.

Then,

1. The United States international bank collects $250000 from the account of Company D;

 

2. The U.S. international bank extracts W200000 from the WCP the U.S. owns and transfers it to the Chinese international bank specifying that it is the fund from Company D to pay to Company C;

3. The Chinese international bank receives W200000 as income and converts it into
1300000 to deposit it into the Company C account;

4. In the account record of the international clearing bank, the WCP of China increases W200000, whereas that of the United States decreases by W200000.

The liquidation process (omitting the service charges that may occur as well as import and export custom clearance procedures) of  Company D importing this batch of shoes from Company C with the FOB prices is now entirely completed. 

During this process, Company D of the United States imports leader shoes from China's Company C. Compared with the current procedures of using the U.S. dollar to import Chinese products, they are greatly simplified. All the pricing and payment transfer procedures including the WCP transfer between the two countries are in accordance with the general world process of the BIS and completed automatically in an instant. China also no longer has to face the complex issues of acquisition, storage and processing of foreign exchanges.

 

Today, we still can not propose a detailed schedule for the WCP, nor can we predict the time for its official implementation. But we believe that it will not be as fast as the three weeks initially envisioned by Mr. Mondale for the euro, nor necessarily as long as the 30 years for the actual realization of the euro.

 

(End)

June 17, 2009


Author’s email address
paulpang21@yahoo.com
(Initially published on www.boxun.com)

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Charley Fei (Shuiyu Fei) is the President of the Maxim Academy of International Economics and Sociology, USA.


Zhongjia Pang is the Chief Researcher of the Maxim Academy of International Economics and Sociology, USA. Email address: paulpang21@yahoo.com
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