Wednesday, November 21, 2007

Engineering the Dollar

The dollar is a unit of measure that changes on a minute by minute basis. Imagine if other units of measure did the same:

The U.S. dollar is in a scary slide. Gold and oil are hitting record highs, while the dollar is hitting record lows. To get how strange this all seems to an engineer like me, imagine the following headline: “Foot Falls against Meter for Fifth Straight Day.”

The accompanying article would breathlessly report that after the U.S. abandoned its “antiquated” fixed-exchange-rate system (one foot equals 0.3048 meters), our beloved foot began plunging in length. A “length trader” would predict that if the foot fell below the “psychologically important 0.2800 meter support level,” it could fall as low as 0.2500 meters. But an economist would say that as long as the foot didn’t fall more than 10 percent, everything would be okay.

The dollar needs to be fixed like other units of measure. The system outlined in this article is similar to the one that Jude Wanniski promoted for many years:

We need to approach the dollar just as we approach our other units of measure. We must first define a fundamental abstract unit of market value (“the dollar”). We must then devise a system for producing official instantiations of that unit (“dollars”) that are faithful to that definition. The dollar thus would be analogous to the foot, and dollars (the green things in your wallet) would be analogous to foot rulers produced by the U.S. Bureau of Standards...

A logical definition of the dollar might be “equal in market value to one five-hundredths of an ounce of gold.” The value of all the dollars in the U.S. monetary base would then be maintained by having the Fed’s open-market operations target the price of gold to keep it near $500 per ounce. Because the real market value of gold cannot run away to zero or infinity, the new monetary control system would be determinate and stable.

What I am describing is not a classic “gold standard.” Back then, gold was the monetary base. Instead, the monetary base would be the same “fiat” currency that we have now. Banks would maintain the value of their dollars the way they do now — by redeeming them with the dollars of the monetary base upon demand.

The dollar is making new lows again today. It doesn't have to be that way.

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