A Theory for Global Economic Stability
Establishing the Usefulness of Complementary Currencies
Modern portfolio theory (MPT) is at the bedrock of finance and governs the allocation of most of the professional investment capital in the world. It would be almost unthinkable for any credible manager of hedge funds, mutual funds, funds of funds, or sovereign wealth funds to disclaim reliance on this body of knowledge that has been proven both theoretically and empirically over decades of research across wide investment classes and vehicles.
MPT holds that portfolio diversification, meaning the simultaneous holding of different assets whose expected performance characteristics are not correlated and therefore complementary, is essential to the optimization of the risk-reward paradigm, thereby maximizing the expected return for a given level of risk. In plain English, it is statistically more profitable and less risky over time to invest in a portfolio of complementary assets than it is to invest in any single asset within that portfolio.
Research has found that a surprisingly small portfolio can offer to the investor nearly all of the expected benefit of diversification. Notably, however, the greatest benefit is found from the first act of diversification; going from a single-asset portfolio to one with two non-correlated assets. Subsequent diversification benefits are significant but decline with each additional asset until nearly all of the potential benefit is captured at the threshold of six assets. Also, the more non-correlated the portfolio assets are, the fewer are required to achieve optimum diversification.
To date, policy makers have apparently not thought to apply MPT to monetary policy due to the fact that type of money has not been viewed as a diversifiable asset.
Money as a Diversifiable Asset
It is important at this juncture to make a critical distinction: by “diversifiable asset”, I am not referring to the differing national fiat currencies (NFC’s). While the diverse national fiat currencies have dissimilar appearances, they all share common characteristics. All are fractional reserve, debt-based, fiat forms of money that are backed by the full faith and credit of the sovereign nation issuer, each of which delegates this function to a central bank. There are, in general, no other asset classes backing these forms of money.
For purposes of this discussion, I therefore view all NFC’s as a single class of asset that is correlated. Evidence for this supposition is found in the phenomenon of “contagion” discussed in numerous papers. (Contagion is the tendency of financial shocks in one country to spread to others.) Indeed, it is generally recognized in finance that the only long-term reasons for any NFC to rise or fall relative to another NFC are to be found in the respective fiscal, monetary, and trade policies of the two nations. Should two nations follow identical policies then their currencies would be expected to remain at a constant exchange rate; they would rise and fall in tandem relative to third-party currencies and effectively constitute a single NFC for many purposes. Further, even without such extreme policy linkage, some nations successfully link their currency to that of another nation for extended periods. In recent decades, multiple nations have done this with the US Dollar.
If one holds a pile of NFC cash in a bank account, even if that cash does nothing but exist as an electronic entry, it is for all financial purposes an asset. Therefore, by extrapolation, the totality of such NFC cash issued by a nation state, whether in the form of paper, coins or electronic entries, may also be considered an asset.
This observation allows for an important extrapolation. If, as I am asserting, money is a diversifiable asset, then such diversification will not be meaningfully achieved by holding a basket comprised of diverse NFC’s.
Using an approximate comparison, this would be the monetary equivalent of holding a vast investment portfolio allocated solely into airline stocks. Such a portfolio would insulate the holder from mismanagement or misfortune of individual airline companies but little else. It would offer no protection against exigencies affecting the entire industry nor would it offer the upside potential represented by other industries.
While such sector-specific investing has become popular in recent years, it is not the sole basis of a professionally managed portfolio. Rather, it becomes itself a component of a broader investment strategy that, generally speaking, will include a wide variety of such sector-specific portfolios.
We have, at best, pursued the equivalent of an “all airline” approach to managing our world’s monetary assets. At worst, we have arguably placed our entire portfolio of monetary assets into a single rickety instrument; one lacking not only diversification but even, generally speaking, the possibility of diversification.
If we view the world’s monetary assets as a portfolio, it is one that has not performed particularly well, with hundreds of boom/bust cycles both local and global in recent decades. Most recently, the 2008 crisis served as a wake-up call to global policy makers that financial stability could not be as smoothly managed as they had believed it could. The world’s portfolio of monetary assets has not afforded the “portfolio owners” the benefits of stability.
Historical Performance of Complementary Currencies
The possibility of real diversification has until recently generally been precluded by national laws that prohibited the issuance of complementary currencies; instruments that are truly (not merely cosmetically) different types of money offering expected performance characteristics that genuinely balance those of the existing national bank debt, fiat money. In complementary currencies, such monetary design features as interest, fractional reserve, central bank issuance, and fiat authority are all open to redesign. Other features such as demurrage, not generally associated with money, can be added for the purpose of stimulating desired behaviors without need for law or regulation.
Societies with unstable currencies tend to be single currency systems, while those with dual currencies (for example, Switzerland) tend to be models of stability. Currently, Switzerland is the only major nation-state with an established and ongoing dual currency system. Its little-known Wir has coexisted gracefully with the better known NFC Swiss Franc for 75 years, a period during which Switzerland’s economic stability has been widely noted but wrongly attributed to political neutrality, tax policies, and other factors. Recent Rensselaer Polytechnic research finds that it is the Wir to which this stability must generally be ascribed. [1]
The Wir offers to participants benefits of Keynesian stimulus without the drawbacks. It could easily be adopted elsewhere, without modification, by private or government initiative.
It has recently been documented that the last great historical experiment with complementary currencies resulted in a society of great wealth, health, and leisure that lasted for about 250 years. It collapsed in the late 13th century due not to any deficiency in the currency system nor the devastation of the Black Plague (which followed rather than caused the collapse) but rather an assertion of monopoly privilege in the political arena: the complementary currency was banned in favor of the national currency controlled by the monarch.
Monetary Sustainability
There are significant real consequences to the instability of the present non-diversified global monetary portfolio.
Our present approach to finance and money maximizes efficiency. Generally speaking, no other criterion is regarded as relevant. Nevertheless, research from the field of ecological systems demonstrates that sustainable systems — those able to endure long periods of growth and rapidly recover from significant shocks to the system — are not primarily efficient but rather moreresilient than efficient. This resiliency, typically in the form of a diversified “portfolio” of constituent elements in the system (fish, turtles, insects etc.), allows for much more rapid recovery from shocks that would decimate a more efficient (i.e. less resilient) system. [2] Here again, the understanding that portfolios of diverse monetary assets are possible enables a viewpoint that maximizes sustainability in the monetary portfolio at the expense of some efficiency but with the benefit of greater real long-term growth.
Investors require stability in the macro environment as a precondition to investing in a nation’s assets. The simultaneous adoption by multiple nation-states of complementary currencies to diversify their NFC portfolios should raise the performance characteristics of all participating nations’ monetary portfolios because of the further diversification effects.
A complementary currency called the Terra,designed by Bernard Lietaer, could eliminate the ongoing disruption to the world’s economy that is caused by one nation’s currency being exalted above the others as the world’s reserve currency. (This is, however, beyond the scope of the present discussion.)
If a system can operate in which a growth curve of steady progress replaces the present rapid and unpredictable booms and busts, which generally define the performance of NFC’s in all nation-states today, then investors will be able to plan with more confidence. Investors will commit funds more easily and on less aggressive terms of repayment (i.e. risk-adjusted required return) if they are more confident of success.
While there will always be risk factors in investing, the risk of a nation’s general economy collapsing is the most severe one that is essentially outside the control of management. Therefore, its removal from investment calculations will have a salutary effect on all manner of investments, especially those on the frontiers of technology where the risk is highest but so too is the potential gain — for us all.
Conclusion
The adoption of complementary currencies has the potential to improve economic results worldwide. They cost little to implement, requiring no additional regulations, taxes or laws. They can be implemented either as private or government initiatives. They thereby are that rare transformational vehicle that should appeal across the political spectrum.
Author’s Note
The definitive source of information about complementary currencies is the book New Money for a New World. They are also featured as a design element for a new kind of society in my own book, A Celebration Society.
[1] http://www.ewp.rpi.edu/hartford/~stoddj/BE/WIR_Update.pdf; http://www.ewp.rpi.edu/hartford/~stoddj/BE/WIR_Panel.pdf
[2] As discussed in New Money for a New World, historical evidence from two real-world experiments pre-World War II Europe (one Austrian; one German) demonstrates that complementary currencies can have a very rapid and highly salutary effect on local economies. Prof. Irving Fisher, one of President Roosevelt’s three top economic advisors said of these experiments, “The correct application of (these currencies) would solve the Depression crisis in the United States in three weeks.”
