DEFICITS, DOLLARS, & CURRENCY DIFFERENTIATION A Brief Review of Monetary Theory Nothing is more sacred to economists than monetary theory. Indeed, many consider the invention of money next only to fire and the wheel in its contribution to human well-being. Certainly money contributes enormously to the efficiency of exchange of goods and services. Ever since Adam Smith we have understood the importance of specialization and exchange as the prime movers of productivity and wealth. Only exchange through the intermediation of money, as contrasted with crude barter, has made possible the enormous diversification and prosperity of the modern world. Illustrative of primitive striving towards the concept of money is the use of large stone wheels by the Trobriand Islanders, the Potlatch of the Indians of the Pacific Northwest, and the use of bead wampum by the New England and Central Atlantic tribes. Each time our understanding of the economy has moved forward it has been by quantum leap, which, in retrospect, has appeared so simple and self-evident that we are left wondering why no one had thought of the process or concept earlier. The Different Uses of Money Early theorists identified three separate uses of money: money as unit of account; money as medium of exchange; and money as store of value. John Maynard Keynes in his seminal work The General Theory of Employment, Interest, and Money , in discussing demand for money, added what some consider important additional precision. Keynes recognized the difference between the transaction use of money, its precautionary use, and its facility for speculation regarding the probable future evolution of the economy. The present paper will put forward the suggestion that money's transaction and precautionary use s can be usefully further subdivided. When it was discovered that gold, by reason of its scarcity, durability, transportability, malleability, and universal demand -- in other words, its intrinsic value -- provided the almost ideal nth commodity in which to calculate the value of all other goods, and against which all other goods could be traded, the notion was also adopted with little additional thought that one form of money was best for all purposes. Of course it took some time for sovereigns to capture a monopoly over coining money: and for much of history local magnates shared in the profits of seignorage (as reflected in the derivation of the term itself). Even in republics like the United States, private banks were permitted to coin gold and silver and print paper receipts (banknotes) for exchange against deposited "real" money. Indeed, in the United States, by reason of the non-existence of gold or silver mines in the original Thirteen Colonies, it was common to accept English shillings, Dutch guilders, and Spanish doubloons, each of which traded at different values against each other according to their different weights and purities. The Optimum Currency Area Concept Some thirty-five years ago, Harry Johnson, a noted Canadian economist, published an insightful paper in the American Economic Review called The Theory of Optimum Currency Areas which went some distance towards providing a theoretical underpinning for the economic thought advanced on purely pragmatic lines by Adolph Hitler's Chancellor of the Exchequer Hjalmar Schact. The Johnson paper, together with the thinking of Schact and the post-WW II experience with multiple exchange rates provides the foundation for this paper. In his paper, Johnson suggested that some especially large countries will inevitably contain more than one natural economic region. Thus in the United States, the Central Bank (The Federal Reserve) is faced with a dilemma when it confronts serious recession in the oil states of Texas, Louisiana, and Oklahoma at the same time that the economy appears to be overheating in industrial New England and rapidly growing California. If the Fed raises the reserve requirement and discount rate or restrains the money supply through Open Market purchases to cool the economic climate in overheated New England, it is bound to worsen unemployment in the areas experiencing recession. Whereas if it stimulates the economy to promote employment and reduce bankruptcies in the areas in recession, it is sure to worsen inflationary pressures elsewhere. William Greider in his study of Federal Reserve policy under Paul Volcker, Secrets of the Temple, faults Volcker for having insisted on wringing Carter Administration out of the economy at the cost of precipitating the worst recession since the '30s. Greider (and by his account a bare minority of Board members) would have preferred a bit more inflation and less of what Joseph Schumpeter the great Harvard student of business cycles called "creative destruction", i.e. the elimination of less-successful and copy-cat businessmen who encumber the productive process while contributing little or nothing in the way of new technology or managerial ideas. According to Schumpeter, the bankruptcy of such individuals has the positive value of releasing resources to make possible the next upward swing of the economy to new and higher plateaus, providing better and cheaper products and better and more well-paid jobs. The "creative destruction" of periodic business cycles in eliminating atherosclerosis from the arteries of business is thus essential to a competitive and well-functioning economy. (As an aside, not a few economists believe that the contemporary non-competitiveness of the American economy is due to fifty years of protection of the economy from any serious periods of retrenchment as a result of virtually uninterrupted central government budget deficits by a Congress which learned only part of the Keynesian message of the Great Depression, until the past six or eight years keeping even less efficient builders, bankers, and manufacturers in business -- despite the rising tide of competition from abroad. Be this as it may, the Johnson study suggests that the economic efficiency of introducing separate currencies in each major economic area, might outweigh by a considerable margin the minor added costs of currency conversion between the regions. Indeed, the reluctance of at least some of the countries of the European Community to give up their separate currencies in favor of a unified European currency unit, seems to be evidence that the Johnson lesson has been heard. It will be interesting to watch, as the post-Gorbachev dust settles in the former Soviet Union, whether the recreation of a dozen different currency units contributes to the smoother functioning of the sub-regions of the former USSR. Johnson, putting reasonable limits to the point he was making, acknowledges that carried to its extreme, his doctrine would mean creating a different currency for each product exchanged, i.e. returning to pure barter. Onward From Johnson -- Optimum Currency Functions Reading the Johnson article thirty-five years ago, it struck me that there were applications to monetary theory left unexplored in the paper. As Senior Economist in the State Department Office of International Monetary Affairs at the time of President Nixon's closing of the "gold window" and the adoption of the Smithsonian Agreement on floating exchange rates, I tried my hand at a couple of papers suggesting alternative policies which were not at all well received by minds educated twenty years earlier in conventional economic thinking. In the intervening years I've been much occupied with the practical issues of analyzing the central budgets of various governments, and the balances of payments and financing practices of Britain, France, Spain, Morocco, and Mexico. And, more recently, teaching in France, the United States, Guatemala, and Mexico. Reflecting on the increasingly troublesome debt problems of many LDCs and the Balance of Payments and Central Government Budget deficits of the United States, thought has irresistibly returned to the applicability of Schact's sketchy development of the notion of multiple exchange rates and Johnson's Optimum Currency Area concept to basic monetary theory. Contemporary Developments in Financial Market Practices, Unbundling, and Monetary Theory Many of the most striking recent developments in corporate finance, and some of the most innovative concepts in stock market offerings have involved "unbundling" stocks and bonds in ways previously not considered, thus making possible offerings to satisfy new and specialized markets. The thought has occurred, why can't Johnson's notion of Optimum Currency Areas be applied to each of the separate uses of money described in the first section of this paper? Couldn't the theory be applied to conceptual, as well as geographical market differences? Why could there not similarly be created a separate, unbundled dollar (or franc, mark, or yen) for transaction use, i.e. for contemporary spending on rent, utilities, food, transportation, and all other monthly needs, where inflation-induced changes of value are of minimal importance -- at a different Schactian rate of exchange determined by the market -- against dollars specifically created to serve as a "store of value", i.e. a savings and/or retirement dollar? Presumably the savings dollar would sell at a discount if current conditions placed a higher value on consumption, thus creating a flow from transaction dollars, resulting in a price-rationed equilibrium of demand. If, for whatever reason, no incentive were necessary to induce sufficient investment to maintain national competitiveness, the market would shift in the other direction, with a premium for conversion into transaction dollars . The Investment dollar might be defined either on a direct investment basis, i.e. the creation of one's own business, or as "at risk" limited partnerships, or broadened to include portfolio investment. If the Fed, or where involved, the SEC, or both working conjointly, were provided with authority to influence these exchange rates by intervention in the market, as is already done with the international dollar by Open Market operations, or, possibly by the equivalent of bank rediscount and reserve requirements, a premium price could be created to attract more money into savings or investments, for public policy reasons, e.g. tilting away from the current historically low domestic savings rate. This might be done, for example, to moderate the United States' current dependency on dollars borrowed abroad to support domestic investment and budgetary needs. Indeed, much the same results might be achieved as in Sweden where the Central Bank at times requires companies to pay a variable proportion of profits into a reserve fund in the form of "blocked earnings" which can only be released for investment during period of recession, as determined by the Central Bank. This has been a powerful economic management tool to even out cyclical swings. Problems of a Paper Currency While much of the world fell into the use of gold or silver as the basic form of money, eventually governments found that this restricted their policy choices too rigorously and assumed responsibility for printing uniform national currencies. And in time paper money replaced specie as the principal form of money in circulation. Initially such paper money was no more than a depository receipt against real gold and silver which remained in bank vaults to avoid wear from being passed from hand to hand. Some older citizens may remember when Federal Reserve Notes circulated in two forms: silver certificates (redeemable upon presentation to a bank for silver dollars), and gold certificates (similarly redeemable in specie) -- until private holding of gold was prohibited to conserve the national gold reserve during the Great Depression. One of the big problems of the contemporary world, however, is that central governments have with rare exceptions shown themselves insufficiently self-disciplined to restrain using the printing press to provide themselves with the credit necessary to meet any and all spending programs espoused by legislators seeking to keep constituents happy. The result has been that available dollars have outrun available goods -- resulting in inflation: the most invidious form of taxation of all, since it is silent, virtually invisible and affects primarily those who are retired or on fixed incomes. Today, of course, the situation is even worse, with plastic money (credit cards), checks, (self-written banknotes), and most importantly "electronic blip" money (central bank computer transfer of credit) which account for upwards of ninety per cent of the money supply. Nevertheless, most economists, would insist that a unified national currency is essential for an efficiently functioning economy -- using the same dollar, or pound, or franc, mark, or yen for all purposes, even though the some economic forces are not necessarily at work with the same vigor or velocity with respect to the several economic realms we have examined. Solutions to Economic Problems Customarily Precede Explanatory Theory It has been observed that economic problems do not always await sound theoretical explanation before expressing themselves. In the depths of the Great Depression, while Keynes was revising Classical Theory to take into account protracted unemployment, something the Classicists, because of the absence of powerful labor unions and the resultant "ratchet effect" of union-controlled wages, did not apprehend as being possible, the German economist Hjalmar Schact came up with the notion of multiple exchange rates. Today discredited and regrettably ignored by the profession because of his involvement with the Nazi cause, Schact recognized that not all foreign exchange transactions are of the same importance to a nation. When an economy is running well, a nation can afford all of the extravagances of a full-blown market democracy -- free choice of imports, unlimited tourism, and protracted residence and education abroad reflecting individual preferences. But in times of national peril, as has been recognized for some time with respect to food and gasoline rationing and compulsory war bond purchases -- which substitute national priorities for personal spending preferences, there may be times when personal preferences must be subject to some disincentives to the purchase of foreign exchange -- assuring sufficient domestic saving to promote industrial expansion, discourage non-essentials such as foreign travel, and stimulate domestic production. Under the Schact plan, this was done by establishing different prices for foreign currency used for different purposes: minimum cost for import of essential raw materials, an intermediate price for business and necessary medical and educational travel, and a sumptuary price for the non-essential purchases and the travel of the rich. Transactions, Savings, Investment, and Speculative Money This Johnson currency notion applied to the relatively sophisticated "uses of money" approach outlined above, leaving the market (as perhaps "nudged" at appropriate moments by Fed or SEC intervention) to establish differential exchange rates between transactions, savings, investment, and speculative uses of money, might provide just the solution needed to help the United States out of its current dependency on foreign borrowing to keep its economy competitive and to offset its chronic budget deficit. In material form, such differentiated dollars could of course exist as different colored notes, spendable only for the purposes intended. But it would appear more reasonable, since only transaction dollars would need to pass from hand to hand (and even then only that share not represented by credit card spending or personal checks), to print only transaction dollars for circulation. Pay checks and credit cards would presumably be denominated in transaction dollars. The other types of dollars would exist only in the form of money funds or savings accounts, and/or stock market book keeping entries, freely purchasable or exchangeable (at premium or discount) depending on government policies and market forces, through banks, investment houses, or foreign exchange bureaus, as with other currencies. Clearly this would make money laundering more difficult, since, with reasonable sophistication the FBI or DEA could track the source of large conversions from transaction dollars , providing a valuable tool in the war on drugs and crime. The Savings Dollar as Unit of Account Savings dollars invested in IRAs or Keogh retirement accounts could further be inflation-indexed (though under this plan this should not be necessary), to provide additional incentive to saving. Moreover, since the value of savings dollars should be relatively stable against transactions dollars , the value of these dollars could serve as the unit of account, or store of value denominator for calculating intertemporal national accounts, with far greater reliability than the currently used periodically up-dated, "base year" system, not requiring the confusing revisions necessary under the present system. If considered desirable, a retirement dollar could also be created with would presumably sell at some premium over higher risk investment, speculative, or transaction dollars. Access to such retirement dollars could be restricted to legal residents of the United States, reducing demand and thus providing additional incentives for people to take advantage of this type of savings. If nothing else, this should eventually reduce dependence on Social Security outlays, helping resolve what will otherwise be a major problem in the next century when the number of retirees will almost equal the number of workers paying Social Security taxes. This would also tend to insulate internal dollar values from swings in the trade dollar, limiting domestic inflationary pressures. At intervals, transaction dollars could be replaced by a new monetary unit to bring values back in line with savings and investment dollars -- which should not depreciate as rapidly. DeGaulle did this when he assumed the French Presidency, replacing the heavily depreciated franc with the heavier New Franc which has proved remarkably stable for over thirty years. This would be far easier to do than re-valuing the present "integrated dollar", which would impose major stresses on the economy, involving as it would property and investment values, whereas transactions money represents only something on the order of five per cent of currency in circulation. This would make it possible to keep the value of transactions money more or less in line with the other kinds of dollars -- and, since savings, investment, and retirement money are likely to prove stable, providing ballast for the whole monetary system, we might even be able to return to a situation where the dollar would show the kind of relative stability it exhibited from the time of the Revolution until the Second World War. The Treasury and Mint might in such circumstances prove less reluctant than at present to introduce new designs, sizes, and colors for money, as in virtually all other countries, to reduce errors in making change and facilitate purchases by foreigners and the vision impaired. Again, practice has in some regards been preceding theory. In Europe, following WWII, the U.S. Military introduced a transactions dollar-type military scrip for use by only the U.S. Armed Forces which helped limit counterfeiting, restrained the black market, and insulated the value of G.I. money from surrounding inflationary forces. Members of the U.S. Military are at present offered an exceptionally high interest rate when they agree to save a predetermined portion of their salary on an automatic deduction basis. Furthermore, a number of other countries offer inflation-indexed bonds to motivate savings. The same results could be afforded on a more flexible, market determined basis, by separating consumption dollars from savings dollars -- and both from retirement dollars With no great stretch of the imagination, a separate speculative dollar could also be created. Rampant speculation has been the cause of most, if not all, of the great crashes of world economic history. Speculative international money movements have been a bugbear in recent exchange rate swings. Were money invested in portfolio holdings or overseas stock markets separated from speculative money, and speculators required to pay a premium for their mischief, international exchange rates might in future be spared some of their wilder swings. Again, the market would determine the rate of exchange, depending on recent experience. If the market has been booming and investors in speculative holdings have been earning well above real bank interest rates, the market would presumably demand a healthy premium to move into speculative dollars . On the other hand, if the market is undergoing a period of decline or uncertainty, speculative dollars may be available at discount. However managed, a separate speculation dollar would be clearly identified as such, with its rate moving according to market forces, and as such provide a restraint on speculative excesses, reducing cyclical overheating and bear market over-selling. At the very least, the need to exchange dollars from one use to another would provide a "firebreak" providing unmistakable signals of trouble and giving governments time to intervene to prevent a Batri-type Great Crash. Some Reflections on Complexity Problems Yes, it can be admitted that this would in some ways appear to be a more complicated world for many people. Savers and investors would be compelled to participate in exchange rate decisions as well as evaluation of markets and institutions. But is can equally be maintained that an "unbundled dollar" would, by the same token, relieve many individuals of speculative decisions they are now required to make regarding the long-term future of their savings and retirement holdings. Indeed, it can be argued, and this author so argues, that it would be a simpler world for the financially unsophisticated and conservative. Workers would be paid in transaction (or consumption) dollars (or, individually or through their unions negotiate for salaries to be paid in proportionate shares of all three [four, five] monies -- much as at present savings bond and direct deposit deductions are negotiated) The simple and conservative could immediately convert to inflation-indexed savings dollars, keeping on hand only enough transaction dollars to meet anticipated consumption needs. Or, as described above, they could exchanget a determined portion into investment dollars for placement with their broker. Or one could put a determined portion into a IRA or Keogh retirement account. The process of dealing with any exchange rate difference need not be any more difficult than paying the front load on a mutual fund, as at present. Or, benefitting from a discount, in the event of low demand, just as many cloded-end funds sell at discount. At, worst.the process should be no more complex than maintaining two or three different savings or investment accounts and transferring money from one to another for convenience -- though, of course, with a slightly variable exchange rate serving to maintain equilibrium between supply and demand in each use. In the case of shifting from one money account -- e.g. transactions to a savings account -- the difference in exchange rate, if any, would be no different than paying the agio to a foreign exchange dealer when buying foreing currency. And the world deals with that every day. At present, all are compelled to be unwilling speculators to some degree, seeing part of our cash or bank holdings holding eroded by inflation, dependent on the actions of the government -- or others. The contemporary incentive is thus to spend and consume with high-value current dollars, rather than save or invest, since month to month inflation in minimal and the sales tax on spending is much less than the tax on capital gains. And, moreover, tax reporting is so much more complex for investments. Foreign Trade Dollar One is hesitant to treat this issue, since it was the primary purpose for Schact's war preparation multiple currency regime, and has thus come into bad repute. And it is not absolutely essential to the application of the Johnston/Timmins optimal dollar notion outlined above. But its utility during the recovery from the Great Depression and during the post-WW II recovery period suggests the utility of at least contemplating creation of a stand-by foreign trade dollar in this period of sever budgetary and balance of payments disequilibrium. A foreign trade dollar would not necessarily have to be further subdivided by priority of purchase; but of course in periods of grave national economic emergency it could be. Managed by the Fed, much as it now acts to smooth out abrupt swings in the market determined floating exchange rate system, a trade dollar could go a long way to restoring equilibrium in the balance-of-payments, despite Japan's reluctance to open its markets to American goods on equal terms, while minimally interfering with the Fed's other monetary tools, used to address other aspects of the economy. It might also prove a useful mechanism to confront any protectionist inclinations of the EU. At a minimum, its existence, and the possibility of manipulating its exchange rate a bit higher or lower according to need, in isolation from the domestic dollar, would give the government a tool considerably more flexible, but quite comparable to tariff policy, for the purpose of stimulating exports or restraining imports. And, unlike tariffs, monetary policy is exempt from GATT (or future WTO) regulation. Capital Budgeting The introduction of unbundled dollars suited to the most appropriate monetary uses for which they will be disbursed, could, as seen, have great utility in giving the authorities the tools necessary to fit expenditure to need. The Central Government Budget would be controlled in part through putting a premium on the cost of dollars used for current expenses (most government outlays); and the Balance of Payments could be nudged towards equilibrium through the premium on imported consumption goods, and a higher domestic savings rate, reducing national dependency on foreign borrowings. Unless Congress tried one of its traditional "end runs", redefining the law in favor of its own spending desires even the U.S. Government would require investment dollars for the purchase of long-lived goods and equipment such as cars and trucks, building, roads, ports, and bridges. Thus the normal contra-cyclical exchange rate incentives and disincentives between transaction and investment dollars would pertain. And this would help restrain government spending in upturns, while incentivising Federal spending in downturns -- something Congress now seems unable to do, despite Lord Keynes' own precepts. This would result in effective Capital Budgeting for the nation, giving us for the first time a clear view of how much, of what appears an enormous deficit, is in reality money saved for the future in the form of capital investment. While much talked about, Congress has never taken realistic steps in this direction. This might be the least insignificant ancillary contribution of dollar unbundling. A Closing Thought on Multiplying Monetary Tools to Match Policy Objectives One of the important contributions to economic thought of the Dutch Nobelist Jan Tinbergen was the insight that policy makers need at least one policy variable to direct towards the achievement of each policy objective. Regrettably, no country has ever had sufficient policy tools to achieve all of its objectives at once, be they rapid and sustainable growth, price stability, efficiency, social equity, budget and balance of payments equilibrium, protection of the environment, national defense, or preservation of a desired national life-style. Thus objectives must be prioritized, and lower priority objectives be put aside as authorities attempt to dominate higher priority objectives. Only after the outbreak of never before experienced stagflation in the late '70s and its unparalleled balance of payments deficit with Japan and Europe did Americans raise efficiency and growth to higher priority after years od dedication to social equity and national defense. But policy makers have consistently lacked sufficient tools to bring national and international accounts into balance. In part this has been because Monetary Policy has been considered a single, indivisible policy variable. When interest rates are raised for domestic purposes, there is an unavoidable spill-over, creating unwanted problems on the international side. Given the history of money and the multiple and manifest forms government controls over it have taken over the centuries, one is led to wonder why, especially given the wartime experience with multiple exchange rates and the contemporary experimentation with inflation-indexed bonds, countries have never before been imaginative enough to take the additional step of introducing different currencies for the several uses of money considered above. This would provide nations with four or five new monetary tools, and thus four or five additional degrees of freedom for achieving their multiple policy objectives. Until this century many countries lives with variable rates of exchange between silver and gold, both commonly used as currency in both Europe and the United States. We put up for many years with the use of worn coins, necessitating the use of counter-scales for merchants to determine the true value of well-worn gold or silver coins presented for purchase of goods. The U.S. for many years underwent the inconvenience of banks accepting for deposit at premium or discount (usually considerable discount) bank notes from other states or towns. And, as noted, in the United States we accepted as money guilders, florins, shillings, and doubloons, as well as dollars. Why not then accept that the attempt to use a single currency for the purchase of contemporary necessities; setting aside the same inflation-prone unit for retirement forty years down the road; using it to import goods from a country where the price of a market basket of goods is often radically different from those at home; placing it in a bank account to save up the down payment on a car or a house several years hence; and putting it at risk in the stock market or a personal business, just do not involve the same risks and calculations. Indeed, they are not at all the same kind of transaction, and call for entirely different types of money. No one cavils at obtaining a different currency when they wish to visit Interlaken instead of Deauville, take in the London theater, or ski at Aspen instead of Chamonix. We provide a hundred different makes and models of car to satisfy virtually every possible taste. Out financial advisors and stock brokers are proud of having devised ways to permit us to invest only in the interest earnings, or capital appreciation or a stock or bond without buying into the capital risk; to opt for zero interest payments with a substantial balloon to minimize current tax liability; or to take a flyer in a particular commodity, commodity index, or mere movement of the stock market average to get around margin requirements. Why should the economics profession and governments not at least consider seriously the application of unbundling as related to monetary theory to see what previously unconsidered solutions there may be to the unparalleled complexity of the problems of our time. References Greider, William. Secrets of the Temple , New York: Simon and Schuster, 1987 Johnson, Harry, The Theory of Optimum Currency Areas, The American Economic Review , 1961 John Maynard Keynes, The General Theory of Employment, Interest, & Money , Cambridge, 1937