-Caveat Lector- from; http://zolatimes.com/V4.2/rand.html Click Here: <A HREF="http://zolatimes.com/V4.2/rand.html">The DMT Rand: a Currency for the Next Hundred Y…</A> ----- The DMT Rand: A Currency for the Next Hundred Years by J. Orlin Grabbe The DMT rand is a private currency and unit of account. It is defined in terms of highly liquid assets whose prices, or values, are readily determined in markets around the world. The DMT rand is the creation of the Digital Monetary Trust, an international trust—or money market fund—which issues anonymous accounts denominated in major currencies, including the rand. The DMT rand is not in any way related to the South African rand. Rather, the name of the currency was chosen in honor of philosopher Ayn Rand. The rand is a monetary unit defined in terms of gold and four fiat currencies: namely, the U.S. dollar, the European euro, the British pound sterling, and the Japanese yen. Why were these currencies/commodities chosen, and under what circumstances will they be changed? Price Discovery, Liquidity, and Efficiency The four currencies making up the rand's definition are those most prevalent in foreign exchange transactions. That is, they have met the market test as the media of exchange most commonly employed in international financial and commercial transactions. According to the most recent central bank survey of foreign exchange trading, carried out in April 1998 (see Bank for International Settlements, 1999), the currencies that most frequently appeared on one side of a foreign exchange transaction (a total of 200 percent for both sides) were U.S. dollar 87 percent Deutsche Mark (euro) 30 percent Japanese yen 21 percent Pound sterling 11 percent After this survey was taken, the Deutsche mark (DM) was replaced by the euro on Jan. 1, 1999. The euro is the common currency of most of the nations of the European Community (with the significant exception of Great Britain). The statistics for the Deutsche mark are presented here as a proxy for the euro. (The actual euro percentages would be somewhat higher.) These same four currencies (substituting the DM for the euro) were also the most commonly traded currencies found in the April 1995 and April 1992 surveys. The percentages in April 1995 were: U.S. dollar 83 percent Deutsche Mark (euro) 37 percent Japanese yen 24 percent Pound sterling 10 percent while in April 1992 they were U.S. dollar 82 percent Deutsche Mark (euro) 40 percent Japanese yen 23 percent Pound sterling 14 percent The markets for these currencies are deep and liquid, transactions costs are low, and prices are readily available. The same is true (see below) for the other component— gold. This means that the value of the DMT rand is readily apparent anywhere in the world, even though the market for the rand itself might be small or limited (as it will necessarily be, at least initially). The Varieties of Currency Experience The use of fiat currencies like the US dollar, the euro, the pound, and the yen in international finance reflects recent historical experience based on the rise of telecommunications. Some historical background is useful. Over the years, the instruments used in international trade and financial transactions have frequently varied. In many local communities (including nation-states), the most widely used commodity, or the product most traded with outsiders, has often functioned as money. In the Oregon territory from 1830 to 1840, for example, beaver skins were a customary medium of exchange both locally and with respect to the outside world (the United States to the east). Then, as the population shifted from fur trapping to farming, wheat became the chief form of money, and from 1840 to 1848 promissory notes were made payable in so many bushels of wheat . Later, with the California gold discoveries in 1848, the Oregon legislature repealed the law making wheat legal tender, and proclaimed that thereafter only gold and silver were to be used to settle taxes and debts. For similar reasons, tobacco long served as the principal currency in Virginia. When the Virginia Company imported 150 "young and uncorrupt girls" as wives for the settlers in 1620 and 1621, the price per wife was initially 100 pounds of tobacco—later climbing to 150 pounds (because of the limited supply of young and uncorrupt girls). Only a few currencies, however, have had long-run durability as well as multi-territorial acceptability. Silver and gold are two of these. Roughly speaking, from the time of Columbus' discovery of America in 1492 to the California gold discovery in 1848, silver dominated in common circulation in America and Europe, while gold thereafter came into dominance following the Californian and Australian gold discoveries (Laughlin, 1901, Chapter 8). Under the rule of the British Empire, the British pound sterling and the gold standard were adopted in much of the world. Later, toward the end of World War Two, the U.S. dollar and gold became the principal international reserve assets under the Bretton Woods agreement—a market position the U.S. dollar and gold have maintained despite the de facto dissolution of the Bretton Woods system in the early 1970s. (For a history of the Betton Woods system, see Grabbe, 1996, Chapter 1). According to the 1999 Annual Report of the International Monetary Fund, the percentage breakdown of the official holdings of reserve assets by industrial countries (a total of 100 percent) were as follows: Reserve Asset Percent of Total Gold 24.6 US dollar 48.5 Deutsche mark (euro) 11.1 Japanese yen 5.3 Pound sterling 2.3 ECU (euro) 1.4 Again, we see the same pattern. The key reserve asset is the US dollar at 48.5 percent, followed by gold at 24.6 percent. The euro (represented by the Deutsche mark and the ECU, and small amounts of additional currencies not listed here), is a distant third (less than 15 percent), followed by the Japanese yen and the British pound sterling. Despite any official statements to the contrary, the holding of gold by central banks and reserve authorities shows the continuing importance of this commodity in the international financial system. In addition, there is liquid worldwide market for gold, with a turnover of about 14.4 billion U.S. dollars per day (Bank for International Settlements, 1997). For background on the gold market as it exists today, see Parts 1 to 6 of my series on gold. The markets for foreign exchange and gold are now completely electronic. This development is driven by the economic incentive to minimize transactions costs. Money is an electronic entry in a computer, and, for most practical purposes, so is gold. (Further perspective on this trend is presented in Grabb e, "Digital Cash and the Future of Money".) Portfolio Diversification Because the fiat currencies that make up the rand are the ones most used for international trade and financial transactions, each of these currencies is also a recipient of positive capital flows at the expense of the others, when any of the issuing central banks is viewed as more prudent than the others (seen from the supply side) or when other economic prospects make the currency more attractive (seen from the demand side). In other words, the dollar may rise at the expense of the yen, or the yen at the expense of the euro, or the euro at the expense of the pound, or any one currency at the expense of the other three. Consequently, there is an automatic element of currency diversification build into the rand from the four fiat currencies that are included in its definition. The gold component, meanwhile, represents a natural hedge against a generalized inflation or currency collapse. In that context, the value of gold will soar, helping maintain the rand's overall value. Conversely, during a time of deflation, the prices of commodities in general (and gold in particular) will fall, but this will be offset by a rise in the value of paper assets (the currency component of the rand's value). At the end of 1999, gold was trading at $290/ounce, about a hundred dollars above the marginal cost of production. (This is viewed from the point of view of mining production; the marginal cost of "production" is virtually zero if sold from central bank reserves.) Consequently, the gold component of the rand is likely to act as a drag on its value for the immediate future, since there is no reason for any commodity to trade above its marginal cost of production, which in the case of gold is around $200/ounce. However, the purpose of diversification is that one doesn't know the course of the future: consequently, the value of the rand will always be tied in part to some commodity as a natural hedge against central bank profligacy. Definition of the Rand National central banks claim a monopoly over the currencies they issue. By contrast, the DMT rand is a private currency, and as such may be issued by any bank, money market fund, company, or other organization—provided they follow the DMT definition, and provided they stand ready to give good value for any rands issued. Thus, when defining the rand, it is a necessary criterion that in the future everyone agree on its market price, or value. This requires that the prices of its components be readily observable (which they are, as discussed above), and also that the definition involve a fixed amount of each component (so that everyone will calculate the value in the same way). On December 30, 1999—the last trading day of 1999 for both currencies and gold—the rand was defined to be 1 rand = .20 US dollar + .20 euro + 20 Japanese yen + .124 British pound + .0007 oz. gold. This definition gives each component of the rand an equal initial weight of 20 percent of the rand's value, using indicative exchange rates as reported by the Federal Reserve Bank of New York at 10 a.m., December 30, 1999, and the gold price as established at the afternoon price fix in the London gold market. This means that each component was defined in such a way that its initial value was 20 US cents, giving a total rand value of 1 US dollar, and a weight for each component of 20 percent. (Note: Some rounding was done to eliminate excessive decimal points in the rand's definition. So the actual value varies slightly from the target 20 cents, and the target US dollar 1. This rounding off marginally underweights the yen [19.56 percent], and marginally overweights gold, the euro, and the pound [20.32, 20.08 and 20.03 percent, respectively].) The rates used in establishing the rand's definition are shown in the following table, along with the US dollar value of each component as of December 30, 1999: Component Market Price(*) Component Amount US Dollar Value of Component US dollar 1 .20 .20 Euro 1.0037 .20 .2007 Japanese yen 102.27 20 .1956 British pound 1.6153 .124 .2003 Gold 290.25 .0007 .2032 Total US Dollar Value: 0.9998(*)Prices are US dollars per component unit, except for the Japanese yen, which is stated as the Japanese yen price of US dollar 1. Of course the rand could have been defined instead to have a beginning value of 1 euro, or 1 British pound, or 100 yen, etc. The choice of 1 US dollar was arbitrary. But the choice of equal weights was deliberate, and reflects the fact that there is no reason to trust one central bank more than the others. The weights of the various components (gold, US dollar, yen, euro, pound) will not stay constant, however. If one component increases in value with respect to the others, its weight will increase; if one component decreases in value with respect to the others, its weight will decrease. If we take the definition of the rand, and extrapolate its value backwards one year to January 1, 1999 (when the euro first came into existence), we can see how the weights of the various components would have fluctuated over the past year. Component Weight Range (percent) US dollar 19.3 to 21.3 Euro 20.0 to 23.2 Japanese yen 16.6 to 19.7 British pound 19.7 to 20.9 Gold 18.3 to 22.1 We see that the Japanese yen was near its peak weight at the end of 1999, reflecting a general appreciation in its value over the course of the year, while the euro was near its low weight at the end of of 1999, reflecting a general depreciation in its value over the year. The US dollar, gold, and the British pound fluctuated on either side of their 20 percent weightings. Changes in the Definition of the Rand Suppose suddenly one day we substituted silver for gold in the definition of the DMT rand. What would happen? Initially this would change nothing, provided the value of the silver equalled the value of the gold on the day the substitution was made. There would be no change in the intrinsic value of the rand. The only future difference would be that the dollar value of the rand would now be somewhat more volatile, based on the observation that the price volatility of silver has historically been higher than the price volatility of gold. And the future value of the rand would reflect the relative performance of silver in terms of the component fiat currencies, instead of the performance of gold. Will the currencies (US dollar, euro, yen, pound) or the commodity (gold) backing the rand ever be changed? Possibly. And here are the guiding principles by which such a change will be determined. 1) The identity of the components backing the rand will undergo periodic review for appropriateness at intervals not to exceed five years. The first five- year interval began on December 30, 1999. 2) No change in the rand's definition shall change the value of the rand at the time the change in definition is made. (In other words, the new rand and the old rand will have the same value on the day the change is made.) 3) The number of currencies and commodities chosen to define the rand shall not be smaller than five. 4) The commodity (as opposed to fiat currency) most used in international financial transactions, and for which there is a broad and liquid market, shall be not be allowed to persist below a weight of 10 percent in the rand's value. In the event that the weight of this commodity does fall below 10 percent, the definition of the rand shall be altered to bring the commodity proportion back to an initial 20 percent. 5) The four currencies most widely traded in the global foreign exchange markets shall be chosen as part of the rand's definition provided that a) there are broad and liquid corporate and government securities markets associated with each of these currencies—markets which are readily accessible to foreigners; and provided that b) the associated governments respect the rights and property of the sovereign citizens of Laissez Faire City, and the customers (depositors) of the Digital Monetary Trust (DMT). 6) Additional currencies or commodities may be chosen in the rand's definition at the discretion of the DMT Currency Committee. The rationale for these principles are as follows. The choice of five-year intervals (point 1) is common in the historical administration of composite-defined currencies (such as the SDR of the International Monetary Fund; or the ECU, which became the euro), but is otherwise arbitrary. Note, however, that a review could take place at short notice (at any time interval smaller than five years), as might be required, for example, if there were an imminent threat of a currency being blocked. Point 2 (no change in initial rand value between old and new definitions) is necessary for continuity in the value of rand-denominated assets. Setting a minimum of five assets (point 3) imposes a minimal amount of portfolio diversification in terms of governments and central banks: not too much trust is placed in any one central bank in terms of defending the value of its currency. The choice of a pure commodity (point 4) as one part of the rand definition is a further diversification against government duplicity (inflation or deflation). The selection of currencies that are most traded in the foreign exchange market (point 5) applies the ultimate test of market acceptability. Countries that impose capital controls, that engage in hyperinflationary policies, or that fail to honor contracts will see trading in their currencies dry up. The countries whose currencies will be widely traded are those with free and deep capital markets, with importance in terms of world trade and production, and with well-developed financial sectors. Gresham's Law vs. Grabbe's Law Many people fail to understand this elementary point (that countries which engage in bad monetary policies will see the markets for their currencies disappear). Often they are prone to quote Gresham's Law (that bad money drives out good) as a mantra, without understanding what it means, or the limited circumstances to which it applies. Does Gresham's Law really imply that good money (good currencies) will not be traded? Gresham's Law holds only when both of two things serve equally well for the legal discharge of debts and taxes, but one is undervalued relative to another. Only in that case does good money (the undervalued currency) drive out bad money (the overvalued currency). Suppose, for example, a tax obligation could be discharged either by payment of $200, or by payment of an ounce of gold, or by payment of 50 ounces of silver. A taxpayer would choose the least valuable of these three to pay his taxes, and would horde (or not use) the other two. Gresham's Law is in this case a simple consequence of the fact that rational people, when offered the same item for purchase at two different prices, will choose the lower price. Gresham's Law is thus just another form of arbitrage. If gold traded for $275/oz., then one would prefer to pay $200 in cash to discharge the tax, rather than to spend $275 for an ounce of gold by which to pay the same tax. But, leaving arbitrage aside, it is clear that when it comes to choosing a medium of exchange, Grabbe's Law applies: good foreign currency drives out bad domestic currency. Witness the oft repeated "dollarization" of hyperinflationary economies in recent decades. Examples have included Brazil, Israel, and Russia at various times. In each of these cases, people have abandoned the use of their own national currency and substituted the U.S. dollar as a means to effect everyday transactions. The rapidly depreciating local currency ceased to function as a medium of exchange, and a relatively "hard" foreign currency was substituted. It has always happened this way. In early America, "[Pennsylvania] notes were intrinsically good, circulated freely at par, and drove the notes of other colonies out of circulation in Pennsylvania" (Hepburn, 1924). During the German hyperinflation of 1920-1923, a steadily increasing proportion of local transactions in Germany were made with foreign banknotes, in preference to a wheelbarrel full of local currency or the continued accretion of zeros on mark notes (100 trillion mark notes were eventually printed). Finally (point 6) it may be the case that in diversifying the global backing of the rand the addition of additional currencies beyond four will become important for reasons not currently foreseen. In conclusion, then, it should be noted that the Digital Monetary Trust intends to issue accounts in the US dollar, the European euro, the Japanese yen, the British pound, and gold, as well as in the rand itself. For some people, accounts denominated in, say, the US dollar will be more appropriate or more attractive. But others will prefer the diversification offered by accounts denominated in the DMT rand. References Bank for International Settlements, Central Bank Survey of Foreign Exchange and Derivative Market Activities, 1998, Basle, May 1999. Bank for International Settlements, 67th Annual Report, Basle, June 1997. Grabbe, J. Orlin, International Financial Markets, 3rd edition, Prentice-Hall, 1996. Grabbe, J. Orlin, Digital Cash and the Future of Money, (http://www.aci.net/ka lliste/dcfutmo.htm). Grabbe, J. Orlin, The Digital Monetary Trust, Part 1, Laissez Faire City Times , Vol 3, No 44, (http://zolatimes.com/V3.44/dmt1.html). Grabbe, J. Orlin, The Digital Monetary Trust, Part 2, Laissez Faire City Times , Vol 3, No 45, (http://zolatimes.com/V3.45/dmt2.html). Grabbe, J. Orlin, The Gold Market, Part 1, Laissez Faire City Times, Vol 2, No 16, (http://zolatimes.com/V2.16/gold1.html). Grabbe, J. Orlin, The Gold Market, Part 2, Laissez Faire City Times, Vol 2, No 18, (http://zolatimes.com/V2.18/gold2.html). Grabbe, J. Orlin, The Gold Market, Part 3, Laissez Faire City Times, Vol 2, No 19, (http://zolatimes.com/V2.19/gold3.html). Grabbe, J. Orlin, The Gold Market, Part 4, Laissez Faire City Times, Vol 2, No 20, (http://zolatimes.com/V2.20/gold4.html). Grabbe, J. Orlin, The Gold Market, Part 5, Laissez Faire City Times, Vol 2, No 22, (http://zolatimes.com/V2.22/gold5.html). Grabbe, J. Orlin, The Gold Market, Part 6, Laissez Faire City Times, Vol 2, No 26, (http://zolatimes.com/V2.26/gold6.html). Hepburn, A.B., History of Currency in the United States, revised edition, 1924. International Monetary Fund, Annual Report, September 1999. Laughlin, J. Laurence, The History of Bimetallism in the United States, D. Appleton and Company, 1901. Lester, Richard A., Monetary Experiments, Princeton University Press, 1939. ------------------------------------------------------------------------ J. Orlin Grabbe is the author of International Financial Markets, and is an internationally recognized derivatives expert who has recently branched out into cryptology, banking security, and digital cash. His home page is located at http://www.aci.net/kalliste/homepage.html. He currently resides in Costa Rica. -30- from The Laissez Faire City Times, Vol 4, No 2, January 10, 2000 ----- Aloha, He'Ping, Om, Shalom, Salaam. Em Hotep, Peace Be, All My Relations. Omnia Bona Bonis, Adieu, Adios, Aloha. Amen. Roads End DECLARATION & DISCLAIMER ========== CTRL is a discussion and informational exchange list. Proselyzting propagandic screeds are not allowed. Substance—not soapboxing! These are sordid matters and 'conspiracy theory', with its many half-truths, misdirections and outright frauds is used politically by different groups with major and minor effects spread throughout the spectrum of time and thought. 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