Gold - the original global currency

As central banks and technology companies try to wrap their heads around how a global digital currency could work 'in the real world', it is worth considering that the real world did once have a form of global currency. And not just any made-up currency that could theoretically be based on a basket of fiat currencies, but an actual trade-able asset that was directly linked to actual fiat currencies through actual fixed exchange rates. Imagine. Also, it didn't work.

The gold standard has often been discussed in the context of monetary policy, serving as a check on inflation by requiring countries or central banks on the gold standard to limit their issuance of fiat currency to the amount of gold they held in their vaults. But there were also clear implications for trade between countries on the gold standard and where citizens of either country could convert their fiat currency into gold.

The price-specie flow was an argument advanced by classical economists as to how the gold standard operated across borders, effectively as a cross border currency or a settlement mechanism. The argument was effectively one of the gold standard acting as a perpetual arbitrage exercise. For example, an economic shock in country A resulting in increased demand for products and thus higher inflation, would trigger an associated increase in imports from country B who was not experiencing a shock. To pay for these imports, citizens of country A would pay via the global currency - gold - which basically acted as a go-between for the two fiat fixed-exchange currencies. To use this gold currency, the customers in country A would hand in their fiat currency for the gold, and transfer the gold to country B. Now country A has less gold, and less fiat currency, and so in theory inflation will cool down. An arrangement that, in theory, is self-managing.

But the success of this global currency came at the expense of effective monetary policy, and ultimately financial stability. And because the gold standard rules were not written in stone - and not an economic law as Ron Paul might suggest - fiat countries could change the rules as they wish. Is war breaking out in the country? Will you allow fear-based behaviour to drain the gold from you country's vaults? And what if you want to ramp up spending to actually win the war? And what about when a fellow gold standard country raises rates for a prolonged period, and you watch helplessly as all of your gold flows to this country to take advantage of higher rates? The answer to how you can deal with these issues is quite straightforward. You go off the gold standard. And that's what countries did.

The Bretton Woods agreement was an attempt to apply the gold standard concept in a more practical way, fixing exchange rates to the U.S. dollar, and the U.S. dollar to gold. How did this end? With doubt that the U.S. was living up to its promise to redeem U.S. dollars for gold. And when pressed, how the U.S. dealt with this situation was quite straightforward. They went off the gold standard.

Money talks, but does it walk? Not so easily, as the gold standard demonstrated.

So what will it take for the new shiny object- a global digital currency - to succeed, not as a derivative, but as an actual standalone form of international settlement? The answer is not so straightforward, and the story of the gold standard should give pause as to the overall implications, and fragility, of any such an arrangement.

Finding ways to better facilitate cross-border transactions in the 21st century global economy is undeniably important. But the ultimate design will need to address the question - at what cost?