Variable Commodity Standard

Variable Commodity Standard

Under a variable commodity standard a currency is officially redeemable in a certain amount of a commodity, such as gold, but the authorities may vary the redemption rate, depending upon other economic conditions. If the commodity is gold, the monetary authorities would vary the amount of gold the central bank stood ready to buy and sell for a unit of currency (e.g., a dollar) to maintain the value of the currency.

One of the legacies of the inflation-ridden 1970s and early 1980s was a renewed search for an inflation-proof currency. Issues surrounding the formation of the European Monetary Union and the planned development of a single European currency, focused additional attention on schemes of monetary reform. In the late 1980s numerous proposals for monetary reform surfaced that incorporated the concept of a variable commodity standard. The common theme in these proposals was the idea of a currency whose value is tied to a weighted basket of goods. The emphasis was on a currency not convertible into a fixed weight of gold, or other commodity, but convertible, at least indirectly, into a weighted basket of goods.

Irving Fisher made one of the first proposals for a variable commodity standard in 1926. He called it the compensated dollar and it required periodic adjustments to the rate at which dollars were redeemable into gold. The magnitude of the adjustments was based upon the deviations of the current dollar value of a basket of goods from the value of the same basket of goods at a point in time. The purpose of Fisher’s proposal was to stabilize the value of the dollar in terms of a basket of goods, rather than a single commodity.

More recent proposals abandoned the idea of periodic adjustments in favor of a currency indirectly convertible into a weighted basket of goods at all times. Under these plans, the monetary authorities would constantly evaluate the value of a weighted basket of goods in terms of a weight of gold or other commodity, and would stand ready to redeem a unit of currency in the amount of gold needed to purchase the weighted basket of goods.

The weighted basket of goods in these schemes would be identical with the weighted basket of goods in a price index, such as the Wholesale Price Index (WPI). The weighted basket of goods might be viewed as a unit of a composite good composed of all the goods in the WPI, and combined in the same proportions as in the WPI. The variable commodity standard then is seen for what it is: A commodity standard that replaces gold or a single commodity with a composite of goods. If the value of a unit of currency (e.g., dollar) remained constant relative to its ability to purchase a unit of a such a composite good, then by definition the inflation rate would be zero.

The mechanics of these schemes have not been worked out satisfactorily, at least for operation over an extended period of time. Recent discussions of variable commodity standards, however, may indicate that the inconvertible paper standard may not represent the pinnacle stage of evolution in monetary standards and that in the eyes of some theoretical researchers there is room for improvement.