Benjamin Graham is remembered primarily as the father of value investing, and as the former professor, employer, friend and investing mentor of Warren Buffett. Yet Graham did a lot more than dispense sound investment advice.
For one thing, he developed a subtle and clever idea for stabilizing currencies -- and economies -- that might bear closer examination today. He called it the commodity reserve currency.
Graham first formulated the idea in response to the recession of 1920-1921. During that crisis, Graham observed that the price of gold was remarkably stable while the prices of many other items, even basic commodities with far greater direct impact on the economy than precious metals, were dropping precipitously. From his perch on Wall Street, Graham saw these declining prices reflected in plummeting corporate earnings.
At the time, each U.S. dollar represented a fixed amount of gold. Graham noticed how that dynamic stabilized the price of gold (and, to a lesser extent, silver) while the price of other goods crashed. Gold producers were “exempt from the difficulties that bedeviled the rest of us,” he wrote.
So, with characteristic inventiveness, Graham wondered how much more stable the economy would be if, instead of precious metals alone, fixed quantities of more essential commodities would be pegged to the value of the dollar. He speculated that this would ensure that the prices of, say, petroleum or wheat would be as stable as that of gold.
Graham never published his macroeconomic prescriptions during that recession, and during the subsequent boom years of the 1920s they no longer seemed relevant. It was not until the onset of the Great Depression, and an ever-widening discrepancy between gold’s price stability and that of basic commodities, that his interest in this area was rekindled. He began to set his old idea to paper.
The plan he advanced in the 1930s revolved around a “commodity-unit” currency. At the time, the dollar represented 23 grams of gold. Graham proposed that his new form of currency represent a basket of 23 commonly used commodities: “23 small quantities of different basic raw materials,” as he put it, “tangible, basic goods that we use and need, in their proper relative amounts.”
He thought this plan would help stabilize the prices of basic foodstuffs, textiles, nonprecious metals and other vital elements of production and consumption, such as rubber, which had all suffered significant declines in price during the Depression. The increased stability, he argued, would ripple throughout the economy, leading to steadier pricing, production, consumption, corporate earnings and employment.
Graham further proposed that to help counter the lower demand for these vital economic inputs in periods of slow growth, the government could purchase a reserve of the 23 commodities from their suppliers and store them. Then, when the economic cycle turned, these reserves would be sold in exchange for money. During the lean years, the reserves could also serve as an emergency supply of basic goods.
Regarding his plan’s effect on price stability and, by extension, economic stability, Graham wrote that “the general price level for basic raw materials in the open market would be held close to the standard level by the most direct method possible,” meaning the purchase of these commodities by the government “in the open market whenever the price level tended to decline, and their sale in the open market whenever it tended to advance above the standard level.”
Graham first published these ideas in the Spring 1933 issue of the Economic Forum, with the title “Stabilized Reflation,” which would later become the basis of “Storage and Stability.” In “World Commodities and World Currencies,” published in 1944, he expanded the concept to an international system that would help prevent the currency wars and protectionism that played a role in instigating World War II.
To that end, Graham made some significant modifications to his domestic plan -- most notably, a smaller basket of 15 commodities and active buying and selling by a sub-agency of the International Monetary Fund, instead of the U.S. government.
The Nobel Prize-winning economist Friedrich Hayek wrote a lengthy article endorsing Graham’s commodity reserve currency, and John Maynard Keynes wrote to Graham expressing agreement with an important aspect of the plan: “On the use of buffer stocks as a means of stabilizing short-term commodity prices, you and I are ardent crusaders on the same side.”
Although Graham’s plan faded into obscurity during the latter half of the 20th century, it has since resurfaced in some notable places.
In his 2002 book “The Money Changers: Currency Reform from Aristotle to E-Cash,” the British economist David Boyle praised “World Commodities and World Currencies” and wrote that “Floating currencies -- as we have them now -- are thoroughly dangerous,” as Graham warned, “because they are not based on anything.” In 2011, John W. Allen, an international-trade specialist who once worked with World Bank President James Wolfensohn, praised the commodity-reserve-currency plan and described Graham as one of “history’s most eminent economists.”
Considering that headlines in the financial media of February 2013 read “Currency War Has Started” and “Currency Wars Return, 1930s Style,” perhaps it’s time for Graham’s plan, or elements thereof, to once again be considered by policy makers.
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