The half-baked UNIT
Alexey Subbotin, an investor and entrepreneur, and Ji Luo, an investment manager running investment operations for family offices and a computer engineer by training wrote a paper on a proposed BRICS trade settlement currency they called the UNIT
(https://wp.unitfoundation.org/).
It is generally assumed by some of the few western commentators who follow the BRICS story that it will be the basis of a proposal to be put forward at the BRICS summit. A Russian specialist working with a Chinese colleague has the outward appearance of a joint Russian and Chinese government-sponsored project. But given the proposers’ backgrounds, this is not so.
Money: Sound and Unsound
Best Price: $20.00
Buy New $21.43
(as of 03:59 UTC - Details)
Furthermore, I can find little merit and some serious flaws in the UNIT proposal. We can all agree the sense in 40% gold backing, but with 60% fiat in various currencies without gold conversion facilities but just valued day-to-day in gold is unnecessarily cumbersome, and the redemption proposal is impractical. The inclusion of blockchain technology is unnecessary, exposing a poor understanding of the relationship between money and credit. Proof of this is the absence of any mention of interest rates on the proposed currency.
In any event, for a currency to be credible the arrangements must be as simple as possible and easily understood to maximise confidence in it for its users. The UNIT fails on these grounds alone.
The reason for reviving this topic (which I wrote about in March) is that there is already mounting speculation about this proposal for a trade settlement currency being on the summit agenda. But from various statements (Deputy Foreign Minister Sergey Ryabkov, and Sergey Glazyev with responsibility for the Eurasian Economic Union currency project particularly) we can forget the UNIT and if a trade settlement currency is proposed it will probably be as an aspiration requiring further discussion.
The speed with which problems for the dollar is mounting suggests that there is insufficient time for leisurely deliberations within the BRICS membership, doubtless in conjunction with the Shanghai Cooperation Organisation and the Eurasian Economic Union, in order to come to an agreement on this issue. Instead, either for defensive or offensive anti-dollar reasons, it makes more sense to implement a proper gold standard which BRICS members can have the option to use or not for trade settlements between them. It could be set up in a matter of a month or two rather than years, and in the face of a collapsing dollar may well have to be.
There are also clear benefits of a gold standard for Russia, whose finances are already suited to it perhaps with some minor adjustments. Either for Russia or a BRICS currency, a proper gold substitute can be implemented easily and simply. To understand how simple it is, I shall describe it in a national context for Russia, but it can equally be established for backing an entirely new cross-border trade settlement medium.
A currency is always credit, imparting its value to all lower forms of credit denominated in it. The objective is to tie the value of the currency firmly to gold which is the ultimate form of money, so that the currency becomes unquestionably a gold substitute.
The standard model
Russia can easily establish the rouble on a gold standard and maintain it, because it has a low debt to GDP and low flat-rate income taxes. Her principal problem is the lack of credibility in the currency, which in its fiat form requires excessively high interest rates to stabilise it. A gold standard would allow these interest rates to fall substantially, and properly implemented allow the rouble to retain its purchasing power by turning it into a credible gold substitute.
The following are the basic principles required to achieve this objective.
1. The central bank is to be split into two separate entities: an Issue Department and a Banking Department. The objective is to ensure that rouble banknotes and bank balances held in the Issue Department are freely encashable into gold coin and bullion.
2. The separation between the Banking and Issue Departments must be clearly defined and confirmed in law. As separate entities, each shall have its own balance sheets, so that the credit activities of one are separated from or influenced by the other.
3. The central bank’s gold reserves must also be transferred to the Issue Department.
4. The quantities in circulation and issue of rouble banknotes, together with commercial bank balances arising from the exchange of gold for rouble deposits must be reflected on the Issue Department’s balance sheet, which is tasked solely with managing the relationship between the gold reserves and the rouble.
5. The Issue Department must have the sole power to set interest rates with the single objective of maintaining sufficient bullion balances at all times. Interest rates will no longer be used as a tool for economic policy.
6. The Banking Department will continue with its other functions on behalf of the Russian state, except for the setting of interest rates. It will act as it sees fit in the management of commercial bank relations, extending credit or withdrawing it when necessary to maintain stability in the overall credit system.
7. Along with the power to set interest rates, the Issue Department will be empowered to maintain reserve balances (the counterpart of bullion submitted to it) paying interest to the commercial banks at a small discount to the official rate, which it sets.
8. Any restrictions and taxes on gold coin and bullion must be removed by law. All foreign currency restrictions and controls must be removed as well to permit the free flow of bullion.
Currently, Russia’s official gold reserves are declared to be 2,336 tonnes. It is thought that between two state funds, the Gokhran (State Fund for Precious Metals) and Russia’s National Wealth Fund, Russia has a further significant holdings of gold bullion. Their holdings need not be folded into the Issue Department (though it may be advantageous to the funds to do so), but public declaration of their quantity would be helpful to establish the gold standard’s initial credibility.
The rouble must be defined as fully exchangeable by weight in gold grammes both as bullion and gold coin. New coin must be minted accordingly, perhaps with a face value of 50,000 roubles and exchangeable in those units (currently the equivalent of about $500, and similar to the value of a British sovereign). The time taken to design and mint the new coin may delay its introduction, but there is no reason why a bullion exchange facility cannot start immediately.
How it works in practice
The bullion exchange facility operates not through the Banking Department of a central bank, but through the Issue Department. In order for a commercial bank to have a credit balance with the Issue Department, bullion must be deposited in the first place. And it is here that the lessons learned from the 1844 Bank Charter Act come into play.
Banks eligible to open an account at the Issue Department can buy gold in domestic and foreign markets, where the lease rate for 12 months is currently less than 2%. We can take that as an indicated rate of interest that global markets pay to borrow gold or receive as depositors. Therefore, in one year a holder of 100 ounces of gold has 102 ounces. Meanwhile, the Bank of Russia’s key benchmark rate is 18%. The uplift in return for a buyer of gold in international markets depositing gold with the Issue Department is 16%, accumulating in a credible gold substitute. This is why the credibility of the standard is so important from the outset.
It now becomes obvious that Russian and other banks qualifying for accounts at the Issue Department will provide the gold deposits through international arbitrage to ensure that the Issue Department will rapidly accumulate all the bullion it needs to operate a secure gold standard. And it is equally clear that with the ability to regulate the interest rate, the issue Department can manage the quantity of its gold reserves. The remaining question is whether the Issue Department should have its liabilities covered entirely by gold, or by a lower level, such as the 40% mentioned in the UNIT paper.
There is no doubt that understanding it is the Issue Department’s interest rate which will control the gold position means that its liabilities need not be 100% backed. What is needed is simply a stable relationship between gold reserves and its substitute. Whether excess bank liabilities — that is additional to the gold held as an asset on the Issue Department’s balance sheet — are parked in the Issue Department or the Banking Department of the central bank should make little difference. It is the assets that match excess bank deposits on the issue department’s balance sheet which matter. And in the Bank of England’s Bank Charter Act of 1844 those assets were initially government debt.
In Russia’s case, it may be wise to minimise the Issue Department’s exposure to government debt to maximise the scheme’s credibility. Furthermore, Russia’s funding needs, apart from temporary war funding appear minimal anyway. For a new BRICS trade settlement currency, the creation of dependent credit may be best left to commercial banks entirely. Therefore, on balance, my opinion is that the Issue Departments of both cases should have gold as their dominant asset as close to 100% of its liabilities as possible, deriving its income from coin seigniorage and the difference between its official deposit rate and the rate paid to banks on their deposits.
It should be noted that the more credible a gold exchange standard is, the less the public will hoard gold coin, and the less bullion will be hoarded by private sector institutions and enterprises. Therefore, in its initial stages, maximum credibility is obviously the key. This can be rapidly achieved by the Russian banks supporting the plan, which they are bound to. Any bank on Russia’s SPFS payments messaging system can open an account with the Issue Department. This should be extended to any licenced bank in the Shanghai Cooperation Organisation and BRICS with secure messaging system access to the Issue Department. As well as acting as principals, these banks can operate on behalf of their customers. Russian oligarchs and draft-dodgers who have sold their roubles would almost certainly rush to buy them back, and even deposit gold with the Issue Department through the agency of their banks.
The Mystery of Banking
Best Price: $2.23
Buy New $7.57
(as of 07:55 UTC - Details)
On current interest rate spreads, bullion inflows should be substantial: arbitrage with western bullion markets will ensure it. Given current sanctions against Russia, London and other markets under the control of the western alliance access will not be directly available to sanctioned banks, a factor which is likely to provide a significant boost to gold trade in Asian and Middle Eastern markets. Sanctions will not stop gold shipments. Furthermore, Russia’s success is bound to lead to imitators, almost certainly the Saudis, and if not immediately, the Chinese are bound to follow.
A rouble priced in gold will also make energy payments in declining fiat currencies even less desirable to Russia, which will have to be sold — for what? The divide between the fiat world and gold standard currencies would become a very wide gulf indeed. A new impetus for the delayed BRICS trade settlement currency is bound to ensue, particularly with Russia having the BRICS chair.
Alternatively, a gold-exchange standard for the rouble implemented on the lines above will be robust enough for BRICS and SCO members to use in place of a new trade settlement currency. Initially that may be difficult due to US sanctions against banks trading in roubles. But a collapse in the dollar, to a large extent accelerated by the introduction of gold backing for the rouble, would resolve that problem in not much time.
In contrast with the UNIT proposal, a gold-exchange standard on these lines would also work for a new BRICS trade settlement currency and is extremely simple to set up, perhaps with less than 100 tonnes of gold initially and an interest rate designed to attract further gold reserves through arbitrage. We can be sure that producers and merchants would prefer to be paid in credit tied firmly to gold’s value, instead of an array of fiat currencies with dubious value.
Reprinted with permission from MacleodFinance Substack.
