Is an 'Energy-Linked' Currency in the Cards?

This article is a guest contribution by Izabella Kaminska, FT.com Alphaville on Monday, April 6th, 2009.

Izabella Kaminska, contributor to FT.com's Alphaville comments on Chris Cook, former director of London's International Petroleum Exchange, who has been lobbying for the creation of an 'energy-linked' currency.

Former director at London’s International Petroleum Exchange (and frequent contributor to FT Alphaville’s Long Room) Chris Cook has long been campaigning for a new monetary system that would link monetary units to energy.

Now, it seems his thoughts are finally being picked up on a large scale across the financial blogosphere. At the core of his proposal is redefining the monetary system so it is linked to energy output specifically.

As he explained to FT Alphaville:

I’m not proposing pricing in oil. I’m proposing denominating exchanges in energy as a unit of measure. Whether it’s called an energy dollar or a petro or an electro does not matter. Electricity, and any form of fuel eg gasoline, nat gas, heating oil, fuel oil will all have a fixed price denominated in it, but a variable price against everything else.

And from his most recent posting on The Oil Drum (emphasis his):

So I will conclude by saying, not for the first time, that oil is not priced in dollars: dollars are priced in oil , and recommending that the G20 turn their attention to a sustainable International Energy Clearing Union alternative to our current unsustainable global monetary system.

The idea is that producers of energy like Russia and Iran could issue units redeemable either in electricity or what he describes as “energy vector” fuels such as gasolinem natural gas — in exchange for value received. All of these have a fixed value denominated in energy.

The next phase is the creation of an International Energy Clearing Union where these units can trade (with the collective guarantees of energy producer and consumer nations generally). As Cook goes on to explain:

Both energy creditor nations — such as Russia, Iran, the GCC and Norway — and energy debtor nations, such as the US, UK and EU would all pay an amount into a global “energy pool” in support of the guarantee. The resulting balances would be deployed in massive investment in new renewable energy infrastructure and energy efficiency savings.

The US, which is the biggest energy debtor by far, could therefore be funded by the Pool in redeploying much of its increasingly baroque military expenditure not just into the “Green New Deal” proposed in the US, but also globally, in partnership with the immense UK and EU intellectual capital at the cutting edge of research and development.

The above would also have a welcome effect on wasteful energy use. As Cook puts it (our emphasis):

The use of an “energy dollar” or “Petro” energy unit, as it was referred to in Iran, addresses one of the most pressing issues. This is the catastrophic waste of carbon-based energy in those countries blessed or cursed with large oil and gas reserves. Anyone who wishes to see the negative effects of gasoline available at 30 cents per gallon on the environment and on the quality of life, need only travel to Tehran.

The unitisation of gasoline, on the other hand, allows the price of gasoline to be raised to global levels, and for the population to be compensated with Units redeemable for gasoline. While some will continue profligate use of gasoline, most will cut back on gasoline use and exchange their Units for something else of value.

And what with global currency talk, the idea itself might not be as radical as first appears. Firstly it’s appealing to those commodity producers and buyers on the political fringe - like Venezuela, China and Russia. Note Chavez’s call to Arab nations last week for support on the creation of an oil-backed currency to challenge the US dollar.

The Fox news article cited above notes that China has already struck deals — most recently with Argentina — to trade in currencies other than the dollar. This is indicative of the will currently in the world to set up some other system . Chavez is set to arrive in China on Tuesday for a two-day visit following a trip to Iran earlier last week, the outcome of which saw an agreement to create a joint Venezuelan/Iranian bank. Iran is another country that is unhappy with the current dollar dominated system and a country Chris Cook has personally advised on alternative strategies - such as development of the ‘petro’ dollar.

But if you thought it was just dollar-reserve countries that would be interested in such a development, note the feelings of V Anantha-Nageswaran, Bank Julius Baer’s chief investment officer, on the matter. In an FT video interview last week, Anantha-Nageswaran said it was not very realistic to expect that the dollar would remain the centre or the anchor of the international monetary system for long. As he said:

I think there have been quite a few, even in the last 35, 40 years, when such a single currency dominated monetary system has exerted a lot of cost, and extracted a heavy demand on other countries participating in that system.

As for the alternative, he proposed:

Well, I think the alternative is not necessarily to go back to the straitjacket of the gold standard, which did impose a lot of constraints on policy makers. All we need is a system which does not have excessive dependence or reliance on one country sticking to prudent policies all the time, or one country undertaking economic policies mostly suited to their national interest.

I think it is possible for economists to design a system where you don’t necessarily have to have a commodity anchor, but you can have a system which is rule-bound, and applies across the board to all countries, because right now we have a system which is quite capital to what the US government or the federal reserve does with respect to its own domestic economy interests, and other countries are simply forced to follow suit, regardless of whether that suits them or not.

But could it actually be back to the drawing board completely, including prospects for a renewed commodity anchor? Quite possibly:

Frankly, I don’t think I have very well-developed thoughts on the architecture that we’ll finally have. I think we need to sort of, go back to the drawing board and look at whether we have to have an SDR, or some other basket of currencies. Well there’s more than one country which contributes to the global monetary architecture, or do we go back to a commodity anchor, if not gold, then something else?

At the end of the day, the real issue is, the United States in 2001 and in 2007, not to mention 1973, pursued monetary policies that it thought were necessary for its own interest, and that had repercussions for the entire world, and look at Europe as well; Germany did what it had to do in 1989, 1990 when it gave one Deutschemark for the East German currency, and that created inflation, higher interest rates, the rest of Europe couldn’t handle that. So basically, when you have this one country dominance, it always leads to issues like this, so that is where I think there is agreement now, but where there is no agreement is, what is the replacement?

And I’m sure it is not something that we can sort out in a week or a day or a quarter, but certainly we need something like, a WTO [?], which was based on a principle of, one country, one vote. No single country enjoyed extraordinary rights or responsibilities in the WTO, IMF or the World Bank. I think we need a similar architecture for the international monetary system, where the rights and responsibilities are equally shared.

Furthermore, the topic of a new reserve system is likely to stay at the forefront of the economic/financial news agenda in the days to come. The latest comments from George Soros - the main advocate of the IMF Special Drawing Rights bailout package agreed at the G2o - suggest as much.

As Reuters reported on Monday, Soros remains of the opinion that the US dollar is clearly under pressure because the entire US banking system as a whole is “basically insolvent”. Consequently, it makes sense that the dollar should be replaced as a world reserve currency - possibly by a system linked to SDRs.

But would that system be as viable as a commodity-linked one? The argument against reviving the gold standard, for example, centres around the original reasons for why it collapsed in the first place — there was not enough gold in the world to reflect growth. That would not be the case with Cook’s energy system, however.

That’s because at the heart of Cook’s system is the concept of peer-to-peer financing via the unitisation of energy. It is not a new currency derived from the combined values of anything else (as would probably underpin an SDR system). It is a new unit altogether. This differentiates it also from some other commodity currency proposals in the market already like the Terra, which is being pitched by Belgian economist Bernard Lietaer — the man who implemented the convergence mechanisms for the Euro Zone.

The Terra, Lietaer argues, would dodge inflationary effects by being based on a basket of the twelve most important commodities (according to their importance in world wide trade). However, because it is designed to trade as a complimentary currency operating in parallel with national currencies it doesn’t provide the same unitisation of energy that Cook’s idea does. It is also differs by being linked to the market prices of the commodities themselves, which vary in standards across the board. Cook’s idea is linked to the actual productivity of those commodities in energy terms - a much more effective way of standardising commodities that everyone uses - be they oil, natural gas, wind power or heating oil.

Meanwhile, the “peer-to-peer” system aims to empower all trade partners by eliminating credit intermediaries themselves. As Cook highlighted in January in the Asia Times:

In this model, the financial service provider ceases to be a middleman, or credit intermediary, and becomes a pure service provider. The fact is that in the Internet age there is no need for credit intermediaries, whether private banks or central banks.

And in another Asia Times article he explained:

In my view, John Maynard Keynes’s proposal in 1944 of an “International Clearing Union” was the correct approach. The key difference in the alternative networked and decentralized architecture I envisage is that the “value unit” (Keynes’s “Bancor”) would not be an inherently worthless “fiat” currency issued by a global institution. It would instead be a redeemable “energy dollar” issued by producer nations within a networked pool of energy production and a global Master Partnership framework agreement. Moreover, a carbon levy - essentially a mandatory, but valuable, investment - could then fund direct investment in renewable energy production (megawatts), and indeed even in energy savings (”negawatts”).

So, as the debate over a new reserve system rages on, the key question will be which way will the world go? Will it be the creation of a totally new system based on the unitisation of energy — itself encouraging the development of green energy alternatives — or a collectivised system based on a currency/commodity basket still linked to old day market prices.

Perhaps one place to look for clues will be the success rate of the Gulf Cooperation Council’s efforts to forge a common currency. In its latest communique the GCC, composed of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates, says it aims to meet in May to discuss the location for a common central bank.

However, the move might yet flounder as the global crisis distracts members’ attention to more pressing domestic affairs. The group has already admitted it will not make its original January 1, 2010 deadline for monetary union.

This article is a guest contribution by Izabella Kaminska, FT.com Alphaville on Monday, April 6th, 2009.