What is the Smith Unit? See this first

Summary
A brief history of money and its uses is presented. A new digital currency, the Smith unit, to facilitate commercial transactions is proposed. Shortcomings of cryptocurrencies (bitcoin), existing paper currencies (dollars, euros, yen, yuan, etc.), and gold and silver are covered.The Smith unit is compared to similar products like the ECU (European Currency Unit-the predecessor to the Euro) and the SDRs (Special Drawing Rights) of the International Monetary Fund.

What is money and what are its uses?



Adam Smith in 'The Wealth of Nations'[1] talks about the two major uses of money, 1) As a facilitator for buying and selling of goods and services by being a unit to measure their value, e.g. 1 kg of potatoes for 1 Euro, and 2) As a measure of someone's worth, e.g. Maria is worth a million dollars. The use of the same term money to denote these two has caused substantial confusion for humanity, as covered by Adam Smith. However, the primary use of money is the former-a unit of the measure of the value of goods and services (labor is a service, and the wages you pay someone in money is their recompense for that labor).

Money is similar to the unit of mass, the kilogram (kg) or the unit of length, the meter (m), which from the Système Internationale (SI) units conventions, are standardized units of measuring mass and length.

However, even the kilogram and the meter are not absolute measures. When you measure something with a weight scale, it is never a completely accurate reading-because of the calibration errors in the weight scale against the 1 kilogram international prototype in Paris[2], which is the standard unit of mass in the SI convention (i.e. when you buy 1 kg of something, it is never really 1 kg). This error, the difference between the mass and the actual mass if you had the prototype in your hands, is tolerated depending on your applications-if you are measuring something ultra-sensitive, you need a very accurate and calibrated scale; whereas for most goods, an error is acceptable (the 1 kg of oranges you weighed are really 999 g if the oranges were weighed by the Paris prototype, but you can live with this error).

Further complicating the issue is that the prototype of mass in Paris is itself a variable (recent attempts to put them in terms of physical constants notwithstanding)[3] and susceptible to drift over time-what it was a hundred years ago is not what it is today, because of corrosion, loss from use and wear and tear, etc. The point is-that even for a physical unit like the kilogram, there is no absolute measure, but we carry on our lives quite well despite the uncertainties and errors.

Money (a dollar or a yuan, for example) is a measure of value just like the kilogram for the mass. Different observers will give a different value for mass, length, etc. for an object depending on the accuracy of the tools they have, or how much experience they have with similar objects; the same is true for value, wherein an object can be assigned different values by different observers.

Value in this sense is a fundamental property of all objects just like the mass or the length, and we can say:

Object properties: Mass (kg), Length (m), Value (dollars, yuans, etc.), and other properties.

What we needed for mass or length in practice were standardized, easily reproducible international units-and the same is needed for the value of an object.

A great disservice has been done to humanity by putting the unit of measure of value in the hands of financial types and banks etc., who are always tinkering with it (often to no effect). This important unit of measuring value needs to be in the hands of an organization of scientists and technologists, as the SI is.

Before the standardization of mass in kilograms, countries and regions of the world had their own standards of mass (e.g. pound in the Great Britain, seer in India, momme in Japan), and some continue to be used to this day. However, the SI units with their standardized definition of kilogram really simplified things-and the SI unit of mass has gradually replaced all other standards in the last 100 to 200 years.

Great Britain might have insisted for national pride reasons that the international unit of mass be the pound, or Japan might have insisted on it being the momme, but the kilogram eventually was accepted in almost all fields of life in all countries.

Not just for mass, but the decimal based SI units have replaced region and country specific units for length, time, etc. as well. The same needs to happen for money-we need to give up the national pride issues falsely associated with a currency, and adopt a worldwide currency.

I propose a unit called the Smith unit. The unit is named in honor of Adam Smith, the founder of Economics.

Defining the Smith unit (SMU)

A Smith unit (SMU, or more simply, just the Smith) is a fixed currency basket derivable from published prices of major world currencies. The unit is 20% each of the US Dollar, the Chinese Yuan, the Euro, and the Japenese Yen and 5% each of the Brazilian Real, the Indian Rupee, the Swiss Franc, and the British Pound on 1 January 2011 and its value was set at one USD ( 1 SMU=1 USD) on this date. The methodology is very similar to how major stock market indices are calculated all over the world.

Based on these percentages and published exchange rates of major currencies in USD (data was taken from the Federal Reserve bank of St. Louis[4]) , the actual currency amounts in one Smith unit are shown in the table below (Column 3):

Table: Currency amounts in 1 Smith unit on 1 Jan. 2011
 Currency
Currency Weight in Smith unit
 Currency Amount in one Smith unit
US Dollar USD
20%
0.2
Chinese Yuan CNY
20%
1.32
Euro EUR
20%
0.150727
Japenese Yen JPY
20%
16.334
Brazilian Real BRL
5%
0.083155
Indian Rupee INR
5%
2.24
Swiss Franc SZF
5%
0.046845
British Pound GBP
5%
0.032484
 Total:
100%
---


The weights were chosen to represent the approximate importance of these countries and their currencies in the world, and easily available public quotes for their prices.

Many other currencies could be included in the basket-but as mentioned above-currencies are not to be used to parade national importance,  and as long as we have a clear and simple standard for buying and selling goods and services, as the Smith unit is, we can use it to define the value of goods and services in all parts of the world, just like the mass of an object is defined in kilograms everywhere.

With the eight currencies above and the associated percentages, we get a good representative paper currency basket for the entire world. Most of the world trade involves at least one of these eight currencies-and adding more currencies to this basket is therefore not necessary.

The detailed Smith unit (or the Smith) calculations file can be downloaded here (.xls format).

The file to calculate the daily value of the Smith quickly can be downloaded here (.xls format).

The currency amounts in the Smith are fixed and not changeable, except when a re-balancing is required, which is covered below. I used data from 1 January 2002 to 31 December 2016 for calculating the Smith unit. Going before and after in time from 1 January 2011, the percentage of currencies in the Smith changes. The maximum weight of any currency was about 26% for the US Dollar, reached on 31 January 2002. The maximum weight of the Chinese Yuan was about 25%, reached on 19 March 2015.

The charts below show how the Smith unit has changed over time vs. the US Dollar since 1 January 2002 until 31 December 2016, a period of 15 years (click on the charts to enlarge them).




There is only one re-balancing rule for the Smith unit:

1. The Smith unit will be re-balanced if one currency becomes 70% of the unit. 

I would like the re-balancing (if needed) to be done by the SI, or the International Committee for Weights and Measures in it's General Conference, which is held every four to six years.

The Smith is an open-source currency, and can be thought of as a currency of an imaginary country called the Smith Republic somewhere in the High Seas, whose only goal is to facilitate the buying and selling of goods for the world.

The Smith Republic has no political connections or preferences for any country, and is most like the SI, which is why I propose that the re-balancing of the Smith, if needed, is to be done by the SI. Data from the last 15 years (2002 to 2016, both years inclusive) shows that no re-balancing has been necessary in these years.

When the world transitioned from gold and silver pegged currencies to floating paper currencies (Bretton Woods abolition in 1971), alarmists published all kinds of warnings-but the transition went about quite smoothly and no country ties it's currency to gold reserves anymore. There's nothing magical about a currency; it's only use is the ease with which it can help in buying and selling of goods by ascertaining their value.

As the proliferation of bitcoin in the last few years has shown, there is no need to involve the banking and financial systems of the world in choosing or controlling currencies-as long as people quote their products in bitcoin and someone (an exchange) converts existing currencies to bitcoins, the new currency can be used to buy and sell goods without issues.

We must agree that there is a real need for a standardized world currency to eliminate the massive transaction costs in conversions from one currency to another-especially in world trade. World travelers also will benefit considerably from a world currency-they lose every time they convert currencies. 

Problems with the bitcoin
The bitcoin has two very serious shortcomings, which make it a risky currency for transactions: 1) Bitcoin can be mined, i.e. more bitcoin can be created by computers, etc. and if mining costs collapse, the currency will fall very considerably in price, or even go to zero and 2) it is liable to fraud-because it can be stolen (the biggest exchange of bitcoins, Mt. Gox, lost USD 500 million of its clients' money in 2014 and was shut down). There are no such problems with using the Smith as a currency unit in transactions, assuming it is accepted as a true currency of a disinterested party.

Moreover, the bitcoin (and other cryptocurrencies), because of its association with solving complex computing problems etc. is unnecessarily complicated. If science and progress is about simplifying complex things and not making simple things complicated, the Smith with its easy to implement calculations is a much nicer solution for a global currency than the bitcoin.

The massive appreciation in the value of the bitcoin against all currencies since its creation shows that it is being used as a store of wealth (the second use of money, pointed above) and speculation, rather than as a currency to help exchange in the buying and selling of goods. It reminds me of Internet stocks of the late 1990's who went up fast, only to collapse later on. A new global currency solution should be relatively stable vs. other major currencies, and the Smith meets that criterion well, by its very design.

One must note that a block chain/distributed ledger system is different from bitcoin the currency (Nakamoto's amazing contribution is the design of the block chain/distributed ledger system, and not the bitcoin), and can work well with existing currencies and the Smith.

Problems with existing paper currencies (dollars, yuans, etc.)
The main problem of using a dollar or a yuan as a world currency is that the currency is a national pride stick. If a country X doesn't have a good relationship with the US, it is hard to convince the businesses in the country X to accept the US dollar. In some cases, e.g. Ecuador and Panama, countries have accepted foreign currencies to be used in every day lives, and do not see any problems. However, there is always the risk that Ecuador goes back to using the Sucre, because a currency being a matter of national pride is well entrenched in society. Italians still debate about going back to the Lira and the Greeks blame their problems on joining the Euro, and want to bring back the Drachma. Worse still, many countries do not want their currency circulating outside their borders (e.g. China and India). Adopting the apolitical Smith, which is a simple mathematical derivative of some of the world's major currencies, solves this problem.

Another problem is best illustrated with an example. If country Y want to use the US dollar as its currency, as long as as there are paper US dollar bills in circulation, the country Y needs to depend on the US Treasury Department (who prints the bills) in some way. The US Treasury has a monopoly over printing US dollar bills, and that makes it very inconvenient for country Y to adopt the US dollar. The US dollar can be adopted for digital transactions in country Y, but it cannot be adopted for bills if country Y does not want to depend on a foreign entity for the circulation of bills within the country. If the US Treasury allowed printing of US dollars outside of the US, just as the one kilogram prototype of mass in SI has many copies all over the world to replicate the kilogram, it would not be an issue, and US dollar bills could become a world currency to replace all paper currencies.

It is unlikely that the US Treasury will give up this exclusive right to print dollar bills-and it is therefore best to start afresh, with a new currency like the Smith, which if needed can have bills in the future, emitted by the SI, with the same methodology used today for replicating the one kilogram prototype.

In this example I took the US dollar and the US Treasury as starting points-but you can imagine the difficulty of adopting the Japanese Yen or the Chinese Yuan as international currencies-because they are even less popular than the US dollar. Coming up with a basket of currencies seems to be good way to solve this problem.

Comparison to the European Currency Unit (ECU) and the Special Drawing Rights (SDRs) of the International Monetary Fund
The ECU was the predecessor to the Euro. It was a basket of currencies just like what is proposed for the Smith here, and the Euro zone did transition successfully to the Euro from the ECU[5]. The major problems with the ECU were 1) That of other paper currencies emitted by countries-a vehicle of national and regional pride. The ECU was used as a political instrument to suppress smaller countries-wherein bigger countries were given larger weights in the basket and apparently because they were more important to Europe. Outside the Euro zone, it was promoted as a tool to further Europe's interest, etc. which made it a bad choice for adoption by other countries and 2) Too much re-balancing, apparently to reflect the share of European trade, making it an arbitrary rule.

The meddling finance and banking types would calculate the share of European trade every five years and adjust the weights of currencies in the ECU. They forgot that trade data itself is approximate and quite volatile, just as most other economic data is.

This is the reason that the Smith has just one re-balancing rule, of a currency becoming 70% of the basket, because wide variations in it's composition are completely okay, as long as the market knows how to convert the various world currencies to the Smith in a transparent manner.

If the Euro did not have these shortcomings, it would serve as a good worldwide currency.

Despite all these problems, the Euro's overall success in replacing all the member states' currencies does show that a currency basket can be used as a currency of many countries, and therefore ensures that if the Smith is adopted by the world, it will become successful as a global currency.

The SDRs of the International Monetary fund[6] have the same problems as the Euro 1) Political unit  2) Arbitrary re-balancing. There is an additional problem with the SDRs-they are too heavy on the US Dollar and the Euro already and are very unlikely to be adopted by a country which doesn't not consider the US or the Euro zone to be their ally.

Implementation guidelines
Having covered how the Smith can be used as a currency, here are some implementation guidelines:

1. Businesses and retailers need to set up a new currency, the Smith, and if needed, tie it to a new country, the imaginary Smith Republic, in their accounting systems. They need to quote the price of their products in Smiths in addition to other currencies.

2. Exchanges need to convert existing currencies to the Smith (much like what they do for bitcoin), so that consumers can use the Smith to buy goods from retailers who accept the Smith. The Smith needs to be quoted in several currencies for this-and exchanges can use the formulas mentioned above to calculate the current price of the Smith.

Exchanges need to offer an easy mechanism to convert the Smith back into other currencies (a two-way market). The indicative value of the Smith will also be published on this website periodically.

3. The Smith is proposed as a unit to facilitate commercial transactions. It is not designed as an investment or a speculation vehicle, or that it will appreciate in time, etc. against other currencies. Clearance and security of Smith accounts and transfers from them should be the same as for currency deposits today.

4. There is no paper currency for the Smith, it is purely digital. There are no Smith coins either. The decision to emit paper currency or coins of Smith can be made in an SI General Conference.

5. Much like the slow and gradual adoption of the ECU in the Euro zone before the complete phasing out of individual country currencies like the German Mark and the French Franc and the launch of the Euro, a switch to Smith as a world currency should be a slow process, with the businesses and consumers always having the choice to deal in whatever currency they are comfortable with-it is important to launch the Smith as a parallel currency, and not a replacement for other currencies. If businesses and consumers see the advantages in buying and selling their goods using the Smith, they will automatically start shifting to it, as happened in the Euro zone with the ECU.

Some people have disagreed with me on thinking of money as a unit of measure of value, like the kilogram for the mass, or the meter for the length. They say that value is not a physical property like the kilogram or the meter. I may remind them of the notion of time, measured in seconds, or temperature, measured in Kelvin, as both being man-made intangible, non-physical properties as well, just like the value. If we have universal units for time and temperature, we certainly can have a universal unit for value. The value of objects may be different at different places and times (the same bottle of water costs a lot different in downtown Paris vs. a small town in Portugal), we all know this and are fine with it; a standardized unit of value worldwide would be like extending the Euro over the whole planet, instead of limiting it to just the Euro zone.

We have moved from gold and silver coins to paper currencies successfully in a period of a few hundred years. However, we now have hundreds of paper currencies-and we need to move forward and standardize everything on one global currency. The Smith is proposed with that final goal in mind.

Sanjay "John" Gandhi
March 2017
Contact me via Twitter @sanjay_world

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