Synthetic Money

7. Conclusions

In this paper we reviewed HKS’s currency invariance and optimal currency basket concepts, illustrated their application to currency data, and extended their analyses to the construction of synthetic money. To demonstrate the notion of synthetic money, we empirically derived a synthetic dollar using six major currencies (excluding the dollar). The results showed that our synthetic dollar is highly correlated with the U.S. dollar and could be used as a substitute currency.

Synthetic money has a number of potential real world applications. For example, in currency pegging operations, a country could tie their currency to a synthetic dollar, rather than the U.S. dollar. This possibility may be relevant to China, which currently pegs the yuan to the dollar. Due to concerns among its major trading partners, the Bank of China has been considering an alternative pegging system to a basket of currencies. A synthetic dollar could be constructed with less than perfect correlation with the U.S. dollar (i.e. partially mimicking the dollar). This basket currency would be consistent with China’s previous currency policy but provide some flexibility vis-à-vis the dollar/yuan exchange rate. Other implications of synthetic money to the issuance of global bonds and currency movement analyses are possible also. Future research is needed to further explore potential applications of synthetic money.

Keywords

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This paper was under review at the International Review of Economics and Finance at the time of going to press.

Acknowledgements

The authors gratefully acknowledge financial support from the Eurasia Foundation, U.S. Information Agency, Russian Foundation of Fundamental Researches, the Center for International Business Studies in the Mays Business School at Texas A&M University, and Utrecht School of Economics at Utrecht University. Helpful comments were received from Julian Gaspar, Jaap Bos, Clemens Kool, Michele Fratianni, Peter Schotman, Michael Koetter, Allard Bruinshoofd, Robert Israel and other participants at the Inaugural Conference (Nul-Lustrum), Utrecht School of Economics, Utrecht University, Netherlands (October 2003).