Is Indirect Convertibility Impossible?: A Reply

Abstract

Greenfield, Woolsey and Yeager (GWY 1995) continue to defend the system of indirect convertibility as a means of tying the value of currency to a given basket of goods. We all accept that if this system is feasible, a deviation from par of the currency price of the basket must initiate some process that restores the par value, and the issuing bank must be able to maintain indirect convertibility whilst this process runs its course. The position of GWY is that the system is stable in this sense. Our position is that any such deviation would force the abandonment of indirect convertibility. Suppose then that the currency price of the basket rises above par. To fulfil its commitment to indirect convertibility, the issuing bank must now reduce the price at which it is prepared to sell gold (in exchange for its currency) below the price at which gold can be bought and sold in the GWY do not find difficulty with this result, despite the opportunity it presents for currency holders to round trip by buying gold from the bank and reselling it at a higher price in the market. In the assumed competitive environment, however, market dealers would not continue paying more for gold than they would pay if they bought the gold direct from the bank. They would reduce their buying price, and their selling price, to equal the bank's redemption price. The known commitment of the bank to sell (or buy) gold for its currency in unlimited quantities at a given price implies that there cannot exist some independent market price that differs from the bank's price. This deduction alone is sufficient to show that indirect convertibility is inoper-