LeoGlossary: Unit Of Account
In economics, unit of account is one of the basic functions of money. It allows for meaningful interpretations of price, costs and profits. Essentially it is a measurement of value based upon a common standard.
Having a standard unit of account allows for the comparison of different goods and service. The metric itself isn't as important as the consistency and understanding of it.
Unit of account gains in importance as international trade expands. Commerce conducted within one nation tends to all utilize the same monetary units. This means that currency is the default.
Things change when individuals or companies operate across national boundaries. When other currencies are involved, all will quantify value differently.
Without a standard unit of account, the financial statements of a multi-national corporation would be a mess. The standardization allows all aspects of the business to be quantified to the unit of account, thus being able to present the results to investors.
Public companies are required to file their financial statements with regulatory bodies. Part of this process is converting overseas operations to the standard utilized in that country. In the United States, the Securities and Exchange Commission (SEC) mandates that all foreign activity be converted into US dollars on the files financial documents.
Historical Context
One of the major issues with coinage over the years was the lack of unit of account. With each government (kingdom) minting its own currency, there was standardization within that area.
Problems around as trade occurred. With the introduction of trading markets in Europe, different currencies started to show up. This made it difficult for merchants to conduct trade.
Global finance was another area affected. Gold is an example of a commodity that was often used as money. It also was traded on many different exchanges around the world. This created an environment where the coins were price in the local currency.
All of this required conversion before the transaction could be completed. It added another step to the settlement process.
Reserve Currency
The world has traditionally adopted a reserve currency. One of the reasons for this was as a means of standardizing transactions.
Since the end of World War II, the US dollar has served as the reserve currency. This came about as a result of the country having the largest economy, some of the most advanced banks, and was a military powerhouse.
This means that the USD is the unit of account. Commodities are priced in USD, with the largest market being oil. Financial statements also tend to default to the USD when used internationally.
Liquidity and depth are two vital factors in being the reserve currency. The plays into the writing of loans.
Banks often offer better interest rates when loans are denominated in USD as compared to the local currency. This is done since Wall Street is more willing to by debt in USD as compared to other currencies such as the euro.
This reduces the risk associated to the lender since the loan is removed from its balance sheet. The risk is then moved to hedge funds who are willing to take it on.
Benefits
A single unit of account is a basis that provides some valuable benefits:
- enables borrowing and lending
- trading of goods and services
- provide consistent financial documents
- allows for the comparison of separate entities, especially those located in different countries
Unit of account is an aspect of accounting. The role in recording keeping is essential.
The US Dollar
The US dollar is the global unit of account. This is enhanced by the Eurodollar System which is the largest market in the world, funding an estimated of 90% of global trade.
Most transactions within this market are denominated in US dollar. The system evolved to the point where there are few eurodollars (currency) in this system.
This currency is collateral. We are dealing with ledger based money. Asset that are priced in dollars are used as the basis for secured lending.
U.S Treasuries are recognized as the best form of collateral. Bills are the highest quality since they have the best liquidity and are always on-the-run. Other forms of sovereign debt have fallen out of favor as their central banks decided to implement NIRP.
The unit of account makes the US dollar even more powerful. Since currency is not involved in most aspects of the monetary system, the unit of account takes on greater proportions. It is now transformed into a unit of measure as opposed to a currency. This resembles a meter or ounce.
Money, when it was coins and banknotes, was once stored in bank vaults. Now it is more important how they fit on the ledgers.
Cryptocurrency
Bitcoin was the first cryptocurrency. The network was set up in a way that solved the double-spend problem without a centralized entity.
The blockchain moved trust from financial institutions. The decentralized ledger meant that all transactions were validated by the nodes that adjusted the balances in each wallet.
One thing unique about Bitcoin is that is created its own unit of account called a satoshi. The belief that Bitcoin will eventually replace the US dollar as the reserve currency means that people will have to accept the satoshi as the main unit of account.
The challenge with the view of Bitcoin maxis is that nobody prices real property in satoshi. There are multiple generations of people around the world who price real assets in US dollars. The meaningful interpretation of a satoshi is absent.
The emergence of stablecoins is solving this problem. They are pegged to fiat currency, most the value of the US dollar. This is meant to piggyback the price stability offered by the size and depth of that currency.
FOREX Market
The FOREX market is an example of one with completely different units of account. Currencies are traded against each other, establishing a bilateral value. When a third one is introduce, price differential could create arbitrage opportunities.
Cryptocurrency operates the same way, Market prices for different assets exists especially fungible tokens. They are often traded for each other similar to the FOREX market.
The exchange rates established by the markets feeds into real world trade. A company in Japan operates in JPY. When dealing with a supplier in France, that entity will deal in EUR. For trade to occur, one of the parties would have to agree to deal in the other currency. The are a number of reasons for this especially slippage and transaction fees associated with FOREX swapping.
A vehicle currency, such as the USD, is often used. If both parties engage regularly in international commerce, they have the requirement for dollars. This means accepting payment in USD is not a strain on the supplier.
Unit of account is the thread that links the entire global economy together.
