Domlung, chi, hun and li": Those words may sound like the beginning of a Chinese

nursery rhyme, but they are actually the four key words you must know in order to

do business with the gold traders at Phnom Penh's Olympic Market. Each one describes

a unit of gold that is known throughout the country by rich and poor alike.

As far as tangible wealth is concerned, gold is Cambodia's linchpin. Despite the

free interchangeable circulation of U.S. dollars and Cambodian riels, gold remains

by far the most important monetary medium. One can argue, in fact, that Cambodia-despite

being one of the poorest countries in the world-is on a de facto gold standard.

Of course people do not go around Phnom Penh with "pieces of eight" in

their pockets. Nor are there any gold reserves to speak of in the vaults of Cambodia's

newly -rebuilt National Bank. But making a claim like this does not mean the real

gold standard of the history books.

That mechanism, only existing worldwide between 1870 and 1913, required the domestic

money supply to be firmly linked at all times to the physical amount of gold a country

possessed at any one time. So, what's the connection with Cambodia?

Interestingly enough, what can be seen in Cambodia is a coherent framework where

gold, U.S. dollars, and the riel are not only freely convertible but provide a reliable

barometer for Cambodia's much-abused exchange rate.

Gold Market Highlights Khmer Ingenuity

The Phnom Penh gold market merits study for several reasons. It is a fascinating

illustration of how ordinary people have reacted to the legalization of the private

sector when the Hun Sen administration started its major shift in April 1989 from

a centralized command-type economy to one responsive to market forces. It is also

an example of human ingenuity-showing how parallel compensating mechanisms emerge

when a population lacks confidence in the national currency as well as the country's

banking sector.

Finally, it is a prime example of how a market has assumed the traditional role of

the government and the banks as the lead mover in setting the parameters for the

country's exchange rate.

This unique phenomenon has its roots in Cambodia's turbulent recent history. In 1970,

when the riel was considered strong, the Lon Nol government banned the parallel circulation

of U.S. dollars; only riels and gold were legal tender, excepting the black market,

of course. During this period people naturally turned to gold whenever the on-going

war provoked fears of the riel not maintaining its value.

Gold's importance in the public's mind was reinforced even more strongly when the

Khmer Rouge, upon coming to power, blew up the National Bank and abolished the use

of money altogether. Between 1975 and 1978, if anything special had to be clandestinely

obtained outside of the dreaded angka party channels, gold pieces or fractions thereof

became the only acceptable means of exchange.

After 1988, when the State of Cambodia found it had few alternatives to countering

the growing national budget deficit other than through simply printing more money,

gold's significance grew even further. For all and sundry gold became the prime inflationary

hedge apart from houses and land.

Since 1990, then, it is no wonder that the gold market has developed to the point

where any Cambodian with the slightest commercial interest knows the daily price

of the various types of gold on sale.

In a country that has undergone three radical currency upheavals within the last

22 years, where banks are distrusted, and where real interest rates are highly negative,

the traditional attributes of gold-scarcity, mobility, anonymity, ease of storage

and transport, recognized standards of purity, and the ability to serve as an effective

store of value-has given the yellow metal an unassailable place in the public's mind.

Therefore, no Cambodian would understand English economist John Maynard Keynes' famous

remark of 50 years ago: "Gold is nothing but a barbarous relic!" For Cambodians

it is the only trustworthy currency.

Until the country has a coherent monetary policy and trustworthy financial services

in which the public's confidence is restored, there is little likelihood of the general

public's perception changing.

Some everyday examples are illustrative. Even when gold does not change hands it

remains the only acceptable numeraire. Thus a house's sale price would be set at,

say, 200 domlung (domlung is the Khmer word for the internationally known tael of

37.5g of pure gold). If the buyer is considered reputable, only the U.S. dollar equivalent

will be asked for. Likewise, motorcycle purchases are known to require gold of 93/95

percent equivalent-and so on.

There are some 2,000 registered gold dealers in Phnom Penh, and the most important

trading center is located at the Olympic Market, where all traders obtain their supplies

and where benchmark prices are set. All other markets have a transaction mark-up.

Three recognized types of gold are on offer in order to cater for every need:

• Gold Leaf: About 98 percent pure; formerly came primarily from Vietnam but is

  now increasingly being extruded locally;

• Kilo bars: Command a bar charge premium which vary according to the degree of

  purity guaranteed;

• Domlung: The same as the tael previously mentioned, weighing 37.5g. Domlungs

  are further divided into 10 chi, 100 hun, or into tiny 1000 li bits.

In terms of quality standards, 24K gold is the norm, 18K is acceptable for jewelry,

and 22K is recognized when mixed with silver. The rural peasants insist, however,

on 24K only-as do city dwellers whenever there is an important transaction involving

land or a house. As purity is often an issue, companies such as Canadia Gold Trust

(the only official assayer and refiner) can guarantee 99.99 percent proof, but will

charge a premium.

As the average Cambodian wants to buy gold whenever they feel they have extra riels

beyond those for their immediate needs, the market provides an important safety net

to the widespread distrust of the domestic market.

The market serves several functions. Apart from providing everyone-rich or poor-a

chance to hedge one's savings, other activities include changing gold into Thai baht

when goods are brought in from Thailand; acting as an intermediary for the organized

smuggling trade with Vietnam where articles have to be paid for in either gold or

dollars; and dollar changing or dollar loans.

Contrary to practice in the West, where gold in itself does not earn any interest,

in Cambodia it does. Investment deposits in the market earn interest while loans

can be taken out for up to two years. The interest is always set in units of the

domlung, i.e. "gold for gold."

Setting the Price for Gold

It is the price-setting function of the market that is the most interesting both

for the layman and professional. At first glance the market is wide, with many buyers

and sellers. It is close to what the economists like to call a "state of perfect

competition," i.e. a situation where there is no bar on the free flow of economic

information and where no one individual can exercise an inordinate influence on prices.

A bit of sleuthing shows the reality is somewhat different. A dozen Chinese traders

at Olympic Market trade trade an average of 400 domlung-about U.S. $165,000-per day

(excluding their gold-dollar transactions), compared with 1 to 2 domlung by any of

the small traders, who all operate on tiny margins. The big traders have the potential

to rig the market. They have done so, at least on occasion-even if only by delaying

their response to a sudden change in the supply and demand of riel.

In the past, and as recently as April 1991, the Hun Sen administration periodically

confined the main gold merchants to their houses for short spells of time in order

to try and counter-influence the market. This move has never been successful. Since

last year there has been no official interference whatsoever. As a legacy of those

times, all the traders are now universally known by their house numbers.

While the monopoly by gold traders is difficult to prove conclusively. Last December,

when the riel was valued at 350 to the dollar, might have been such an occasion to

prove the monopoly-even if only in terms of a lagged response to a sudden change

in the riel supply/demand equation.

The price-setting function of the market has wide economic implications for the country

as a whole. Although little is known about the gold-dollar-riel relationship or about

the handful of dominant Chinese merchants, sufficient facts can be gleaned to make

an enlightened guess at the process.

The gold price in Phnom Penh is based on the London price supplemented by information

on movements in the Hong Kong market, where the gold price is quoted in taels. The

London price, which is in U.S. dollars per ounce, is converted into domlung by dividing

the world price plus a U.S. $2 or $3 fee (for expenses such as transport and payoffs

to officials) by 0.83. For example, U.S. $320 plus U.S. $2 multiplied by 0.83 yields

a 24K-domlung price of U.S. $412. The price of one kilogram of gold is then easily

obtained through multiplying by 26.684-in the above case, U.S. $10,994. These odd

numbers are a result of converting ounces into their gram equivalents. Because of

the added fee, the Phnom Penh gold price is necessarily higher than the Hong Kong

price.

A quirk of the Phnom Penh market is to quote gold prices in terms of chi per U.S.

$100-in the above case, 2.427 chi. The U.S. dollar-chi rate is also widely used.

As for the riel price of the domlung, it is a function of actual and expected riel

supply, local demand for "riels-only-tax-and-excise-payments," and demand

for dollars to pay for private imports.

When it is known-as is the case now-that the government has ordered a massive quantity

of riel to meet salaries and other expenditures, the domlung is marked up in riel

terms. The big market makers are kept aware of the degree of riel oversupply or undersupply

by all the traders who have come to them to replenish their stocks.

As the market is fluid in terms of riel supply-and-demand expectations, prices can

easily change between morning and afternoon. This is why, on several days this year,

the riel price of the domlung has varied by as much as 13 percent either way, even

though there has been no change in the London gold price.

Once the riel price has been fixed, the market's exchange rate for the dollar follows

automatically.

With the money supply progressing rapidly (from riel 27.4 billion in December 1989

to riel 68.4 billion in December 1990 and riel 100.3 billion in December 1991) and

with more than 90 percent of all monies being held outside of the banking system,

there is little the authorities can do for the present (nor UNTAC for that matter,

until a credit line is established for the unfunded budget deficit) but shadow the

unofficial market rate.

There are a number of interesting conclusions to be drawn from what is going on at

the Olympic Market.

In the past, exchange rates in centrally planned communist economies (and Cambodia

was no exception) had little or no economic role. How could they, with domestic prices

almost totally insulated from movements in world market prices?

In Cambodia's present transitional mode-with a limited exposure to the outside world-the

fact that the Olympic Market sets the central rate for calculating the transaction

price for traded goods is somewhat ironic. It also does not pose a serious problem,

at the moment, as it tends to reflect monetary fundamentals. In an "economie

sauvage," no one can argue that it is way off what it should be.

"Economie Sauvage" or Market Reform?

However, as market reforms proceed, this will have to change. The key pass-through

role of foreign exchange rates in reinforcing the need for a more efficient allocation

of resources will have to be recognized by the next government.

When this happens, a series of steps will follow-the most significant being related

to inflation, i.e. the need to stop printing money to finance government expenditure.

That should be a welcome bonus for Cambodians unable to compensate for the continuous

rise in their cost of living.

The present situation, while pointing up the Phnom Penh administration's fundamental

cash flow problem, can still be said to have a positive side.

Khmers have long been seen by their next door neighbors in Vietnam and Thailand (and

many expatriates as well) as having few commercial attributes despite having many

other commendable national characteristics. A cursory look at the Phnom Penh gold

market should provoke a re-thinking of this patronizing attitude.

Any professional observer would be forced to admit that there is a crucially important

market operating spontaneously here with a high degree of economic rationality, despite

existing in an irrational economic environment.

Given the magnitude of the rehabilitation tasks facing the country after 20 years

of civil strife, the ability of ordinary Cambodians to behave like a western "Homus

Economicus" should be seen as a welcome augur for the future.

- Robin Davies is a visiting professor at Phnom Penh's Institute of Economics.