(See Note at the end of this post regarding co-authors of the paper)
In the last three decades the predominant floating rate system has developed a volatile foreign exchange market. The result has been an accumulation of financial crisis that have struck developing countries at large. In this paper
* we expose a theoretical background of alternative exchange rate systems that have been put in place in different moments in history, and we offer a new one that globalization and the recent experience of the Euro makes it more feasible than ever before: a Single Global Currency. Neither the current nor the past exchange rate systems seem to fit for a new global environment where capital and trade flows easily. In this paper we analyze the hypothesis of a Single Global Currency as a potential solution. This idea would face many nationalistic hurdles in local politics, but the economic rationale behind it is the starting point to open opportunities towards an integrated world.
“Stability is not everything, but without stability, everything is nothing.”Karl Schiller, German economics minister from 1966 to 1972.
“When the currencies float, the people sink.”Carlos Alberto Montaner, Cuban writer.
Introduction For most of our history, national currency value was in a way linked to either some external asset or to other currencies. Gold and silver played that role for centuries, and after World War II it was agreed under the Bretton Woods system that all nations would define parities based on the US dollar value, which itself was pegged to gold. It is only since 1973 that we have an international monetary system in which most of the exchange rates of the national currencies float in response to market pressures without much official guidance, as Milton Friedman and other economists had been advocating for many years.
For many developing countries with weak financial systems, it may simply not be affordable to have a currency that is not anchored to some available alternative asset(s) of stable value. Fixing the exchange rate is a simple, transparent, and time-honored way of providing such an anchor, and for many developing economies, it is the only stable alternative. A sound currency is a necessary condition for the promotion of economic prosperity. Without stability there can be no sustainable growth.
During the 20th century, and particularly after World War II, the international community grew from a few dozen nations to over 200 independent territories and countries, most of which started printing their own money. The incredible growth of central banking and the extensive use of fiat money (currency that is not backed by the asset it is pegged to) resulted in many terrible episodes of high inflation and outright hyperinflation. As Paul Volcker, former Chairman of the Federal Reserve pointed out, “The truly unique power of a central bank, after all, is the power to create money, and ultimately the power to create is the power to destroy.”
The success or failure of the world economy depends on various policies that are agreed on or encouraged by governments. On that end, systematic tariff reductions, free trade areas, and policies that favor and reduce costs of capital mobility, transportation and communications have accelerated the modern trend toward globalization. However, globalization is much less efficient than it could be due to some defects in our international monetary system. As Professor Mundell emphasized, “The inefficiency of our current "system" is reflected in the hundreds of trillions of dollars of wasted capital movements that cross international borders every year solely as a consequence of uncertainty over exchange rates.”
Under the present system, over a trillion dollars change hands each day. These currency movements are managed by professionals who must anticipate or protect themselves against adverse changes in exchange rates, which often lead to speculations for or against particular currencies. Governments also frequently intervene to protect their currencies’ positions or to seek trade advantages. The system is fundamentally unjust, but also very expensive due to the cost of the transactions. Assuming only a bid-offer spread of 0.03% per transaction, which is tight even for an inter-bank activity, the total cost for the global economy is more than seventy-five billion dollars US per year.
The problem is enlarged by the fact that, in a global world, capital flows very fast from one country to another. The fact that the size of the “competing” currencies is so large makes developing and small economies susceptible to a minute sneeze from any hard currency, multi-national, and investor. Additionally, if we take into account the appetite of many speculative agents in the markets that try to make profits taking advantage of those vulnerabilities, the necessity for better solutions that may provide stability becomes clear. Currency crises have hit dozens of economies hard in the last fifteen years, triggering skyrocketing imported inflation and damaging capital accounts.
Since only four currencies account for over four-fifths of the foreign exchange markets, it would not be that difficult to open discussions among them to peg or fix them, obliging the others to follow and achieve stability.
According to the traditional model, a country with current-account deficits could expect to see its currency depreciate; this would make imports more expensive and exports cheaper, restoring the economy to equilibrium. But in a world where international flows of capital overwhelm international flows of trade, this does not work. Floating exchange rates destabilize trade and investment by wrenching relative prices away from their fundamental values (in opposition to the distorted market value). In the last series of financial crises suffered by developing economies, the exchange-rate movements were either the trigger or the amplifier thereof. Governments of small open economies now know that leaving the exchange rate level to the market is not an option to level the market; they must always keep one eye on the currency. And this has also been true for intermediate exchange-rate regimes. That was the lesson of the European Monetary System debacle of 1992 (Black Wednesday in the UK). Semi-fixed systems cannot survive in integrated capital markets since they are the first prey speculative investors will go after at the first sign of an unstable economy, triggering a crisis that would not have occurred without the easy flow of capital.
Currency unions allow individual countries to come together to pool their currencies and create a new one (i.e. European Union) and there is great stability in the currency. Stability is found because responsibility for bank supervision and the provision of liquidity in the event of bank panic officially remains with the national regulator and national central banks. Whereas a currency union has a central bank to act as lender of last resort, a country with a currency board does not. Thus, these regimes are vulnerable to runs on banks.
Professor Robert A. Mundell focused part of his career on assessing currency unions and identifying costs and benefits associated with them. His work has been mentioned as one of the theoretical supports for the Euro process. In his arguments we can find most of the reasons a country should analyze before deciding to join or not to join a Currency Union . Some of the arguments in favor would be:
- To gain the price stability of the Currency Union;
- To reduce transactions costs in its trade with a major partner and to eliminate the cost of printing and maintaining a separate national currency;
- To participate in a purchasing power parity area, which would be fostered by fixed exchange rates and even more by monetary union;
- To establish an anchor for policy, a fixed point around which expectations can be formulated and policies can revolve;
- To remove discretion from monetary and fiscal policy authorities;
- To keep the exchange rate from being kicked around as a political football by vested interests that want depreciation to increase profits, or to bail out debtors;
- To establish an automatic mechanism that will enforce monetary and fiscal discipline;
- To provide a catalyst for political alliance or integration;
- To reinforce or establish an economic power bloc that will have more clout in international economic discussions and have a greater power to improve, by its trade policy, its terms of trade;
- To participate in a restoration of a reformed international monetary system.
Among the reasons against joining a Currency Union would be:
- The use of the exchange rate as an instrument to influence fiscal policies or to capture employment from other countries;
- To avoid an unfriendly country benefiting from the economies-of-size advantages of the large currency area;
- Keep ability of seigniorage as an international means of payment and a potential source of hidden or off-budget funding;
- To avoid national conflict that the regime of fixed exchange rates could cause with the constitutional mandate to preserve price stability a central bank may have;
- Refrain from losing a dimension of national sovereignty that is a vital symbol of national independence;
- To elude politically unstable framework if other countries enter in conflict;
- Unwillingness to accept the degree of integration implied by the Currency Union agreement, such as common standards, immigration, labor or tax legislation.
Why a Single Global CurrencyAnalysis
Having a distinct currency and the protection of its use are generally and collectively viewed as an expression of sovereignty. Currencies are national to most people: one nation/one money. On the contrary, the use of money is not confined to its territorial limits. A few countries already have monies that are currently used by non-residents for their local transactions.
Certain elements of power are also associated with national money - political symbolism, seigniorage, macroeconomic management, and monetary insulation - that often measure gains and losses as well as risks and opportunities. A single global currency (SGC) would eliminate the risks and losses that often result in currency failures that trigger balance of payment problems, which are attached to same elements that nation-states safeguard. The use of SGC would eliminate costly currency exchanges and expensive hedges against currency fluctuations and a global central bank or global monetary union represented by people from different national governments and international financial institutions will be formed to manage it.
The most common opposition to the idea of SGC is xenophobic, i.e. the fear of losing national identity. Governments perceive that surrendering your own money compromises independence and signifies repression from foreign forces. The natural tendency for nation-states would be to resist the idea. Infeasibility of monetary unions and the domestic ability to devalue money (in order to boost exports) are also prevailing arguments against SGC. This is why education and the appropriate promotion strategy are keys towards achieving successful implementation.
Robert Mundell's article written in 1960, called the "Theory of Optimum Currency Areas", started the planning for the euro and other common currencies. In the late nineties, the European Monetary System (EMS) was established, which introduced the European Currency Unit. EMS was the predecessor to the European Monetary Union. The European Central Bank was constructed, and in alliance with the national central banks formed the "Euro system", analogous to the U.S. Federal Reserve System. The existing Euro currency was issued to the public in 2002.
Advantages of SGCA single currency monetary union that introduces a new currency and a global central bank is conceivable even in the absence of political integration. A single global currency would be a very persuasive medium for stimulating political integration and international cooperation.
When using a national currency, most countries struggle with preventing drastic depreciation or appreciation in the exchange rate and convincing their trading partners that their exchange rate will be stable over a future period of time. Usually they rely on policies that encourage trade surplus (current account external balance) and the accumulation of large foreign exchange reserves. That would not be necessary if a single currency is put into practice . In today’s system of multiple currencies, many countries control aggregate demand to ensure maintenance of external balance. If the market favors a currency resulting in appreciation pressure, to avoid losing appeal for their products, a country may try to restrict their fiscal policy. This in turn reduces the growth rate of these countries. If a global currency is adopted, growth rates for individual countries will increase, as countries will be allowed to employ expansionary policies instead of being artificially depressed.
Having a single currency increases transparency since it allows for easier economic comparison because there is only one currency. This is useful in identifying the economic / financial disparities that do exist on a global scale, especially income and consumer spending. Also, it lessens the risks associated with transactions on an international level . With a global currency, a country’s monetary policy is determined by the supranational central bank and not by the domestic bank. Because flexible prices and labor mobility become more important when a currency union exists, governments have an incentive to make markets work more efficiently. There will be less regional economic differentiation. In a custom union, the central bank cannot lower interest rates in one country because there is a recession or simultaneously increased interest rates in another country that is booming.
The denomination of prices all over the world in a single unit makes trading easier. Trading across borders will be accomplished with the ease of trading between states within countries. Thus, the only barriers to trade that will remain will be tariffs and other controls.
SGC eliminates speculative attacks caused by uncertainty of international exchange rate values. The 1994 Tequila crisis in Mexico was triggered by speculations about the devaluation of the peso. This led to massive capital flight in the absence of restrictions on capital flows that many other countries experienced in the last decade. “Confidence in the stability of the value of money is fundamental to the general acceptability of money.” Currency failures and risks also occur in the event of natural disasters, industry sector downfalls or domestic political disarray. Furthermore the risks attached to the phenomenon known as the “Dutch disease” would be eradicated. SGC will dismiss these threats.
Transaction costs associated with currency trading will vanish. The world trades some $1.8+ trillion in currencies everyday . Abolishing this market would save companies billions in hedging and foreign exchange costs.
When a currency union exists, countries can no longer use devaluation as a part of their economic policy to gain an advantage over other countries. Because the central bank which oversees the currency union is not controlled by a single government, it will be easier for the Central Bank to focus on its primary objective – to control prices and fight inflation.
Benefits from seigniorage will be directed to the global central bank. Seigniorage is "the difference between what money can buy and its cost of production. Therefore, seigniorage is the benefit that a government or other monetary authority derives from the ability to create money." The ability to print money would be useful in financing initiatives and policies towards international public goods such as foreign debt reduction to help eradicate poverty, projects to solve environmental issues, the cure of diseases, etc. In the international exchange arena, if one country's money is held by another, the latter gains seigniorage benefits in the form of reserves. There will be no need for countries and monetary unions to maintain international reserves of other countries with a global currency setup. It would also minimize if not eliminate domestic corruption from abusing the benefits of seigniorage.
Cordeiro in his article, “Different Monetary Systems: Costs and Benefits to Whom?”, asserts that economists generally emphasize the importance of the consumer’s well being and their preferences when talking about free trade or trade in goods and services. On the contrary, economists have focused on the well being of the government (the supplier) with monetary policy issues. He argues that monetary policy should benefit the consumer. Otherwise, convertible national currencies will still exist because governments and politicians benefit the most as producers of the money. Consumer preferences are aligned with low inflation, low interest rates and other factors that increase purchasing power . All these are associated with monetary stability that leads to social benefits. In fact, there is an idea to establish monetary stability as a fundamental human right just as the right to education (article 26), right of adequate standard of living (art. 25) and right to social security (art 24) . The benefits of SGC would also pave the way towards the fulfillment of the other principal human rights mentioned in the Declaration.
The transaction costs of switching to a single global currency will initially have a negative impact on the individual countries. The transfer of seigniorage for these countries to the global central bank will eliminate a direct source of income that is used to fund national initiatives and operations. However, the long term benefits from eliminating transaction costs are continuous and will therefore, supersede the cost. The important thing to remember is while seigniorage is being transferred, it will still exist but governed by the global monetary authority.
While there are costs attached to the formation of SGC, the long term-benefits are much larger. By reaping the economic gains of a monetary union, countries will be willing to work together to form stronger political ties. In addition to this, political tensions may be appeased creating a natural convergence towards international collaboration.
Global and domestic political issues Relinquishing state monetary management vs. sharing monetary sovereignty:
Political factors/barriers will be the primary barrier to the introduction of a single currency. As previously mentioned, a country's money is a significant symbol of nationalism. It is similar to their flag. Patriotism and centralization of political authority progressed in the nineteenth century with the influence of the American and French revolutions. National governments defended their borders against threats of external authority. Control of money was part of the process. It is extremely difficult for nation-states to lose control of their currency. Besides, the formation of currency unions was not an easy and speedy task. Governments had to overcome market forces and renounce centuries of money traditions.
It may be difficult to let go of the link between nationalism and money. However, history and existing currency unions provide alternatives to sharing monetary power. There are two types for such an alliance. The first is the concept of having a supranatural authority that controls the currency policies, e.g. the European Union as it exists today. The second concept is an exchange rate union, where members agree to fix their exchange rates among them within certain margins. That was the previous step of the Euro (European Rate Mechanism) during the eighties and beginning of the nineties.
Another viable alternative for which Mundell has advocated over the past years is the formation of a multiple-currency monetary union for three countries: United States, European Union and Japan. “The dollar, euro and the yen areas make up nearly 60 percent of the world economy.” In addition, all three currencies have been proven to be stable. Using this approach, the countries would maintain fixed exchange rates between their currencies. Mundell further asserts that the dollar is the most widely used currency (more monetary mass) and thus, should be used as the pivot currency. Each of the three central banks would remain active but will have different roles. Also Moore mentioned that “Abandoning national currencies and convergence on the money of the center is in a country’s long-run self-interest. Dollarization and euroization are second-best solutions to a world central bank or currency union, but are clearly preferable to the status quo of flexible exchange rates and convertible national currencies.”
Recommendations
A single global currency makes strong economic sense. However, it is too ideal with the current global and domestic political environments and its implementation would take time and powerful persuasion. As an interim approach, the following should be the next steps:
Step 1
Rich nations should take the lead in developing a global partnership:
Governments often face difficulties in managing a single country – managing a world membership in a single currency union is even more challenging! Economically, all countries strive to achieve stability and growth. However, political sentiments and competing interests will make it difficult to get a consensus.
Step 2
Develop Mundell’s idea regarding the three regional blocs approach based on the three main hard currencies:
The primary benefit towards moving to regional blocs (Americas, Europe and Asia) is global monetary stability. Advantages also include ease of trade and increased transparency. With less currencies involved the convergence towards a single global currency union would be easier to implement. The absence of exchange rates eliminates any uncertainty caused by future expected exchange rates. History proved that attempts to maintain fixed exchange rates have eventually failed. If regional blocs are formed, it would be difficult for any nation to be isolated and will have to eventually join.
Step 3
Establish a Global Monetary Board (separated from World Bank and IMF) that would set the path for a monetary conference towards currency unification:
Globalization has changed financial markets dramatically in the recent years, distorting small economies and destabilizing domestic prices. A global monetary authority with the help of national governments should work on reducing the vulnerabilities of developing economies. It would manage the benefits of seigniorage providing financial aid, especially in case of natural disasters or economic downfall. It should also be responsible for organizing monetary conferences to discuss nation-state roles, policies and strategies to implement an SGC. If implemented, there should be a name for it (e.g. terra, mondo).
Step 4
Encourage regional economic integration by leveraging from competitive advantages:
Once regional blocs are formed, the member countries would specialize in goods and services that they produce better in relative terms so overall economic benefits for the region would be assured through intra-regional trade. The inter-regional trade would eventually translate to global trade. The structural change would pave the way towards international economic and political integration.
Step 5
Promote educational initiatives and other strategies to explain the benefits of a Single Global Currency:
Nations hold on to traditional processes and conventional methods. Introducing a new concept would trigger resistance because of the fear of losing monetary control and sovereignty. The natural tendency is to setup defense mechanisms against these externalities. Education and the appropriate marketing strategies are needed to facilitate buy-in. If the benefits of an SGC are made transparent to the public, accommodation of the new currency would be easily accepted.
Conclusion
While pseudo-SGC arrangements are attainable, the total movement towards a single global currency remains to be a worldwide challenge. Many economists and the vast majority did not think the Euro was possible in the early 90's until its issuance in 2002. Is there hope? Perhaps we should all wait and watch as history churns its advancement and realization.
*: This post is part of a paper my colleagues Sahap Gizlen, Theresa McKenzie, Shane Oommen and Mia Vida Villanueva, and I wrote for Professor Lukauskas' class
International Economic Policy Analysis, which is part of the EMPA Program at SIPA-Columbia University
