As international monetary and financial transactions become increasingly integrated, some countries have chosen to form regional currency blocs, while others have established rigid exchange rate pegs to other countries, through the adoption of a currency board, or have adopted the currency of another country as their own. This declining trend in the number of independent currencies seems to be motivated by the perceived benefits of currency integration—such as commercial efficiencies and economies of scale. But would the same perceived benefits be further maximized by a move to a single currency for the world? Or does the experience of the euro zone so far suggest that the difficulties inherent in corralling different and divergent economies into a single currency would be magnified and possibly disastrous if carried out worldwide?
These questions and related issues were the subject of a recent IMF Economic Forum—”One World, One Currency: Destination or Delusion?” moderated by Alexander Swoboda, Senior Policy Advisor in the IMF’s Research Department. Participants included Robert Mundell, Professor of Economics at Columbia University and winner of the 1999 Nobel Prize for Economics; Maurice Obstfeld, Professor of Economics at the University of California, Berkeley; and Paul Masson, Senior Advisor in the IMF Research Department.
A world currency area
The concept of a single world currency, Mundell said, has few, if any, champions. It is not likely, particularly among democratic regimes, that the requisite political motivation could be found to convince countries to relinquish their national currency, which is symbolic of national sovereignty, in favor of a single currency. Although he is a longtime advocate of a world currency, Mundell said it was probably more interesting to talk about “one world, one currency area”—that is, a zone of fixed exchange rates.
Despite the current problems the euro zone is experiencing, Mundell said he was confident the union would prevail. Already, he suggested, every country that has joined the Economic and Monetary Union (EMU) has a better monetary policy than it had before it joined. Speculative capital movements have been virtually eliminated, and since EMU’s implementation, there has not been a single intra-Europe financial crisis.
In Mundell’s opinion, one reason that EMU has worked and will continue to work is that it has satisfied the basic requirements of an optimal currency area:
common target or anchor for monetary policy;
common measure for inflation;
locked exchange rates, implying a common monetary policy; and
means for dividing up the seigniorage (a source of revenue derived from the government’s right to create money).
If the euro zone has met these requirements, Mundell asked, could they be met on a global basis? Starting with the essential requirement of a common anchor, Mundell said the approach he found most interesting was for the three big currencies—the U.S. dollar, the euro, and the yen—to form a common monetary policy that would serve as the anchor for the world price level, and then fix the exchange rates among these three areas. The euro and the yen should lock in their exchange rates with the U.S. dollar, since the United States, with a GDP of more than $10 trillion, is the largest currency area. Once a common inflation target was chosen, he said, a three-currency union (with perhaps an outside unit of account for the rest of the world to use) would make it no more difficult to manage inflation than in any single country today. To those skeptical of fixed exchange rates who claim that different rates of inflation call for fluctuations in exchange rates, Mundell would answer that the yen, dollar, and euro areas are “zones of stability” and that different rates of inflation would not be a serious issue.
The major impediment to this plan, Mundell said, would likely be the refusal of the United States to agree to fixed exchange rates. Historically, he noted, the reigning superpower has taken this position, as, for example, the United Kingdom did in the nineteenth century. The United States might be persuaded to assume leadership, however, if Japan and Europe indicated a willingness to go ahead on their own. The euro zone opens up the possibility of a reconfiguration of power, Mundell said. The United States, in an effort to maintain a balance of power, should provide the leadership needed to establish not a single currency but a world currency area.
Diversity still an option
Referring to Mundell’s seminal analysis of optimal currency areas, Maurice Obstfeld noted that Mundell’s theory, as well as subsequent economic analysis, actually pays scant attention to the issue of a single currency. Nevertheless, this theory is the basis for the belief that there can be efficiency gains from having larger and larger currency areas. Therefore, it is possible to draw implications from Mundell’s original analysis—as well as subsequent enlargements on the theory—for the desirability of a world currency down the road.
Mundell’s analysis, Obstfeld said, was based on a trade-off between the benefits of a single currency in terms of reduced transaction costs and uncertainty and the ability of regions to adjust to idiosyncratic or asymmetric shocks. According to Mundell, when two regions join in a currency union with sticky wages and prices and no labor mobility between the two areas, giving up the exchange rate does not allow for as smooth an adjustment to idiosyncratic regional shocks as might occur with exchange rate flexibility. The current situation in the euro zone provides a telling example, Obstfeld noted, where already there are signs that a single monetary policy is unable to address the problems of every constituent member. Although eligibility to participate in EMU requires that candidate countries bring inflation down to levels stipulated by the Maastricht Treaty, some regions— Ireland, for example—appear to be diverging from those levels. This suggests that, in the presence of idiosyncratic shocks, a single currency is not going to produce the same inflation rate, or the same rate of output growth and rates of employment and unemployment, in all regions. These considerations, Obstfeld said, need to be measured against the broader gains to be derived from the efficiency of using a single currency.
Advocates of fixed exchange rates, or any regime that calls on country authorities to relinquish an independent monetary policy, point to the credibility gained from pegging to a low-inflation currency. However, Obstfeld said, the credibility issue raises a host of critical political issues. Mundell has said that economically sensible boundaries for a common currency area need not, in theory, correspond to national boundaries but, Obstfeld pointed out, political boundaries are a fact; the countries exist. Securing a broad consensus for, say, a currency board arrangement or a peg to the U.S. dollar may be possible within national borders, as in Argentina, but among the major industrial countries, Obstfeld suggested, we are unlikely to see a return to the Bretton Woods system where one superpower runs the show and everyone else lets it “call the monetary shots.”
The critical issue in setting up a currency union, then, is agreeing on who runs monetary policy. In Europe, this issue was solved through the establishment of the European Central Bank (ECB), Obstfeld said. But in Europe, the supranational organization has run way ahead of the political organization, as reflected in Denmark’s recent referendum against joining EMU and the United Kingdom’s retreat from participation.
Political constraints argue against a world currency, at least in the near term, Obstfeld said. In the meantime, he did not view floating—at least, among some of the larger economies—as a bad way to run the world economy. For the foreseeable future, he said, we can expect to see a world where smaller countries may opt to join a union through a currency board, euroization, or dollarization; where larger countries float; and where the big currency areas coexist with occasional attempts at coordination and intervention, but basically with governments acting in what they perceive as the national interest.
Fewer currencies, no single currency
The euro and the observed trend toward dollarization open up the possibility of a radical reduction in the number of currencies, Paul Masson noted. He asked, however, if this trend was likely to continue to its logical conclusion—the creation of a single world currency.
To answer this question, he said, one must first look at the role money plays in both the national and the international economy. At the national level, money has traditionally fulfilled three roles—a medium of exchange, a store of value, and a unit of account. At the international level, currency may be used for invoicing trade, denominating assets and liabilities, holding foreign exchange reserves, and providing a vehicle for foreign exchange transactions. It can also serve as a currency to which other currencies are pegged—that is, an anchor for other countries’ monetary policy.
Technology and globalization, however, are blurring the distinctions between national and international uses of money and have the potential for changing these uses radically, Masson argued. Certainly, the creation of the euro has fundamentally altered the relationship between national sovereignty and national money. In addition, multinational corporations make transfers between their branches or subsidiaries that have no relation to the currencies in which the profits or revenues are earned, and often report their financial results in both local currency and a major world currency, such as the U.S. dollar. Also, currency swaps allow the transformation of capital flow denominations, while derivative instruments permit sophisticated hedging against currency risk.
Another development is that technology and financial innovations have been leading to the possibility of cashless economy. Credit cards and electronic banking have, Masson noted, economized on the use of currency and bank deposits—that is, traditional money. When we look at financial institutions, we see that required reserves on bank deposits have been reduced in many countries, and clearing balances have been reduced almost to zero, shrinking the size of high-powered money and, arguably, the effectiveness of monetary policy.
What do these trends mean for the international monetary system? On the one hand, they suggest a move toward fewer currencies. Payments may increasingly be made outside the control of governments and central banks. The notion of competing moneys may be given greater scope, allowing individuals and companies to choose between moneys. Also, because the scope for monetary independence has been reduced by increases in capital mobility, countries may be less reluctant to give up their national currency, provided the dominant world or regional currency exhibits the necessary stability in terms of purchasing power.
On the other hand, the technological advances that have allowed for the separation of the various roles of money may make the coexistence of different currencies in any given country or monetary area easier. Also, the forces of globalization are not stamping out nationalism, and a currency remains an important symbol of national or regional sovereignty, even though in practice it may not be associated with much monetary independence. Therefore, Masson said he doubted that currencies would disappear en masse or that a single world currency would emerge.
But questions remain, he said, about regional blocs and the elimination or consolidation of currencies within regional currency areas. The euro bloc will no doubt develop further, Masson suggested, mainly because of the political motivating factor—membership in the European Union. For the dollar, only the economic factor comes into play, because the United States has steadfastly refused to share monetary or other forms of sovereignty, while with a few exceptions, its own trading partners decline to abandon their own currencies. Unless the political reality changes, Masson concluded, this situation will continue.
Summing up, Masson said he envisioned a world where currency use would increasingly be dictated by private choice, not government fiat; where two major currencies—the U.S. dollar and the euro—would coexist, if uneasily; and where there would continue to be many minor currencies. But the number of currencies will matter less, because individuals will have greater options for hedging or choosing the currency in which to transact and will have less of a need to hold cash balances.