Do not rush to write off national currencies
Do not rush to write off national currencies
By Benjamin Cohen
Published: April 18 2006 20:09 | Last updated: April 18 2006 20:09. Copyright by The Financial Times
Are national currencies becoming obsolete? Like most nations around the world, every state of Europe until recently had its own national money – franc, mark, lira, whatever. Now 12 countries share the euro and, as a result of enlargement of the European Union, more are scheduled to join the eurozone in the not-so-distant future. Elsewhere, nations such as Ecuador and El Salvador have replaced their own money with the US dollar. Are many more national currencies fated to disappear?
For some monetary specialists, the answer is obvious. Many more countries will soon give up national currencies. Either they will join together in a monetary union or they will adopt a popular foreign currency such as the greenback or euro. “In the long run,” predicts Michel Camdessus, former managing director of the International Monetary Fund, “we are moving toward a world of fewer currencies.”
In reality, however, such predictions are utterly wrong. We are not moving towards greatly fewer currencies. National currencies are not becoming obsolete.
The logic behind the obsolescence argument is clear. As the barriers separating national economies have gradually declined, many people around the world now find themselves able to choose what money to use, their own national currency or a foreign alternative. In effect, currencies compete for market share. As in any market, the weaker competitors may simply go out of business. Governments may find that the cost of defending a national money is simply too high to bear.
Driving the process is the power of economies of scale. Once people have a choice among currencies, they are naturally drawn to the strongest competitors with the broadest transactional networks, since this reduces transaction costs. For money’s users, the smaller the number of currencies, the better. How small? The American economist, Paul Krugman, suggests perhaps 20 to 30. Nobel Prize-winner Robert Mundell goes further, suggesting the optimal number of currencies is like the optimal number of gods: “An odd number, preferably less than three”.
The logic behind the obsolescence argument is not wrong – but it is incomplete. Mr Camdessus and others focus only on the demand side of the market, where efficiency considerations do suggest a preference for the smallest number of currencies possible. But they ignore the supply side, where preferences can be expected to be quite different. Most governments prefer to preserve currencies no matter how uncompetitive their money may be.
For governments, a national money serves several vital functions. In economic terms, it provides a powerful instrument for macroeconomic management as well as a means to underwrite public spending via money creation. Politically, it embodies a symbol of national identity as well as a form of insulation against foreign control of domestic purchasing power. Can we really expect many governments to surrender these advantages willingly?
Moreover, there is no need for governments to surrender them, even if their currencies are uncompetitive. They have other choices. Rather than “dollarise”, they can establish some form of currency board, which would preserve their national money even while anchoring it to a foreign money such as the dollar or euro. Or, instead of a monetary union, they can agree to a more limited form of regional co-operation that leaves national currencies in place. Options are not as limited as the obsolescence argument suggests.
Ultimately such decisions are political, driven by the logic of state sovereignty, not market efficiency. The management of money is a fundamental determinant of the distribution of wealth and power in the world. To give up a national currency means, in effect, to “outsource” monetary policy. The government is no longer able to exercise monopoly control over the circulation and use of money within its own frontiers. Instead, monetary sovereignty is delegated to a favoured foreign supplier, such as the US, or to the joint institutions of a monetary union.
Eurozone members were willing to give up monetary sovereignty because of their commitment to the EU’s broader goals. But how many governments outside Europe are likely to be as comfortable putting others in charge of their monetary affairs? In practice, resistance to monetary outsourcing will be strong. Most national currencies will not disappear.
The writer is professor of international political economy at the University of California, Santa Barbara; his latest book is The Future of Money (Princeton University Press)
By Benjamin Cohen
Published: April 18 2006 20:09 | Last updated: April 18 2006 20:09. Copyright by The Financial Times
Are national currencies becoming obsolete? Like most nations around the world, every state of Europe until recently had its own national money – franc, mark, lira, whatever. Now 12 countries share the euro and, as a result of enlargement of the European Union, more are scheduled to join the eurozone in the not-so-distant future. Elsewhere, nations such as Ecuador and El Salvador have replaced their own money with the US dollar. Are many more national currencies fated to disappear?
For some monetary specialists, the answer is obvious. Many more countries will soon give up national currencies. Either they will join together in a monetary union or they will adopt a popular foreign currency such as the greenback or euro. “In the long run,” predicts Michel Camdessus, former managing director of the International Monetary Fund, “we are moving toward a world of fewer currencies.”
In reality, however, such predictions are utterly wrong. We are not moving towards greatly fewer currencies. National currencies are not becoming obsolete.
The logic behind the obsolescence argument is clear. As the barriers separating national economies have gradually declined, many people around the world now find themselves able to choose what money to use, their own national currency or a foreign alternative. In effect, currencies compete for market share. As in any market, the weaker competitors may simply go out of business. Governments may find that the cost of defending a national money is simply too high to bear.
Driving the process is the power of economies of scale. Once people have a choice among currencies, they are naturally drawn to the strongest competitors with the broadest transactional networks, since this reduces transaction costs. For money’s users, the smaller the number of currencies, the better. How small? The American economist, Paul Krugman, suggests perhaps 20 to 30. Nobel Prize-winner Robert Mundell goes further, suggesting the optimal number of currencies is like the optimal number of gods: “An odd number, preferably less than three”.
The logic behind the obsolescence argument is not wrong – but it is incomplete. Mr Camdessus and others focus only on the demand side of the market, where efficiency considerations do suggest a preference for the smallest number of currencies possible. But they ignore the supply side, where preferences can be expected to be quite different. Most governments prefer to preserve currencies no matter how uncompetitive their money may be.
For governments, a national money serves several vital functions. In economic terms, it provides a powerful instrument for macroeconomic management as well as a means to underwrite public spending via money creation. Politically, it embodies a symbol of national identity as well as a form of insulation against foreign control of domestic purchasing power. Can we really expect many governments to surrender these advantages willingly?
Moreover, there is no need for governments to surrender them, even if their currencies are uncompetitive. They have other choices. Rather than “dollarise”, they can establish some form of currency board, which would preserve their national money even while anchoring it to a foreign money such as the dollar or euro. Or, instead of a monetary union, they can agree to a more limited form of regional co-operation that leaves national currencies in place. Options are not as limited as the obsolescence argument suggests.
Ultimately such decisions are political, driven by the logic of state sovereignty, not market efficiency. The management of money is a fundamental determinant of the distribution of wealth and power in the world. To give up a national currency means, in effect, to “outsource” monetary policy. The government is no longer able to exercise monopoly control over the circulation and use of money within its own frontiers. Instead, monetary sovereignty is delegated to a favoured foreign supplier, such as the US, or to the joint institutions of a monetary union.
Eurozone members were willing to give up monetary sovereignty because of their commitment to the EU’s broader goals. But how many governments outside Europe are likely to be as comfortable putting others in charge of their monetary affairs? In practice, resistance to monetary outsourcing will be strong. Most national currencies will not disappear.
The writer is professor of international political economy at the University of California, Santa Barbara; his latest book is The Future of Money (Princeton University Press)
posted by Carlos T Mock at 7:33 PM
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