A Single International Currency?

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After three hundred years of fumbling experiments, and now twenty years of satisfactory testing, maybe America has stumbled upon a currency system that works. Resting on the fact that most Americans are either debtors or creditors, and the rest don't care, the quantity and value of American dollars grow out of negotiated agreement between banking and government. All banks want higher interest rates, and all governments, perpetually in debt, want lower ones. Other creditors trust the incentives of banks, other debtors trust government, both sides know trickiness in endless negotiations is futile. What was once a battlefield, is now peaceful; these people actually respect each other. Many people may dislike the prevailing rate, but all acknowledge the process is legitimate.

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Aside from some don't ask, don't tell, mystery that somehow compels agreement by regions of the country feeling injured by agreements their representatives make , negotiating postures are pretty simple and clear. It is safely assumed that the government wants to inflate; all governments have done so for thousands of years. Therefore, the basic Federal Reserve policy of targeting interest rates to restrain inflation is clearly a concession to banks. Banks would naturally want the highest rate that does not cause a recession. Debtors do not mind lower rates yielding just a little inflation, hoping to pay off their debts later with cheaper money. Government, acting as agent for debtors, nevertheless knows that rampant inflation loses elections and occasionally, as in inter war Germany and Austria, destroys the middle class. So, with everyone else resisting inflation, debtors must be satisfied with 2% annual inflation. That's arbitrary, reflecting its origin in the haggling process. Inflation-targeting plus two percent; that's the system.

If only there weren't all those other countries in the world. If they inflate or deflate, we can just float our currency exchange rate to maintain international trade; that isn't so bad, although frequent readjustment of prices is a costly nuisance to international settlements. If some country freezes its currency at an unrealistic price, however, speculators will move money around to take advantage. Enter Gresham's Law, commonly expressed as Bad money drives out the Good. In the present situation, the phrasing might be, "When two currencies of unequal value circulate together, the good currency quickly disappears." So, when truant governments cheat on their currency values, well-behaved countries find their own currency is hoarded. Potentially, that leads to currency shortages, as happened to Argentina when Brazil devalued in 1999. So, countries running an honest currency soon feel pressure to print more of it; Brazil exported its inflation to Argentina. Plenty of wars have been started for less provocation. When something causes that extra money eventually to come out of hiding, there will be inflation, notwithstanding the attempt to target inflation by the central bank. The Federal Reserve in our case would be forced to raise interest rates sky high, promptly triggering housing and stock market crashes. So the point returns; if our Federal Reserve system works so well, why can't everybody do the same thing on an international level. In fact, what's the matter with having one big world currency?

Maybe, some say, we could have a World Reserve Bank, issuing an international currency. What we seem to have in place is U.S. money serving as a Reserve Currency for the world. The force behind this system is again Gresham's Law, that since we have the strongest currency in the world, when it circulates in other countries in the company of local currencies, it quickly "disappears". That is, it is hoarded out of sight and nothing but local money is ordinarily visible. Unfortunately, that implies that if it ever should weaken, it will quickly reappear and flood the host country with inflation, whereupon the host government will ship it all back to enjoy your own inflation, thank you. Thus, being the reserve currency for the whole world allows you to have some inflation and ship it abroad, but if it ever comes back home, there could be a painful disruption. The last time this happened was when the British Pound surrendered the reserve role to the American dollar. It was a bad time, especially for the British economy.

The question periodically arises whether it might be better to use a "basket" of currencies as the reserve against temporary monetary shortages, with the United States sharing some of its free ride on inflation, but reducing the disruptive risk of someday getting it all back at once.

Using a basket of everybody's money as a pool of international reserves might smooth out the tidal waves, but it probably would not create the same stability we enjoy with the Federal Reserve. If you regard a country's money supply as one great big short-term bond, then a basket of currencies is a basket of bonds, issued by a world full of debtors. In that situation, world-wide inflation is almost inevitable. It might be slow to arrive, but this basket needs balance from a regiment of bankers, all insisting on restraint, or even deflation. In a world with nationalized banks, and subsidized banking systems, it is hard to imagine any international banking voice without a strong political component. Mandatory contributions of gold bullion might be considered, but it is hard to think of any adequate substitute for the flexibility of adversary tension between permanent creditors and permanent debtors. The situation is not permanently hopeless, however. The risk is that some nations have more to lose from a collapse of trade than others. Continuing world improvement in economic conditions may one day make a unified world currency feasible. But as St. Augustine famously said, "Not yet."

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