A Single International Currency?

It's Only Paper

After three hundred years of fumbling maybe America has stumbled on 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 agreement between banking and government. Bank profits are increased by higher interest rates, while all governments, perpetually in debt, want lower ones. Some creditors place trust in the incentives of banks to prevail, 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 outcome, but all acknowledge the tension produces a legitimate compromise.

Match Wits with Ben Franklin

Aside from some "don't ask, don't tell" mystery that somehow compels assent by regions of the country feeling injured by agreements their representatives make, negotiating postures are pretty simple and clear. It is safely assumed 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 could just float our currency exchange rate to maintain international trade; that isn't so bad, although frequent readjustment of prices is a costly nuisance. 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 original phrasing might be better: "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; Brazil "exported its inflation" to Argentina. Plenty of wars have been started for less provocation. When something causes that extra money to come out of hiding, there will be inflation, notwithstanding attempts 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?

The Economist, printed in London, refers to the United States in its October 17, 2011 edition as the "World's largest currency union", but goes on to state that it only became a true currency union in the Presidency of Franklin Roosevelt, That's even though most people suppose Alexander Hamilton unified it with the Compromise of 1790 which among other things traded the nation's capital away from Philadelphia. No, Hamilton only unified the Revolutionary War debts, which at that time were the main debts of the country. In time, the country and the economy grew in size until our currency was really no longer unified, and the individual states and banks issued their own money. Nicholas Biddle had an endearing habit of buying up the circulating currency of a weak bank, and presenting it as a bagful to the teller's window. If the bank was really overextended, it then went bankrupt, and other marginal currency-issuers were taught a bitter stress test about printing unreserved paper money. According to The Economist, the main stabilizer was not migration of money, but migration of workers. Unemployed people by the many thousand would move to a state with a labor shortage, a solution made practical by the extremely low cost of real estate. In Europe, a far more practical adjustment comes from moving funds from one state to another, although there is today enough migration across the Mediterranean to demonstrate how disruptive it is to mix unwelcome languages, religions and cultures. The problem of maintaining a common currency union is hard enough, but the Europeans have the additional problem of creating one.

Nevertheless maybe, some say, we could have a World Reserve Bank, issuing a common international currency. What we now 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 weaker local currencies, it quickly "disappears". That is, it is hoarded out of sight and nothing but local money is ordinarily visible. Under these circumstances, only the United States is able to print money without creating inflation. 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 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 trading away some of its free ride on inflation in return for reducing the 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 from tempests we enjoy with the Federal Reserve. If you regard a country's money supply as one big short-term bond, then a basket of currencies is a basket of bonds, issued by a world full of debtors. In that situation, pressure for world-wide inflation is inevitable. In a world with nationalized banks and/or 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, just remote. The enduring risk is that some nations always have more to lose from a collapse of trade than others. Continuing improvement in world economic conditions may one day make a unified world currency feasible. As St. Augustine famously said, "Make me chaste, but not yet."

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