A couple of days ago my CW alarm starting buzzing furiously. For something like the sixth time in a month, a businessman I was talking to had just declared, in the tones of someone stating a profound insight, that the modern world economy no longer has room for scores of different national currencies–that the inexorable logic of globalization will soon force most countries to adopt the dollar, the euro, or the yen as their means of exchange. This particular speaker was Latin American, and was clearly influenced by the recent discussion of “dollarization” as a solution to his region’s woes, but I have heard pretty much the same line from Asians and Europeans. No doubt about it: A new conventional wisdom has emerged. And you know what that means: It’s time to start debunking.
At first sight, it might seem obvious that the fewer currencies there are, the better. After all, a proliferation of national moneys means more hassle and expense, because you keep on having to change money and to pay the associated commissions. It also means more uncertainty, because you are never quite sure what foreign goods are going to cost or what foreign customers will be willing to pay. And as globalization proceeds–as the volume of international transactions rises, both absolutely and relative to world output–the cost of having many currencies also rises. So why not have fewer–maybe only one?
There’s also the matter of speculation. The financial crises that have shaken much of the world all started, at least in the first instance, with investors betting that the currency of the afflicted nation would fall in value against harder currencies such as the dollar. Why not spoil the speculators’ game by giving them nothing to speculate about–by replacing pesos and reis with portraits of George Washington (or, if you happen to be European, with generic pictures of bridges and gates–for more on European currency design, see this 1997 Slate piece)?
But not so fast. There are still some very good arguments for maintaining separate national currencies. Not only that, while globalization and technological change in some ways are pushing the world toward fewer currencies, in other ways they actually reinforce the advantages of monetary pluralism.
The classic argument in favor of separate national currencies, with fluctuating relative values, was made by none other than Milton Friedman. (One appealing aspect of this particular debate is that it cuts across the usual ideological lines. European socialists like unified currencies, so does the Cato Institute. American liberals like floating exchange rates, so do Thatcherites.) Friedman started from a more or less undeniable observation: Sometimes changing market conditions force broad changes in the ratios of national price levels. For example, right now the Irish economy is booming and the German economy’s sputtering. Clearly, prices and wages in Ireland need to rise compared with those in Germany. Now, you could simply rely on supply and demand to do the job, producing inflation in Ireland and deflation in Germany. But even a free-marketeer such as Friedman realized that this is asking a lot of markets and that it would be much easier to keep German prices stable in German currency, Irish prices stable in Irish currency, and let the exchange rate between the two currencies do the adjusting.
Friedman offered a brilliant analogy. He likened exchange rate adjustment to the act of setting clocks forward in the spring. A truly devout free-market believer should–if he is consistent–decry this as unwarranted government interference. Why not leave people free to choose–to start the working day earlier if and only if they feel like it? But in reality there is a coordination problem. It is hard for any one business to shift its work schedule unless everyone else does the same. As a result, it turns out to be much easier to achieve the desired time shift by leaving the schedules unchanged but resetting the clocks. In the same way, Friedman argued, a country whose wages and prices are too high compared with those abroad will find it much easier to make the necessary adjustment via a change in the value of its currency than through thousands of changes in individual prices.
S o there is a trade-off. You don’t want too many currencies–you wouldn’t want to have separate dollars for Brooklyn and Queens. But when two countries are subject to strong “asymmetric shocks”–which is econospeak for saying that if they shared a common currency one would sometimes be in a boom while the other was in a slump and vice versa–there is a good case for their having separate currencies whose relative values are allowed to fluctuate. The question, then, is whether changes in the nature of the world economy have altered the terms of trade-off–and if so, in which direction.
Now the increasing volume of international trade and investment does, other things being the same, make it more costly to maintain multiple currencies. But other things are not the same, and other forces arguably make the optimal number of currencies in the world larger rather than smaller.
Consider, in particular, the effects of modern information and communication technology–which may also be the driving force behind globalization. Surely that technology has made it easier, not harder, to deal with a world of many currencies. For example, European advocates of a single currency used to delight in pointing out that if you took a grand tour of the European Union, starting with 100 deutsche marks and changing your money into local currency at each stop, at the end you would have only something like 40 marks. This was always a bit of a red herring, since the commissions that businesses pay on foreign exchange transactions are far smaller than the fees at foreign exchange kiosks. But anyway, who needs to change money nowadays? When I go to Europe, I pay for most things by credit card and get petty cash from local ATMs, which are happy to accept my BankBoston card.
Information technology also makes it easier for businesses to deal with the risks associated with fluctuating currencies. It has always been true that such risks could in principle be “hedged” away through; the problem was that the necessary markets were sometimes thin or nonexistent. Thanks to computers, however, investment banks now offer a vast array of financial instruments, and hedging has become much easier.
I can’t resist mentioning a related issue. When you talk to euro enthusiasts, they invariably claim that one of the great benefits of the new currency will be “price transparency.” Once all European prices are quoted in euros, it will be obvious to consumers when a German company is charging more than its French competitor or vice versa–whereas it wouldn’t be if the prices were quoted in francs and marks and had to be converted at the going exchange rate. This claim always puzzles me: Here we are in the information age, able to process gigabytes of data with a single mouse click–but we imagine that people can’t multiply and divide?
The one remaining question is that of currency speculation–fear of speculators, not the desire for efficiency, is what has led Argentina to talk seriously about replacing pesos with dollars and made dollarization at least a topic of discussion elsewhere in Latin America. But while currency speculation may have had disastrous impacts in some countries, in others letting the currency drop seems to have been just what the doctor ordered. Australia’s floating dollar has apparently allowed the island continent to sail almost unscathed through the Asian crisis. Even in Brazil it appears that fears that a drop in the currency would bring back hyperinflation were unwarranted. And to me, Argentina and Brazil both look a lot like Australia: resource-rich nations a long way from anywhere, with no dominant Northern Hemisphere trading partner. Economic logic suggests that in the long run such countries, if they can put their inflationary histories behind them, have no business adopting the currency of a faraway country which will not take their interests into account.
So let’s recognize this current enthusiasm for currency unification as what it is: an intellectual fad, not a deep insight. I say let a hundred currencies bloom. Well, maybe 20 or 30.