We have a global economy, but we don’t have a global currency. Technology is now reaching the point where a common digital currency, enabled by near-universal mobile phone adoption, certainly makes this possible. And however far fetched a global currency may sound, recall that before the first world war, ditching the gold standard seemed equally implausible.
The current system is both risky and inefficient. Different monies are not only a nuisance for tourists who arrive home with pockets full of unspendable foreign coins. Global firms waste time and resources on largely futile efforts to hedge currency risk (benefiting only the banks that act as middlemen).
The major benefit of a global currency is that there would no longer be currency risk in international trade. In addition, no country can no longer use currency exchange as a means to make their goods cheaper on the global market and hence there would be somewhat of a level playing field. The most obvious downfall to the introduction of a global currency would be the loss of independent monetary policy to regulate national economies.
Benjamin Cohen, professor of International Political Economy at the University of California says that power is influence, and it is also the ability to do what you want without having to worry about what others want, according to Cohen. The United States dollar has been a dominant currency because the U.S. economy has dominated since World War II. What makes the dollar attractive, according to Cohen, is the U.S. financial market. The U.S. dollar offers liquidity advantages that no other does.
Few currencies are able to meet all the demanding economic and political qualifications for internationalization. That is not pessimism but realism. Given the substantial stakes involved, the competition that is at the core of the process of internationalization is bound to be unforgiving.
Currency internationalization alters monetary geography by accentuating the hierarchical relationship among currencies, expanding the domains of a few popular moneys well beyond the jurisdictions of the countries that issue them. The outcome is produced by a sort of a Darwinian process of natural selection, driven above all by the force of competition—much like Gresham’s Law, except in reverse. Instead of “bad” money driving out “good,” as Gresham’s Law traditionally holds, the good money drives out bad. There is nothing irrational about the process. On the contrary, internationalization may be regarded as a quite natural demand response to prevailing market structures and incentives.
Let’s recall that while under the Bretton Woods system, the U.S. dollar’s primacy was rooted in law, this has not been the case for the past 30 years: dollar usage has continued as a matter of choice. The U.S. dollar dominates the global economy, used in settling trade and investment deals but also held in reserve in vast quantities by central banks in case of a payments crisis. This demand for dollars keeps the U.S. borrowing costs lower than they otherwise would be, reinforcing the country’s economic clout and helping to pay for the world’s strongest armed forces. Its widespread acceptance is partly the consequence of the dominant position of the U.S. economy, but has also been sustained by the following factors:
- The depth and liquidity of the United States’ financial and forex markets, which remained resilient even during the financial crisis.
- The U.S. economy’s track record of macroeconomic stability, which bolsters confidence in the dollar’s long term purchasing power.
- The willingness of the U.S. fiscal and monetary authorities to allow the dollar to be used in international transactions, and to generate sufficient high quality liabilities to meet international demand for assets denominated in dollars.
- Network effects—the more a currency is used and held, the more useful it becomes, which in turn increases demand for it even more.
The U.S. dollar’s status as the leading global currency gives the U.S. immense political as well as financial clout, but that power risks being eroded — with unpredictable strategic consequences — as the Chinese renminbi and possibly other currencies assume greater prominence.
Cohen describes what he calls a currency pyramid, which includes the U.S. dollar at the very peak. It has universal scope and domain. Potentially the renminbi, China’s currency (a.k.a. the yuan), which is still just a minnow, according to Cohen, but its international use is growing quite rapidly. It reflects that China has achieved a degree of autonomy that’s almost unprecedented.
Some people would like one world currency, which would come with a great deal of power. While it is interesting to speculate about the future of the international monetary system, and the U.S. dollar’s role in it, the reality is that the current system has proved its resilience while the alternatives have not; and though change is likely over time, it will not happen overnight, or by decree.
According to Cohen, as long as we have a political system that relies on state sovereignty, we’re going to live with an imperfect monetary system and the best we can hope for is international institutions that can help smooth some of the rough edges.
For today’s international monetary system, the perfect – an unattainable single central bank and currency – should not be made the enemy of the good. Working within our existing means, it is surely possible to improve our policy tools and boost global growth and prosperity.