What Have Economists Said Or Written About a Single Global Currency

Business & Finance

2002 John Lipsky, Chief Economist JPMorganChase

Although he advocates moving slowly toward integration,John Lipsky has an ultimate vision more radical thanRobert Mundell’s. Rather than linking the dollar,

the euroand the yen in a three-currency monetary union, he favors

bringing the world’s economies together in a singlecurrency. “A Global Currency Unit — perhaps somethinglike John Maynard Keynes’ original proposal for the post-WWII era, to be created by the International MonetaryFund — isn’t going to be considered seriously in theforeseeable future,” he admits. “Nonetheless, such anidea could make good sense in a more distant future. If well managed, a single global currency could promotecredible long-term price stability, improving the globaleconomy’s efficiency and productivity.”

Thought a magazine produced by JP MorganChase for clients of JPMorgan Investor Services 4th Quarter 2001

2002

Uniting as one by John Costello
CFO Magazine, Australia's web magazine for senior finance staff

...... And that leads us, dear reader, to the nub of the current discussion on globalisation. Should we have a common world currency? After all, we’ve standardised on a single system of weights and measures (apart from the US, which sticks resolutely to miles, inches, gallons and pounds). We’re already seeing moves by major stock exchanges to merge on a global scale. So why not a single global currency? They’ve got a single currency in Europe with the euro, after all. Several Latin American countries have indicated they will abandon their local currency and switch to the US dollar. For us in Australia, a single currency would certainly solve the problem of what to do when you find a New Zealand coin in your loose change. The argument I’ve heard most recently is that rather than a single world currency, we have several according to groups of major trading nations. This would see North and South America tied to the US dollar. Of course, it would then be simply known as the dollar. The Europeans already have the euro. A related currency to the euro would be the afro, naturally. So where would that leave us? Well, we could tie ourselves to the Japanese yen and rename it the aspac. All that’s left is what I refer to as the ‘Stan countries’ – Pakistan, Uzbekistan, Afghanistan and so on. I guess they could take their pick between the afro and the aspac. But all this produces another problem. Who would administer each currency and, in the end, who would look after the inevitable single world currency? It would be a problem that Drake never saw years ago as we mulled over our muscat. Just for now, if you don’t mind, I’ll go back to daydreaming of a more efficient and certainly more glamorous rail system.

2000 The end of monetary sovereignty
As markets integrate and globalize, national currencies should become fewer and stronger.

- DIANA FARRELL AND SUSAN LUND (The McKinsey Quarterly, 2000 Number 4, pp. 56-67).

Traditional economic symbols of national sovereignty are going the way of the dinosaur. Around the world, national airlines, telephone companies, banks, and other government-owned institutions, once bulwarks and extensions of the nation itself, are being privatized and placed under market control. In the aftermath of the financial crises of the 1990s, many of them sparked by drastic currency depreciations, it is time for policy makers to narrow sovereignty's scope still further by treating currencies as what they are - simple mediums of exchange.

While policy makers tinker with exchange rate regimes, companies and investors around the world are quietly choosing to operate in a single standard currency: the US dollar. Like it or not, the same economic considerations that impelled 11 European nations to replace their national currencies with the euro are turning the dollar into the de facto global currency. Why? Because the United States has adapted to the new economic era of global markets by developing a financial market infrastructure that meets the needs of investors, issuers, and intermediaries.

As the dollar comes to predominate, emerging markets that maintain illiquid national currencies incur a significantly higher cost of capital and stunt the development of their financial markets. And while much ink has been spilled about the benefits of an independent monetary policy, the record of many central banks in emerging markets has been one of hyperinflation, overvaluation, and capital flight.

We are not, however, arguing for the hegemony of the dollar. Instead, we look forward to competition among currencies. Countries should either adopt the most attractive leading currency or compete to create one, a process that would strengthen all contenders and ensure the emergence of the best global medium of exchange. Even in the best of circumstances, it will take a decade or more for one or a few truly global currencies to appear, so instead of flinching from the fierce political opposition that is bound to arise, legislators, regulators, and central bankers should begin moving in that direction today.

GLOBAL MARKETS ARE ADOPTING A SINGLE CURRENCY

Around the world, product and capital markets are becoming increasingly integrated. Governments are opening their borders to foreign goods and capital while technology is revolutionizing communication, permitting companies to operate globally. To facilitate transactions and reduce costs, market participants are adopting a common medium of exchange, the US dollar.

For most of the time since the end of World War II, the US dollar has been the world's dominant currency. At the start of the 1970s, when it was still the benchmark currency of the Bretton Woods system, the US dollar accounted for almost 80 percent of central-bank reserves around the world. After the collapse of that system a little later in the decade, other currencies, no longer pegged to the dollar, could compete for international standing. Yet they failed to achieve it. On the eve of the euro's creation, in 1997, the dollar accounted for only 60 percent of central-bank reserves, but there was no corresponding increase in holdings of the deutsche mark or yen, which remained at 12 and 5 percent, respectively.

Despite the rapid growth of equity and bond markets, almost half of equities and bonds around the world are denominated in dollars (Exhibit 1). Savers have accumulated nearly $30 trillion in dollar-denominated bonds, equities, and currency depositsЧthe world's largest such pool. By contrast, 9 percent of equities and 16 percent of bonds are denominated in yen, while euro-area currencies account for 15 percent of equities and 24 percent of bonds. The adoption of the euro has caused companies within the European monetary zone to issue far more equities and bonds than they used to, but the currency has yet to attract many foreign issuers.

The dollar's predominance can't be explained by the size of the US economy, which, though the world's largest, accounts for less than 30 percent of the global gross domestic product. Instead, it reflects the world's marked preference for dollar-based financial instruments. Take international bank lending. US banks extend only 10 percent of foreign-bank loans, yet 45 percent of the value of foreign-bank loans is denominated in dollars. In most emerging markets, the proportion is even higher. In Thailand, for example, almost all foreign loans on the eve of the 1997 crisis were denominated in dollars, even though fewer than 10 percent of them came from US banks.
Moreover, the dollar's status in global financial transactions is underscored by its role in foreign-exchange trading: it is involved in nine out of ten foreign-exchange transactions and accounts for most of the trading against every other currency.

Two-thirds of all deutsche mark trades, for instance, are with the US dollar. In the case of less liquid currencies, the proportion rises; almost 90 percent of trading in the Singapore dollar is with the US dollar. The concentration of all trading in a single currency pools liquidity and reduces transaction costs. If every currency were to trade with every other

GLOBAL MARKETS ARE ADOPTING A SINGLE CURRENCY

And the dollar is becoming even more important as increasing amounts of financial activity take place in international rather than purely domestic markets. Twenty years ago, capital was funneled from savers to borrowers by means of bank loans, and capital markets were mainly national affairs. Today, capital markets are supplanting banks as the primary intermediaries, although the pace of change varies from country to country. In the United States, which is furthest along in this transition, bonds and equities represent nearly three-quarters of the total stock of financial assets, up from 60 percent in 1990. At the same time, capital markets around the world have been opened to foreign participation, and companies increasingly seek international financing. These changes have raised the demand for dollars. The nominal value of dollar-denominated bonds issued outside the United States grew from $402.1 billion in 1986 to $2.4 trillion in 1999Чan annual growth rate of 14.9 percent.

In global product markets, too, the dollar is king. Prices of most commodities are quoted in dollars, and dollars are used to pay for almost half of all imports and exports, even though the United States is involved in no more than 29 percent of global trade transactions (Exhibit 3). Global companies thus find it in their interest to dollarize their operations. The Mexican conglomerate Grupo IMSA is a good example. Since the advent of the North American Free Trade Agreement (NAFTA), in 1994, the proportion of Grupo IMSAТs products sold in dollars has grown to 90 percent. A company can eliminate currency risk from its balance sheet by paying dollars for inputs as well. As a result, Grupo IMSA pays its top executives and a growing proportion of its raw-material suppliers in dollars. To facilitate this trend, many Mexican executives now favor making the dollar a second legal currency.

In addition, the dollar is the foreign currency most widely held by private citizens, denominating almost 80 percent of foreign-currency deposits around the world. Dollar deposits account for more than one-third of total deposits in countries as diverse as Argentina, Cambodia, Peru, and Turkey. Because banks tend to lend in the same currency as their deposits, dollar-denominated loans also abound in these countries.

Throughout the world, US dollars and the local currency are often used interchangeably for routine transactions in real estate, for supplier and professional contracts, and for measurements of inventory. As a result, in countries such as Bolivia, Nicaragua, Peru, and Uruguay, almost as much value is circulating in dollars as in local currency. Russia has an estimated $44 billion in US currency, or almost 2.5 times the value of rubles in circulation. Indeed, roughly 60 percent of all US dollars in circulation are now held outside the United States, according to the US Federal Reserve Board. As almost three-quarters of new dollar notes end up abroad, this proportion can only grow.

Why the dollar?

Undoubtedly, the political stability and military might of the United States contribute to the strength of the dollar, but the main reason for its leading role is the world-class financial infrastructure that supports it. The Federal Reserve Board has held inflation in check since the early 1980s, providing a stable monetary base, while the US Securities and Exchange Commission rigorously governs US financial markets, promoting fair operation and the protection of investors. US accounting standards provide the world's highest level of transparency; the US legal system gives creditors and shareholders extensive rights; and the country harbors the world's strongest financial skills as well as most innovation in financial products.

Because a currency becomes more desirable the more people use it, the dollar has become almost beyond challenge. For the same reason, financiers choose the dollar for their innovations, such as the securitization of assets - further widening the distance between it and all other currencies.

What about the euro? What about the yen?
While the euro could eventually rival the dollar, it now lacks the dollar's credibility and infrastructure. The euro is a new and only partially tested currency. The European Central Bank has too short a track record, and its decision making is hampered by political and economic contention.

Although European financial markets are developing rapidly, they are still far behind those in the United States. US companies and government agencies have issued bonds and equities amounting to 278 percent of GDP, against 139 percent for Germany and France and a European average of 183 percent, despite similar per capita income levels (Exhibit 4).

Europe's less investor-friendly market infrastructure explains almost all of the gap. Capital market regulation there is not as vigilant, and legal protection for creditors and minority shareholders is weak. Furthermore, different sets of national regulations still govern financial markets in the euro area, thus preventing their true integration into a single market, while accounting and reporting requirements make it harder to assess the true condition of euro-area companies. All of these factors prevent the euro from challenging the dollar, at least for the time being.

The yen, for its part, suffers from all of the euroТs liabilities and more. High levels of share cross-holdings and a tradition of centralized economic planning - among other factors culminating in Japan's present woes - mean that few non-Japanese companies or investors participate in the Tokyo market. The yen isn't widely used to denominate transactions even in Asia.

ILLIQUID NATIONAL CURRENCIES ARE COSTLY

Global competition makes maintaining an illiquid national currency more and more costly. For one thing, it raises borrowers' cost of capital. A Thai government ten-year bond denominated in baht, for example, traded for 1,218 basis points over US Treasuries in January 1999. At the same time, a Eurodollar bond issued by the Thai government traded for just 288 basis points over US Treasuries. While part of the difference reflects Thai inflation (8.1 percent in 1998), fully 120 basis points of it can be attributed to the risk that the baht will decline in value. This is a huge penalty for Thai companies to pay in a competitive world. Companies in other emerging markets face a similarly bloated cost of capital.