A Single Global Currency? Not Any Time Soon Nor in the Long Run in Which We Are All Dead

Author: Nouriel Roubini  ·  August 23rd, 2004  ·  91155http%3A%2F%2Fwww.economonitor.com%2Fnouriel%2F2004%2F08%2F23%2Fa-single-global-currency-not-any-time-soon-nor-in-the-long-run-in-which-we-are-all-dead%2FA+Single+Global+Currency%3F+Not+Any+Time+Soon+Nor+in+the+Long+Run+in+Which+We+Are+All+Dead2004-08-23+13%3A38%3A41Nouriel+Roubinihttp%3A%2F%2Fwww.economonitor.com%2Fnouriel%2F2004%2F08%2F23%2Fa-single-global-currency-not-any-time-soon-nor-in-the-long-run-in-which-we-are-all-dead%2F › Share This Print

The usually sharp Martin Wolf of the FT has recently come out in favor of a single global currency for all countries:

Martin Wolf “We Need a Global Currency” “Last month was the 60th anniversary of the conference at Bretton Woods, New Hampshire, that inaugurated the post-second world war international economic order. The flood of analysis that this occasion brought forth has concentrated on that meeting’s institutional progeny: the International Monetary Fund and the World Bank. But a bigger question needs to be addressed. It is whether floating exchange rates have proved to be the ideal replacement for the unsustainable adjustable exchange-rate pegs of the Bretton Woods monetary regime. The answer is: no.

…. A world in which borrowing abroad is hugely dangerous for most relatively poor countries is undesirable. A world that compels the anchor currency country to run huge current account deficits looks unstable. We should seek to lift these constraints. The simplest way to do so would be to add a global currency to a global economy. For emerging market economies, at least, this would be a huge boon.

I am well aware of the economic and political objections to this idea. But if the global market economy is to thrive over the decades ahead, a global currency seems the logical concomitant. In its absence, the world of free capital flows will never work as well as it might. This is a world I am unlikely ever to see. But maybe my children or grandchildren will do so.”

His case in favor of a global currency is a combination of different arguments. First, he is concerned about the U.S. running large current account deficits and accumulating debt. Second, he is concerned about emerging market economies having to borrow in foreign currency (as they suffer of “original sin” or “liability dollarization” as in the celebrated arguments of Hausman and Eichengreen) and thus being vulnerable to highly disruptive financial crises when capital reversals and sudden stops occur and currencies collapse. Third, he is concerned about the excessive and inefficient accumulation of forex reserves by Asian and other emerging market economies. All these phenomena, he argues, are explained by currency instability that would be eliminated by a single global currency.

These arguments, however, do not make a compelling case for a single global currency. Spending time with Robert Mundell – a great supporter of a global currency – in the Tuscany hills may impair one’s better judgement about the benefits of a single global currency. There are many arguments against such single global currency.

First, as forcefully argued in a recent monograph by Goldstein and Turner, liability dollarization is not as widespread as claimed by Hausman & Co.; also, countries are not bound to remain in “liability dollarization” hell forever; “original sin” may not be really eternal and may rather be a purgatory from which you can graduate (and start issuing local currency debt) if you follow sound economic policies for a while.

Second, even if emerging markets were to suffer of “original sin” it is not obvious that they are good candidates for formal dollarization. As in have discussed in previous papers of mine, the conditions for a country being a good candidate for adopting a foreign currency (formal dollarization) are very stringent and very few do satisfy them. Even an originally gung-ho supporter of dollarization for many emerging market economies such as Hausmann has recently come around in favor of flexibles exchange rates and in favor of resolving “original sin” via institutional changes in international financial markets so as to allow emerging market economies to borrow abroad in their own currency.

Third, a single global currrency would prevent currency crises but would not necessarily prevent debt and financial crises. Take the case of Panama: it dollarized a century ago but it has been in a fiscal mess for the last three decades, has been the most prolonged user of IMF resources and it defaulted on its external debt in the 1980s and eventually reduced it with a Brady bond deal. So, eliminating currency risk does not lead to economic virtue, as the recent case of Ecuador also suggests. Liquidity runs can still occur (and they are even more dangerous as domestic lender of last resort support tools are much more limited with a single global currency) and debt crises can also occur with grave severity.

Fourth, would a single global currency prevent large global current account imbalances such as those currently observed? Not necessarily as currency misalignment is only one of the ways that such imbalances are created and persist over time. Since the current account balance is equal to savings-investment balance, the recent large US current account deficit – driven by fiscal deficits – would have been almost as large as it is now even with a single global currency. Indeed, the US fiscal deficit would have led to a current account deficit (twin deficits) even in the absence of currency movements: real appreciation and depreciation can occur via changes in nominal prices rather than currency values when domestic currencies are pegged or non-existent. Yes, saving-investment imbalances driven by factors such as fiscal imbalances may be exacerbated by the currency misalignments that such imbalances create; but eliminating currency movements does not prevent large current account imbalances from emerging in the first place. If anything, lack of currency risk may make the financing of such large imbalances easier, as there is not risk of capital losses on US dollar assets held abroad if the dollar does not exist and cannot depreciate. Thus, lack of currency volatility may cause imbalances to persist longer and thus cause a more severe – and in long run unsustainable – accumulation of external debt.

Fifth, if we had a single global currency, we would need a single global central bank that would set the single global short term policy interest rate (the global Fed Funds rate). But, if business cycles of major regions – US, Europe, Japan/Asia and other emerging markets – are not highly syncronized to begin with, a common world interest rate would not be optimal; it could be outright dangerous and destabilizing instead.

Sixth, if there was a single global currency someone would have to provide lender of last resort support in the case of bank runs and banking crises. But how would a global central bank decide whether to “bail out” or provide liquidity to a particular country banking system but not to another one? Which criteria would be used? A single global currency requires also a single global supervisor and regulator of the banking and financial system; otherwise moral hazard distortions from potential lender of last support could be severe. But are we ready to accept a single global financial regulator?

Seventh, the reason why Asian and other emerging market economies are accumulating foreign reserves is not anymore their concern about the risk of a liquidity run (as in 1997-98); in fact, the accumulation of such a war chest of reserves is now well in excess of what is required to avoid a liquidity run. The Asians are accumulating reserves because they want to prevent an appreciation of their currencies relative to the US dollar (a variant of this argument is the Garber, Folkerts-Landau and Dooley argument of the restoration of a Bretton Woods 2 regime of global fixed exchange rates). But we are really not in a new BW2 regime (as argued in a forthcoming paper of mine with Brad Setser). Also, Asian countries’ desire to follow a low-consumption, high-savings, high export and large current account surplus growth model could be partially achieve
d even in a world of a single currency. If your economic policies repress consumption and stimulate savings, your excess of national saving relative to investment will lead to current account surpluses and export-led growth. Yes, maintaining an artificially cheap currency can help but such global current account imbalances depend more on saving investment imbalances than on exogenous currency misalignments that causes such imbalances. Afterall, currency misalignment is in large part a product of such macro savings-investment imbalances in the first place.

Finally, monetary unions have been historically associated with political unions; and, indeed, EMU emerged as a stage of a drive towards political union in Europe. Monetary Unions without political unions have historically failed, as the Latin Monetary Union of the 19th century. So, a single global currency will require something closer to a single political union in the world. And chances of having a single global government are nil, to say the least.

In summary, not only is the likelihood that we will see a single global currency in our lifetimes slim; it is also a bad idea to begin with. It is still possible that, in 20 to 30 years, the number of national currencies may be significant smaller. If, and that is a big if, the Euro/EMU experiment is successful, most of an integrated greater Europe would eventually be under a single currency. In the Americas, a few more countries (on top of the recently dollarized Ecuador and El Salvador) may also decide to unilaterally dollarize. A NAMU (North American Monetary Union) including the USA, Canada and Mexico would make some economic sense but it is politically unlikely to come alive. So, the process of monetary unification in the Americas will be slow at best and based on unilateral dollarizations rather than formal Monetary Unions as in the EMU.

Finally in the Asian region the desire for some currency stability may lead to more formal currency arrangements. At first, like in Europe, the Asians could go for a loose form of ERM/EMS (or better AMS) with wide but narrowing bands. A formal AMU (Asian Monetary Union) is quite unlikely for two main reasons: 1. in Europe EMS led to EMU because Europe was integrating politically, not just economically; 2. any monetary union requires an implict strong anchor currency as a intermediate step to a MU (the US dollar for the Americas’ unilateral dollarizations; the German Mark for the Europe and the EMS to EMU process). But in Asia, it is not clear which currency would be the anchor of such AMU. Japan, and its currency the Yen, used to be the leading economic power. But now, the emergence of China as the major regional economy implies that Asians currency policies and managed floats are driven more by China’s currency policy than by Japan’s. But China and its currency do not have yet the economic/financial and political status to become the true anchors of a AMU.

Thus, while it is not far fetched to believe that in 30 plus or so years, there may be three broad currency blocs with the world, one in the Americas anchored around the US dollar, one in Eurasia anchored around the Euro and one on Asia anchored around the Yen or the Yuan, we could expect, at most three global currencies in our lifetimes, certainly not a single global currency. And even this process towards three main global currencies is likely to be bumpy and highly uncertain: unilateral dollarizations in the Americas may have little appeal to most Latin economies if they do not imply a road to a symmetric monetary union, an idea that is a politically toxic in the US. In Europe, the EMU has still to prove itself before it can become the currency of all the EU 15, now 25 and soon 30-40 plus members. And in Asia, monetary and currency stability may depend on the resolution of the question of who will be the political and economic hegemon of the region: Japan, now China, or maybe India in some future?

So, for the time being a single global currency in the next two decades? Not a fat chance of that happening and/or being desirable!