Currency Questions, Essay Example

In this brief paper I will try to answer some basic questions about the nature of currency systems. The most basic one seems to be: how many currencies should there be? English philosopher John Stuart Mill believed there should be one, or at least fewer than many: So much of barbarism, however, still remains in the transactions of most civilised nations, that almost all independent countries choose to assert their nationality by having, to their own inconvenience and that of their neighbours, a peculiar currency of their own. On this point I begin.

How many currencies there should be depends on your view of what a currency is. For most of modern history, the money that people have used represented a nation. The Euro, introduced as the currency of the European Union in 1999, is something entirely new in that it officially represents (as of now, anyway) 17 nations. It defines an optimal currency area (OCA),  a politically determined region thought by some to be best economically served by a single currency. But whether nation or union, all currencies represent a political entity and are under the control of that entity through a central bank. Advocates of such currencies (some of whom back a single world currency) believe that OCAs greatly increase economic efficiency. Within the OCA, multinationals don’t have to worry about falling and rising currency values in customer nations, and tourists need no moneychangers. A great boon that seems self-evident to anyone.

But not so fast. Nations and currency unions can’t themselves generate capital, being just arbitrarily-bordered political conceptions, cutting across ethnic, geographic, or  political forces as if they didn’t exist. Capital is generated only in mutually trading cities that each replace their own imports with their own production in order to import or export something new, adding people, goods, and territory explosively. Since antiquity many cities were city-states and had their own currencies. Singapore and Hong Kong still do. National or Union currencies, especially of large areas, are handicapped because they can register their changing values only in terms of international trade. For example, if Russia discovered more oil within its borders, its ruble would rise in value because more people would want to buy that oil. But in the event of a recession, a hot winter, or a new Japanese electric-car battery, the ruble will fall because fewer people will need it. That changing value changes prices. Economists call this information feedback. But a national or OCA currency creates no feedback within its own borders. For example, in the U.S., there is no feedback-loop measuring fluctuations of  trade between, say, Detroit and Pittsburgh, which may explain why those cities lost their markets. Western nations like the U.S. and Canada have far more domestic trade than international trade. Yet there is no feedback controlling it. So a “strong” U.S. dollar can and does price domestic manufacturers out of their world markets. They either go bust or move to another country with a “weaker” currency. Like China.

China (with its own lack of internal feedback) has kept its currency competitively weak by design. This keeps its products cheap on the international markets and centers its economy on exports. This can be termed strategic devaluation, as opposed to a tactical devaluation, which is what the Euro’s PIGS’ (Portugal, Ireland, Greece, Spain) would dearly love to do, but can’t.

The current Euro crises was caused because the Euro has the same value, regardless of where it is borrowed or how it is spent. After 1999, the PIGS (and France), who previously would have been considered relatively poor credit-risks and made to pay a higher rate of interest in their own money, ended up with the same credit rating as the disciplined Germans. As a result, the debtors partied like it was still 1999. Now the hangover. But because of the single Euro, they cannot devalue their currencies like they used to do, allowing their nations’ products to be cheaper for each other’s buyers, letting their exports lead the way out of crushing debt. They are stuck, and faced with loan-shark bailout conditions from the European Central Bank, or the chaotic consequences of ditching the Euro. So we can say that the Euro crisis is caused by not enough currencies, rather than too many. So there is actually an argument for city currencies.

The original medium of exchange was gold. Other currencies varied in value in comparison to it. In antiquity, everyone was on the gold standard by default — there was no other universally accepted money. Later, with the introduction of paper money, things got more complicated. The U.S. was on a gold standard for much of its history, except in times of war, which was so expensive that paper money was mandated and then inflated until worthless. During peacetime, citizens could go to a bank and demand gold for dollars or vice versa, but the price of gold depends on its physical supply, like any commodity. It can impose discipline too, and after Roosevelt (1932), elected leaders who failed to evade such discipline risked their jobs. When the 1944 Bretton Wood agreement replaced gold with the dollar as the international currency, its price in gold and other currencies was fixed (pegged) by political fiat. By the 1970s, American inflation, fed by the Vietnam War and the Great Society, had destroyed those rates. The market set them thereafter, and in an ongoing quest for national discipline, dollarization is sometimes tried: a stagnant or developing nation, recognizing its political inability to manage its own currency, quits it or shares it with another, like border towns do. A nation using U.S. dollars trades at whatever exchange rate the U.S is earning, so a small export-economy could be ruined. (Think of a mouse hooked to an elephant’s lungs.) Tourism must then replace that lost money. Other stratagems include linked exchange rates, which tethers one currency to another to limit fluctuations; and managed floats, also known as dirty floats, in which a central bank intervenes in a floating currency only when deemed essential. All such arrangements can work only to the extent that they are not severely tested by money markets sensing an overvalued currency.

In a world of fiat money, fiscal discipline is rarer than gold. Bitcoin, anyone?