Why Doesn’t the World Have One Currency?
The notion of adopting a single, global currency has been a subject of numerous debates and discussions.
It’s an idea that, on the surface, appears to offer many benefits, such as eliminating exchange rate risks and facilitating global trade.
However, the reality of implementing such a system (beyond a limited economic sphere) is impractical.
This article takes a deeper look at the reasons why countries maintain individual currencies, the pros and cons of a common currency, and the impacts of dollarization and currency pegs.
Key Takeaways – Why Doesn’t the World Have One Currency?
- Individual currencies are important for countries to have control over their monetary policy, including domestic interest rates, exchange rates, and inflation. This allows them to manage their economies according to their unique conditions and objectives.
- The eurozone serves as a case study for a common currency, the euro. While it eliminates exchange rate risks and promotes regional economic integration, it also leads to a loss of monetary policy autonomy for member-states, which may not align with their economic situations.
- Dollarization and currency pegs are alternative approaches to monetary policy. Dollarization can increase stability but results in a loss of monetary control, while currency pegs offer stability but limit flexibility and expose the country to speculative attacks. Each approach has its pros and cons, and the choice depends on a country’s specific circumstances.
The Importance of Individual Currencies for Monetary Policy Management
Countries use monetary policy as a tool to maintain economic stability and promote growth.
Individual currencies play an important role in this process.
Control Over Domestic Interest Rates
Higher interest rates can make borrowing more expensive, curbing excessive spending and controlling inflation.
On the other hand, lower interest rates can stimulate economic activity by making loans more affordable, thus encouraging investment and growth.
Exchange Rate Management
Countries can manage their exchange rates to boost their economies.
A technique known as competitive devaluation can be employed to decrease the value of a country’s currency, making its exports cheaper and more attractive on the global market, thereby promoting export growth.
As we covered a bit above, central banks use monetary policy to control inflation.
By adjusting interest rates to control lending/loan growth and managing the money supply, they can influence domestic price stability.
This, in turn, can affect consumer spending (which is most of economic growth in developed countries) and overall economic growth.
The Eurozone: A Case Study of a Common Currency
The eurozone provides a real-world example of multiple nations sharing a common currency – the euro.
The Pros of a Common Currency
A shared currency eliminates exchange rate risks, making it easier for businesses to trade and invest across borders.
It can also strengthen regional economic integration, fostering deeper cooperation and synergy among member states.
The Cons of a Common Currency
However, a common currency also means loss of monetary policy autonomy.
Member nations must abide by the monetary policy set by the European Central Bank, which may not always align with their individual economic situations – a “one-size-fits-all” approach.
Moreover, a common currency makes member states more susceptible to regional economic crises, as witnessed during the Eurozone debt crisis. As well as intermittent financial problems for some countries along the way.
Example: Greece 2012
Take the example of Greece in 2012.
When it had to face its debt problem in 2012. It had adopted the euro and so, therefore, it didn’t have autonomy over its monetary policy. That was controlled by the ECB.
If it had stayed on the drachma it would have simply devalued its currency and spread the effects externally. People’s incomes would stay the same internally (though fall in relative terms – e.g., imports would have become more expensive).
Its exports would have become cheaper internationally, stimulating external demand for their products and services.
Being monetarily linked to everyone else in the EU, it didn’t have control over its situation and instead had to take the effects internally, with GDP falling 40 percent.
In cases where a country can control its monetary policy because it has its own currency and the debts are poorly managed, it can take usually about a decade to return to the previous level of economic output. (Each situation is different, but that’s where you get the term “lost decade”.)
When you don’t have an independent monetary policy, this can take quite a bit longer. In Greece’s case, it can take decades. The same was true with Iceland in 2007-08.
Common currencies create vulnerabilities
In general, this type of pegged currency regime makes Europe the most vulnerable of all developed market economies when there’s a contraction in output.
Individual countries largely lack the tools to combat their problems.
The euro has tended to be too weak for stronger economies like Germany and too strong for countries in the periphery, like Greece, Portugal, Spain, and Italy.
Countries that have stronger growth may want a strong currency to help curb excesses (e.g., inflationary pressure). On the other hand, a weaker economy may want a weaker currency to help them grow (i.e., more export growth)
Dollarization and Currency Pegs: Pros and Cons
Dollarization is when a country adopts the US dollar as its official currency.
This can increase stability and credibility, and possibly result in lower borrowing costs.
However, it also means a total loss of control over monetary policy and a vulnerability to external economic shocks originating in the US.
Dollarization generally occurs when monetary problems (e.g., chronic inflation, debt defaults) have been so bad in the past that even a currency peg (discussed below) is considered undesirable.
A currency peg is when a country fixes its exchange rate to the value of another country’s currency.
This can promote exchange rate stability and boost investor confidence.
However, it limits the flexibility of monetary policy and exposes the country to the risk of speculative attacks, which could destabilize the currency peg.
Such events are most likely to work when the exchange rate peg is inconsistent with the underlying economic fundamentals.
What Currency Do Countries Peg To?
Usually the world’s leading reserve currencies and/or that of their top trading partner.
For example, in the case of Vietnam, their top trading partner is the US and the world’s leading reserve currency is the US dollar, so they peg their currency to the USD.
Was Bretton Woods a One-Currency System?
No, the Bretton Woods system was not a one-currency system.
The Bretton Woods system was an international financial framework established in 1944 in Bretton Woods, New Hampshire.
Representatives from 44 countries met to create a more stable economic environment after the devastations of World War II.
Under this system, countries agreed to peg their currencies to the US dollar, which was itself convertible to gold at a fixed rate of $35 per ounce. The fixed exchange rate system allowed for more stability and predictability in international trade and finance.
However, each country still had its own currency.
The difference was that the value of their currency was pegged to the US dollar (and indirectly to gold), rather than being allowed to float freely and be determined by market forces.
This is different from a one-currency system, where all participating countries use the same physical currency.
The Bretton Woods system lasted until August 15, 1971, when the United States unilaterally terminated the convertibility of the US dollar to gold, an event often referred to as the Nixon Shock.
This effectively ended the Bretton Woods system and led to the modern system of freely floating fiat currencies.
Could The Whole World Use Just One Currency?
FAQs – Why Doesn’t the World Have One Currency?
Why is it important for countries to have control over their domestic interest rates?
Control over domestic interest rates allows countries to influence borrowing costs, which in turn impacts investment and economic growth.
By adjusting interest rates, central banks can stimulate or curb economic activity depending on the country’s economic conditions and objectives.
How can managing exchange rates help promote export growth?
By managing their exchange rates, countries can engage in competitive devaluation, making their exports cheaper for foreign buyers.
This can help boost export growth and support domestic industries that rely on international markets.
Why is inflation control important for a country’s economy?
Inflation control is important for maintaining domestic price stability.
High inflation can erode purchasing power, affect consumer spending, and negatively impact economic growth and productivity.
Conversely, low inflation can encourage spending and investment, thereby fostering economic growth.
What are the main benefits of the eurozone for its member countries?
The eurozone offers several benefits to its member countries, including the elimination of exchange rate risks, facilitation of trade and investment, and strengthening of regional economic integration.
By adopting a common currency, member countries can enjoy a more seamless and efficient economic environment.
How does the loss of monetary policy autonomy affect countries in a common currency zone like the eurozone?
The loss of monetary policy autonomy means that countries within the eurozone cannot independently adjust their interest rates or implement other monetary policy measures.
This can lead to a one-size-fits-all monetary policy, which may not be suitable for all member countries, especially those facing unique economic challenges.
What economies are dollarized?
Dollarization is the process by which a country adopts a foreign currency (typically the US dollar) as its official currency.
The countries that are fully dollarized (i.e., the US dollar is their official currency) are:
- East Timor
- El Salvador
- Federated States of Micronesia
- Marshall Islands
Some countries and territories use the US dollar alongside another currency.
These are not fully dollarized but are examples of a “dual” or “multiple” currency situation.
- Costa Rica
- North Korea
Moreover, many other countries, while not officially dollarized, may use the US dollar widely in certain sectors or regions.
Exporters are a common one.
Other countries may save in it extensively.
What is the main difference between dollarization and currency pegs?
Dollarization refers to the adoption of a foreign currency (usually the US dollar) as a country’s official currency.
Currency pegs, on the other hand, involve fixing a country’s exchange rate to another currency or a basket of currencies.
While both approaches aim to provide exchange rate stability, dollarization entails a complete relinquishment of monetary policy control, whereas currency pegs still allow for some degree of monetary policy flexibility.
(This accounts for why currency pegs are more popular than complete dollarization.)
Can a global currency ever become a reality?
There are numerous political, economic, and practical obstacles that make it virtually impossible.
Issues such as disparities in economic development, political sovereignty, and the complexities of managing a global monetary policy make a single global currency unworkable.
While the idea of a single global currency may seem attractive, there are several reasons why individual currencies remain the norm.
The ability to control domestic interest rates, exchange rates, and inflation allows countries to manage their monetary policy based on their unique economic conditions.
Although adopting a common currency or another country’s currency can offer stability in some circumstances, it is important to consider the potential drawbacks of relinquishing monetary policy control.
Overall, the decision to maintain individual currencies or adopt a shared one should be based on a careful assessment of a country’s specific needs and economic context.