From EMU to AMU? The Case for Regional Currencies

Zanny Minton Beddoes

From Foreign Affairs, July/August 1999

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Summary:  The euro is just the beginning. Within a few decades, single-currency zones will dominate international finance -- although East Asia may be the odd zone out.

Zanny Minton Beddoes is the Washington economics correspondent for The Economist.

When tomorrow's historians look back at the recent financial crises and subsequent efforts to reform global finance, they will reach two conclusions. First, the grand rhetoric of creating a new global architecture yielded few concrete results. Second, we failed to foresee the most profound consequence of the turmoil: regional currency unions. By 2030 the world will have two major currency zones -- one European, the other American. The euro will be used from Brest to Bucharest, and the dollar from Alaska to Argentina -- perhaps even in Asia. These regional currencies will form the bedrock of the next century's financial stability.

That claim may seem bold, even outlandish. The concept of regionalism, whether financial, military, or commercial, hardly enjoys an auspicious reputation. Free-trade enthusiasts fret that regional trade arrangements divert more trade than they create. Europe's single market was long portrayed as "Fortress Europe" by outsiders. European aspirations for an independent defense initiative raise some eyebrows in Washington. Japan's proposal to create an Asian monetary fund in 1997 was quickly squashed by the Americans. In each case, opponents fear that regional approaches are exclusionary, protectionist, or destabilizing. But in finance, that prejudice is misplaced. Regional currencies will prove the best route to reconciling the economic imperatives of increasing international capital mobility with the political realities of the nation-state.

To understand why regional currency zones are in the cards, start by considering why the status quo is untenable. Over the past five years, financial turmoil has shattered the semi-fixed exchange-rate regimes that much of the developing world once favored. One after the other, countries with pegged (but ultimately adjustable) exchange rates had to devalue in the face of massive capital outflows. The recent crises have taught emerging economies a lesson that rich countries first learned through the collapse of the Bretton Woods system in the early 1970s, later reinforced by the 1993 collapse of the European exchange-rate mechanism: in a world of increasingly mobile capital, countries can either allow their currencies to float or fix them irrevocably, for instance through currency boards. They can even go further and attempt currency union. But the muddled middle ground, so popular in the years when capital was less mobile, has been wiped out by technological innovation and policy liberalization.

So much for the status quo. What might the future offer? Conventional wisdom among elites holds that most countries should opt for floating rates. By allowing their currency to float, the argument goes, emerging economies can maintain an independent monetary policy while insulating themselves from the vicissitudes of global capital flows. This view has gained even more credence in the past few months as Brazil's decision to float its currency, the real, did not produce the high inflation that many observers had feared. Nonetheless, most countries will find that advice sorely mistaken, for the second lesson of the emerging-market turmoil is that floating exchange rates tend not to protect a country from volatility. Indeed, they may even increase financial turbulence.

By rich-country standards most ...

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