The End of National Currency

Benn Steil

From Foreign Affairs, May/June 2007

Summary:  Global financial instability has sparked a surge in "monetary nationalism" -- the idea that countries must make and control their own currencies. But globalization and monetary nationalism are a dangerous combination, a cause of financial crises and geopolitical tension. The world needs to abandon unwanted currencies, replacing them with dollars, euros, and multinational currencies as yet unborn.

Benn Steil is Director of International Economics at the Council on Foreign Relations and a co-author of Financial Statecraft.

Four decades ago, the renowned French economist Jacques Rueff, writing just a few years before the collapse of the Bretton Woods dollar-based gold-exchange standard, argued that the system "attains such a degree of absurdity that no human brain having the power to reason can defend it." The precariousness of the dollar's position today is similar. The United States can run a chronic balance-of-payments deficit and never feel the effects. Dollars sent abroad immediately come home in the form of loans, as dollars are of no use abroad. "If I had an agreement with my tailor that whatever money I pay him he returns to me the very same day as a loan," Rueff explained by way of analogy, "I would have no objection at all to ordering more suits from him."

With the U.S. current account deficit running at an enormous 6.6 percent of GDP (about $2 billion a day must be imported to sustain it), the United States is in the fortunate position of the suit buyer with a Chinese tailor who instantaneously returns his payments in the form of loans -- generally, in the U.S. case, as purchases of U.S. Treasury bonds. The current account deficit is partially fueled by the budget deficit (a dollar more of the latter yields about 20-50 cents more of the former), which will soar in the next decade in the absence of reforms to curtail federal "entitlement" spending on medical care and retirement benefits for a longer-living population. The United States -- and, indeed, its Chinese tailor -- must therefore be concerned with the sustainability of what Rueff called an "absurdity." In the absence of long-term fiscal prudence, the United States risks undermining the faith foreigners have placed in its management of the dollar -- that is, their belief that the U.S. government can continue to sustain low inflation without having to resort to growth-crushing interest-rate hikes as a means of ensuring continued high capital inflows.

PRIVATIZING MONEY

It is widely assumed that the natural alternative to the dollar as a global currency is the euro. Faith in the euro's endurance, however, is still fragile -- undermined by the same fiscal concerns that afflict the dollar but with the added angst stemming from concerns about the temptations faced by Italy and others to return to monetary nationalism. But there is another alternative, the world's most enduring form of money: gold.

It must be stressed that a well-managed fiat money system has considerable advantages over a commodity-based one, not least of which that it does not waste valuable resources. There is little to commend in digging up gold in South Africa just to bury it again in Fort Knox. The question is how long such a well-managed fiat system can endure in the United States. The historical record of national monies, going back over 2,500 years, is by and large awful.

At the turn of the twentieth century -- the height of the gold standard -- Simmel commented, "Although money with no intrinsic value would be the best means of exchange in an ideal social order, until that point is reached the most satisfactory form of money may be that which is bound to a material substance." Today, with money no longer bound to any material substance, it is worth asking whether the world even approximates the "ideal social order" that could sustain a fiat dollar as the foundation of the global financial system. There is no way effectively to insure against the unwinding of global imbalances should China, with over a trillion dollars of reserves, and other countries with dollar-rich central banks come to fear the unbearable lightness of their holdings.

So what about gold? A revived gold standard is out of the question. In the nineteenth century, governments spent less than ten percent of national income in a given year. Today, they routinely spend half or more, and so they would never subordinate spending to the stringent requirements of sustaining a commodity-based monetary system. But private gold banks already exist, allowing account holders to make international payments in the form of shares in actual gold bars. Although clearly a niche business at present, gold banking has grown dramatically in recent years, in tandem with the dollar's decline. A new gold-based international monetary system surely sounds far-fetched. But so, in 1900, did a monetary system without gold. Modern technology makes a revival of gold money, through private gold banks, possible even without government support.

COMMON CURRENCIES

Virtually every major argument recently leveled against globalization has been leveled against markets generally (and, in turn, debunked) for hundreds of years. But the argument against capital flows in a world with 150 fluctuating national fiat monies is fundamentally different. It is highly compelling -- so much so that even globalization's staunchest supporters treat capital flows as an exception, a matter to be intellectually quarantined until effective crisis inoculations can be developed. But the notion that capital flows are inherently destabilizing is logically and historically false. The lessons of gold-based globalization in the nineteenth century simply must be relearned. Just as the prodigious daily capital flows between New York and California, two of the world's 12 largest economies, are so uneventful that no one even notices them, capital flows between countries sharing a single currency, such as the dollar or the euro, attract not the slightest attention from even the most passionate antiglobalization activists.

Countries whose currencies remain unwanted by foreigners will continue to experiment with crisis-prevention policies, imposing capital controls and building up war chests of dollar reserves. Few will repeat Argentina's misguided efforts to fix a dollar exchange rate without the dollars to do so. If these policies keep the IMF bored for a few more years, they will be for the good.