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.

But the world can do better. Since economic development outside the process of globalization is no longer possible, countries should abandon monetary nationalism. Governments should replace national currencies with the dollar or the euro or, in the case of Asia, collaborate to produce a new multinational currency over a comparably large and economically diversified area.

Europeans used to say that being a country required having a national airline, a stock exchange, and a currency. Today, no European country is any worse off without them. Even grumpy Italy has benefited enormously from the lower interest rates and permanent end to lira speculation that accompanied its adoption of the euro. A future pan-Asian currency, managed according to the same principle of targeting low and stable inflation, would represent the most promising way for China to fully liberalize its financial and capital markets without fear of damaging renminbi speculation (the Chinese economy is only the size of California's and Florida's combined). Most of the world's smaller and poorer countries would clearly be best off unilaterally adopting the dollar or the euro, which would enable their safe and rapid integration into global financial markets. Latin American countries should dollarize; eastern European countries and Turkey, euroize. Broadly speaking, this prescription follows from relative trade flows, but there are exceptions; Argentina, for example, does more eurozone than U.S. trade, but Argentines think and save in dollars.

Of course, dollarizing countries must give up independent monetary policy as a tool of government macroeconomic management. But since the Holy Grail of monetary policy is to get interest rates down to the lowest level consistent with low and stable inflation, an argument against dollarization on this ground is, for most of the world, frivolous. How many Latin American countries can cut interest rates below those in the United States? The average inflation-adjusted lending rate in Latin America is about 20 percent. One must therefore ask what possible boon to the national economy developing-country central banks can hope to achieve from the ability to guide nominal local rates up and down on a discretionary basis. It is like choosing a Hyundai with manual transmission over a Lexus with automatic: the former gives the driver more control but at the cost of inferior performance under any condition.

As for the United States, it needs to perpetuate the sound money policies of former Federal Reserve Chairs Paul Volcker and Alan Greenspan and return to long-term fiscal discipline. This is the only sure way to keep the United States' foreign tailors, with their massive and growing holdings of dollar debt, feeling wealthy and secure. It is the market that made the dollar into global money -- and what the market giveth, the market can taketh away. If the tailors balk and the dollar fails, the market may privatize money on its own.