Kaushik Basu: Economic Graffiti

India Today, December 14, 1998
Dec 14, 1998

ECONOMIC GRAFFITI
One Global Currency

The future of money: from cowries to the euro and beyond.

Kaushik Basu

The European Union is on track towards a common currency for 11 of its 15 member nations. The culmination of this currency merger will occur on July 1, 2002, when national currencies cease to be legal tender and all citizens of the participating nations switch over to the use of euro notes and coins. The main motivation behind the euro is, arguably, to boost European trade and challenge the US dollar's primacy as world currency.

Whatever the motivation, this is a more momentous event for the world than most people realise. The reason is it points to the future. The current international monetary system is increasingly showing up as unviable for the emerging world economy. My guess is the euro is the start of a long process that will take us to a single currency world.

This was in fact a recommendation made in 1878 by Stanley Jevons, the English economist. In outlining the advantages of an "international money" he had to, it must be admitted, scrape the bottom. By the time a similar case was again made in 1984 by Richard Cooper of Harvard University -- he argued for one currency to be shared by all the industrialised nations of the world -- the idea didn't seem quite as far-fetched. Since then the structure of the world economy has changed even further; and the repeated crises of the '90s -- Sweden 1992; Mexico 1994; Thailand, Indonesia, South Korea 1997; and Japan currently teetering on the brink -- are evidence of this.

The most significant change is the ease with which capital now flows in and out of nations. If the stock market is expected to boom in Bangkok, money pours into the Bangkok stock exchange from all over the world. True, stock markets were always volatile but in today's inter-connected world there is an additional problem.

Suppose you have bought shares in Thailand. Unlike a Thai investor, you will be watching two prices: the stock prices in Thailand and the exchange rate of the Thai baht. If you expect the baht to fall, even if you do not expect the stock price to fall, you will want to sell your stock. This is because as an Indian you will have to keep in mind that after you sell the stock and collect the bahts you will have to change the bahts to rupees in order to spend them in India. If the baht loses value, you lose.

Now if all foreigners sell Thai stocks because they expect the baht to fall, this will cause the stock prices to fall. This intertwining of the stock market with the foreign exchange market renders both markets more volatile. A spark in one could ignite the other.

Note that if all countries used the same currency then one half of this twin risk would be gone. There will be no exchange rates to watch. My sense is that ultimately, for good or for bad, this is the way the world will go.

A common currency area does amount to reduced elbow room for each country in terms of fiscal and monetary policy. For one, we can't have one currency with several central banks (one in each country, as now) with rights to create money. In that case each nation's central bank will tend to print money and hand it over to its citizens to increase their buying power. This will fuel inflation.

So a prerequisite for one currency is one central bank to be shared by all countries. This is difficult enough for homogeneous Europe. In today's fractious world it will be well-nigh impossible. However, there may be ways of inching towards this without going the whole way. For one, clusters of countries can try to come together under a common currency. We can build safeguards to ensure that no single country has excessive power over the central bank.

All this may not be quite as impossible as it seems today. After all, the institution of money has undergone wild changes in the past. As recently as in the 19th century Mademoiselle Zelie, a Parisian singer giving a concert in the Pacific Islands, was promised one-third of the collection at the gate. At the end of the concert, Zelie was handed over a pig, 23 turkeys, 44 chickens, plus coconuts, bananas and lemons. It was a handsome payment but of little use to her.

Indeed once one thinks of the early and ubiquitous system of barter one realises how much contemporary society owes to the institution of modern money. Barter societies gradually realised the importance of having one good to serve as the medium of exchange. Corn, cowry shells and tobacco, all have been tried. In Norway one could even deposit corn in banks. The trouble with most of these "currencies" was that you could literally grow money in your backyard; and this led to price instability.

By the late 17th century, paper currency had come into existence. Till recent times, banks were allowed to issue their own currency. This resulted in competition and an over-supply of notes. The concept of one currency for each nation, which only a central bank can legally issue, is fairly new.

As economies became more complex, many of the older monies got replaced by newer systems. To each generation it must have seemed that money could take no other form than the one it was used to. But history provides ample evidence that the seemingly immutable also gets antiquated. Perhaps the euro takes us to the brink of one such stage of monetary history.

The author is C. Marks professor of economics, Cornell University.

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