In one of my previous articles on an economic and monetary union, we had discussed the possibility of the Eurodollar becoming a future world currency. Let’s explore this fanciful idea further and reason out the pros and cons of such a currency and what experts have really proposed.
To begin with a world currency and a local currency may be viewed as two opposite ends of the currency spectrum. The Euro may be seen as a currency that is somewhere in the middle as it was formed by uniting a number of local currencies.
The concept of pegging local currencies to the US dollar, the Euro, Pound Sterling or any other currency also indicates that these local currencies are in reality a shadow of their parent currencies. These currencies can virtually be replaced by the currency they are pegged to. Going by this line of argument, the world of currencies may actually be a much smaller place than it appears, making the leap towards a world currency a bit shorter.
In fact the US dollar and to some extent the Euro are representative of world currencies as nearly 65% of global central bank reserves are held in US dollars, while around 25% are in euros. Nearly 60% of international financial transactions are denominated in US dollars, making it a global medium of exchange. The emergence of the Euro since 1999 has given the US dollar tough competition. It has been estimated that since early 2007 the value of Euro notes in circulation has risen to over € 600 billion, making it the currency with highest value of cash in circulation in the world!
Economists have proposed several variants of a world currency like the Terra, digital gold currency backed by gold, the Eurodollar formed by the union of the Euro and the dollar, extension of SDRs or the IMF backed currency called Special Drawing Rights. The formation of any such currency would have to be backed by a supreme Central Bank.
The Terra is one such world currency that was proposed by the Belgian economist Bernard A. Lietaer. The Terra was to be based on a basket of 12 key commodities that could be considered essential for today’s world. These include, 30% gold, 2 kg grain, 200 g meat, 1 L wine, 3 kg steel, 200 g cotton wool, 200 g copper, 10 kWh of electricity and half an hour of labour. The Terra was expected to be a currency that would be free from inflation.
Benefits of a single world currency
A single world currency could bring with it substantial benefits such as:
- Elimination of transaction costs related to trading currencies
- Do away with the need of maintaining forex reserves
- Do away with currency risk, benefiting foreign investors
- Eliminate the chance of currency failure, which would make foreign investment decisions much easier in emerging economies
- Such a currency would in one go eliminate the problem of current account deficits as there would be no need for foreign exchange
While, the benefits seem immense, such a currency could virtually do away with the need for forex trading!! But, forex traders can relax for now as the adoption of such a currency is not a likelihood in the near future due to the vast variations in global political and economic structures. Some of the key reasons that go against a single currency include:
- Loss of national monetary policy – A single currency would imply a single interest rate. Thus, a region or nation experiencing economic depression will be unable to use the interest rate lever to boost the economy. Similarly a country with high inflation will be unable to independently raise interest rates to contain inflation. Moreover, Islamic countries, which form a large part of the geography, do not believe in interest rates!!
- Political barriers – Political differences between nations make it extremely difficult for them to adopt a common currency. It can lead to a loss in political sovereignty as monetary interests would need to surpass political interests. This is unlikely to be acceptable to most of the nations and the idea of a single currency may be difficult to implement.