Appreciating the risk of sounding like a lunatic, lone dissenting voice given the apparent turmoil engulfing the world’s financial markets especially the Euro currency, I still would like to make the case for a single currency where applicable. Before we proceed lets briefly waffle through the Evolution of currency
Evolution of Money and the Arrival of currency:
Money since historic times has always been defined as a medium of exchange. Essentially, a means by which two or more parties execute a transaction and compensate each other in settlement of contractual obligations for goods and/or services provided and consumed.
In other words, money was anything the two parties in every transaction wanted to use as a means of exchange (our predecessors used items including cows, cowries, bags of foodstuff amongst others). The key point was that both parties AGREED the items which they used as the medium of exchange.
A major shortcoming of this format was the amount of effort required to find a common item which two parties could agree was the preferred medium. Imagine a bricklayer trying to buy food, would that mean he had to build a house for every meal he wanted to eat? Or worse still who would exchange food for bricks?? (Thus challenge number one was the standardization of Money)
In addition to this challenge of standardization of money, there was also the fact that increased civilization and as people migrated from one town to the other, from one country to another, what one culture valued as money was completely different to what other cultures deemed to be valuable. E.g. In West Africa the think cowries valued by certain cultures compared to others who preferred livestock. (Thus challenge number two was value of money)
To address the challenges of posed by early versions of money, it was necessary to define the characteristics of what constitutes money then subsequently attempt to agree what Money should be.
Eminent economists generally agreed that Money should have the following characteristics
- Widely Accepted: Money must be an item that is widely accepted as a medium of exchange and mechanism for settlement of payment. If it was NOT widely accepted then it was not money
- Store of Value: Money must have value for it to be used in exchange of goods and services thus it must be limited in supply and people should not have access to an unlimited amount else it would be worthless
- Fungible: Money should be divisible into smaller denominations and quantifiable else it could not be universally utilized (e.g. you should use a fewer cowries to buy bread than to buy a house)
- Durable: Money must not be perishable or have a finite shelf life as it should be something that could be used iteratively without risk of value diminishing or risk of not being utilized for future transactions.
- Portable: Money was something that users should be able to carry around with ease. Thus if it could not be conveniently carried about, that lost its appeal
- Standard: item categorized as money had to be uniform thus ensure ease of quantification and measurement.
With the above characteristics for Money agreed, various contenders emerged and the use of these contenders evolved. Notably,
- cowries (durable, portable, fungible) to
- gold / silver coins (durable, portable, fungible, standard, store of value).
However these contenders still had challenges such as cowries where not always of a standard form and shape whilst coins (gold/silver) easily became very cumbersome for settlement of large contractual obligations.
This led to the advent of representative money / fiat money. In its simplest form, representative / fiat money is a receipt indicating how much the bearer of that receipt was entitled to upon presentation of that document. Imagine rather than travelling with donkeys carrying sacks of gold coins, users simply had to hold a piece of paper to use in settling transactions. With increased volume of transactions, these pieces of paper could now be exchanged without the bearer needing to cash in and withdraw the sack of gold coins …….Thus the arrival of currency.
Definition of currency:
Strange as it may seem currency and money are used interchangeably BUT they are not the same
Money has intrinsic value. Simple example if you had kept $100 bill under your pillow in 2008 and you just found it now in 2012, that $100 bill is simply that and cannot do more for you and definitely will not have changed the number
However if you kept a $500 gold bar under your pillow in 2008, that $500 gold bar should be worth in excess of $1,500 (see below chart). Thus gold is money with all the associated characteristics of money
Currency on the other hand has no intrinsic value, is simply used a medium of exchange and refers to the paper cash which gives the bearer the right to money. Thus currency has to be backed by something of value
Modernizing economies made several efforts to further standardize world currencies notable amongst them were the
- Gold standard.
- This was a widely used mechanism up to the first and second world wars with the objective of this standard being that countries issuing currencies had to keep reserves of gold to support the level of currency being issued. Thus the more gold you kept in reserve, the more attractive your currency was.
- By the end of 1945, this standard was discontinued as many western countries had expended a vast majority of their gold reserves in the wars and could not afford to have their currencies measured against an asset which they did not have
- Bretton Woods Standard, next after the gold standard, world economies agreed to value their currencies against the US dollar which was perceived to be stable and represented a decent store of value. This began to be less effective when the US changed their policies in 1970s with regards to amount of gold being held and started to print more money than the amount of gold they held.
Nonetheless, the above attempts simply show that world economies continue to seek to peg their currencies based upon commodities which serves as a store of value. In fact, despite the official abandonment of the gold standard and the Bretton woods system, Gold and Dollar still represent the commodities used by wealthy nations for investing their national reserves. Thus the richer the nation, the more gold and dollar they sought to hold (see below chart)
Case for a Single currency:
Industrialization has brought about the fragmentation of nations and more independent sovereigns who all aspire to achieve unique identities (National Flag, Anthem, Social & Fiscal policies, National Currency et al).
This increased fragmentation especially in Europe and increasingly Africa means that constituent nations in these regions are regressing slowly back to a situation where a country’s currency is no longer widely acceptable but rather limited to a specific demography.
To mitigate this regression, countries began pooling together to create Trading Blocs (Common Markets), as well as supporting currencies (see table 1 for notable trading blocs and timelines)
The European Union is the largest of the trading blocs and in 2002, after many false starts, finally adopted the Euro as a single currency for eligible nations.
The benefits of a common market with a single currency which far outweigh the cons include
1. Free trade within the bloc
Knowing that they have free access to each other’s markets, members are encouraged to specialise. This means that, at the regional level, there is a wider application of the principle of comparative advantage.
2. Market access and trade creation
Easier access to each other’s markets means that trade between members is likely to increase. Trade creation exists when free trade enables high cost domestic producers to be replaced by lower cost, and more efficient imports. Because low cost imports lead to lower priced imports, there is a ‘consumption effect’, with increased demand resulting from lower prices.
3. Economies of scale
Producers can benefit from the application of scale economies, which will lead to lower costs and lower prices for consumers.
Jobs may be created as a consequence of increased trade between member economies.
Firms inside the bloc are protected from cheaper imports from outside, such as the protection of the EU shoe industry from cheap imports from China and Vietnam.
However to be very clear, the fundamental requirements for National or Trading BLOC currency still remain that
- the currency MUST be supported by a commodity which is a store of value (e.g. gold / dollar reserve) and
- Users of that currency MUST continually enhance their reserves by implementing robust fiscal policies which strengthen the nation / member nations. (don’t spend more than you earn)
The problems ailing the Euro could easily have been avoided if the fundamental requirements for that currency where adhered to by member nations and if stricter fiscal policy controls were implemented.
However, there may still be time to correct those problems by ejecting from the Euro, those members whose finances no longer support them being members of the trading bloc.
As a proponent of economic growth via organic means including trading between nations, I’m fully supportive for the nations pooling together to create trading blocs common markets and single currencies,
However, as more nations move forward with the idea of common markets and single currencies (see table 1 below), I’m hoping that lessons have been learnt from the effects failing to adhere to all requirements of implementing a single currency.
The last thing we need is for world growth to be impeded with another round of currency risks and sovereign debt insolvencies.
Table1: Notable Trading Blocs and timelines/ proposals for implementing Single markets and currencies
Region Bloc Single Market Currency Union European EU – European Union Yes Yes – Euro – 2002 Americas CARICOM – Caribbean Community Yes Proposed Africa ECOWAS Proposed Proposed EAC – East African Community Proposed – 2015 Proposed – 2015 SADC – South Africa Development Community Proposed – 2015 Proposed – 2016 Asia ASEAN – Association of South East Asian Nations Proposed – 2015 TBD
|Region||Bloc||Single Market||Currency Union|
|European||EU – European Union||Yes||Yes – Euro – 2002|
|Americas||CARICOM – Caribbean Community||Yes||Proposed|
|EAC – East African Community||Proposed – 2015||Proposed – 2015|
|SADC – South Africa Development Community||Proposed – 2015||Proposed – 2016|
|Asia||ASEAN – Association of South East Asian Nations||Proposed – 2015||TBD|
E. OKONKOW IS A FINANCIAL ANALYST FOR A LEADING WALL STREET BANK. HE HAS OVER 10 YEARS EXPERIENCE IN ACCOUNTING, BANKING AND FINANCIAL MARKET OPERATIONS