I understand the economy on a domestic scale but as things get larger with exchange rates, imports, exports things get a bit fuzzy for me.
Would having a single currency that all countries and territories use for trade be good or bad for the world economy?
Bad. Monetary policy is used to set interest rates depending on the economic condition the region with the monetary policy is in. If you had one world currency, you would need a one-size-fits-all monetary policy.
A recent example is Greece - tied to the Euro and the monetary policy of the European Central Bank, the Greeks could not adjust their interest rate and money supply to meet the condition of their economy. If they still had the drachma, they would have been able to do so, and wouldn’t be as much of an economic basket case as they are now.
I suppose you could have different currencies for use internally, and a separate currency for trade - like dollars are used for trade in oil right now, that could be a workable system, but I’m not sure that’s what you were asking.
Paul Krugman has discussed this very often in his New York Times columns, over the last several years.
Hang tight, I’ll see if I can scrounge up some links . . .
A few examples:
The Money Trap Nov. 14, 2013
Europe’s Economic Suicide April 15, 2012
A Continent Adrift March 16, 2009
Killing the Euro Dec. 1, 2011
To be sure, much of Krugman’s criticism is aimed at European policy makers, especially the European Central Bank, for their allegedly horrendous decision-making. But there is a strong implication (and Krugman says it explicitly from time to time) that a unified currency system is inherently unworkable, or at least inherently vulnerable to very bad policy-making.
The advantages of currency union are reduced transactions costs and transparency of pricing by avoiding conversion from one currency to another. Also there can be an advantage to the extent a country comes to the political decision it’s not worth the cost and trouble, or it can’t trust its own institutions, to conduct monetary policy and farms it out for free by using somebody else’s currency (as some small countries do like Panama using the USD, etc).
The disadvantage comes where there isn’t enough economic integration, particularly mobility of capital and labor to make a single monetary policy appropriate across the entire area using the currency. That’s an empirical issue. At first glance the US is a big and highly diverse place, so why does one currency and monetary policy work well when booming commodity markets are sparking economies like those of Alaska but at the same time depressing those of urbanized northeast states? It’s a matter of degree. It’s not as if it’s a no brainer that a single currency always works well for every part of the US but can’t work for the Euro zone. But the lack of true political unity and full labor/capital mobility within the Euro zone clearly make it harder there. But now with Euro crisis apparently waning, can we really say the disadvantages outweigh the advantages in the Euro zone? It’s not totally obvious, even if Paul Krugman (who according to Paul Krugman is never wrong) says so…
But when various countries have outright opposing political systems, and very low levels of labor mobility a single currency would be a clearly stupid idea, and that would be the situation with a world currency in the current state of the world.
The above is premised on currency meaning fiat ‘paper’ currency like US$, Euro etc now. Using say gold or directly gold backed money for the whole world wouldn’t have the same political issue of a tight/loose monetary policy at a given time being appropriate in all places, but just substitute the problem of no way to adjust monetary policy anywhere. Some people really believe in a rigid gold standard and aren’t going to be convinced otherwise by a sentence or two by some guy on the internet; I’m just saying that (re) imposing a precious metal money standard is itself a huge change, where ever you might do so.
The economies of Alabama and California are pretty dissimilar and yet they’ve been running on the same currency for some years now.
While there are demerits to having a shared currency, there’s advantages to free trade that can counterbalance that, and generally there’s going to be other methods than currency manipulation to adjust a local economy.
I think Greece’s main problems are bad government and a populace who doesn’t pay taxes.
I don’t think anyone’s claiming that Greece owes its economic woes to being a member of a currency union. Greece could not easily respond to its rapidly worsening economy since it did not have an independent monetary policy (and Euro Central Bank monetary policy is much more controlled by the Germans and the French than the Greeks.)
I’m not quite sure I follow you - when you say ‘currency manipulation to adjust a local economy’ are you talking about monetary policy?
Yes the first is a matter of degree, as compared to various European countries. But the tendency nowadays for exaggerated politics (‘red state’ v ‘blue state’ etc) to dominate discussion might lead some to overestimate how much of an issue it is to have a single monetary policy (and other federal policies) in California and Alabama. Those places are still a lot more similar and integrated economically than Germany and Greece, and there are a lot fewer cultural barriers to people picking up and moving from one to the other (if you’ve worked blue collar jobs in CA you know a lot of white working class people there are from the South or their parents were, much more than you’d encounter among white working class people in say the northeast US). But are Germany and Greece integrated enough for the Euro to ultimately work out? It’s quite possible they are IMO.
On the second I don’t think you said the Euro caused Greece’s problems and I don’t disagree with the problems you cited. However, entry into the Euro zone almost surely exacerbated Greece’s problems via the market’s tendency not to distinguish among Euro sovereign credits, till the crisis brewed up. This tended to effectively loosen credit and encourage borrowing in the peripheral Euro zone countries.
The economies of New York City and any random town in western New York are pretty dissimilar. But that dissimilarity is meaningless because they are both part of an integrated overall economy. Neither is trying to act on its own in a world market.
Greece certainly has home grown problems. That has nothing to do with the issue of whether they could solve or at least alleviate those problems with an independent currency. Most economists say that they could. That’s really the only important point.
In economics, there’s something called Optimal Currency Area (OCA) theory. In a nutshell, it lays out the criteria that’s necessary if you want to have a single currency. I’ll just quote the wiki article here (note, I’ve snipped stuff just to lay out the criteria):
Now, there is a lot of disagreement about which factors are the most important. Some people also suggest additional factors. For example, a number of economists have come around to the idea that centralized bank regulation and centralized bank support are also necessary for an OCA (I think Krugman holds this view, but I can’t remember).
As one can guess, it would be very difficult for the world to implement these criteria in any reasonable timeframe. We’re not going to have open immigration anytime soon. Countries are probably never going to agree to the sort of fiscal transfers that would make an OCA work. And the other criteria are also going to be very difficult to implement.
As for the US, it hits all the criteria for OCA (even the additional bank criteria I mentioned) in spades. However, there are people here and there, who will argue that the US should have had multiple currencies prior to the 20th century. And sometimes the gold-silver standard debates of the latter part of the 19th century in the US are cited as evidence in favor of OCA.
As for Greece (or the other periphery countries in the Eurozone), one common way to get out of the type of economic crisis they are in is to devalue/inflate the currency. Greece no longer has the ability to do this*, so they’ve lost a very powerful tool that could have gotten them out of their economic crisis (not without some initial and severe pain, but probably quicker than what we’ve seen).
*In reality, Greece could do this by dropping out of the Eurozone, but I don’t want to complicate this thread with that discussion.
Ah, what the heck. I will talk about the issue of a country, such as Greece, leaving the Eurozone. This is a bit complicated, but I’ll try to simplify it.
So, let’s take the US. If, say, all the banks in Florida fail tomorrow, then the US government will step in, seize the banks and recapitalize them. Or, it can step in and lend them money until they get back on their feet. Now, the US government can do this because it has the ability to borrow money and it can print money to lend to the banks if it has to.
But, let’s say all the banks in Greece were to fail (say, there’s a massive bank run). Greece can’t just print money to save the banks. So, it has to go borrow money. But if nobody is willing to lend to it, then it’s got a problem. And the only way to solve that problem is to drop out of the Eurozone, start printing Drachmas, and convert all its bank accounts to Drachmas.
Ok, but there’s no bank run yet, so everything’s fine, right? But, what if a lot of Greeks starting thinking that a bank run is going to happen in the future? They’re going to yank all their money out of Greek banks, because they don’t want their money converted to Drachmas. The fear of a future bank run could create a present bank run.
So, the very fear that Greece could drop out of the Eurozone in the future can create a feedback loop which forces Greece out of the Eurozone. And there have been a few times where it looked as if that might happen over the past few years, but then the ECB or various EU nations stepped in with an ad-hoc plan at the last minute to avert that sort of crisis. But if nobody had stepped in, we probably would have been looking at a crackup of the Eurozone.
In the US, you can’t get that type of feedback loop, because nobody is allowed to drop out of the currency union. And that’s because nobody is allowed to drop out of the United States. So, even though having a centralized government is not part of Optimal Currency Area theory, a centralized government eliminates a potential feedback loop that could break up a currency area.
Very bad. Assuming you have a political system that resembles our current situation in any way, you’d have over a hundred individual nations any of which could enact financial policies which would destabilize the international currency. There’s even a Tragedy of the Commons incentive because a nation which adopts unsound financial policies will benefit more if other countries are trying to resist those policies.
its bad …
also having it on a credit system
in other words, no paper ( or physical ) money … tracking everything
oh but a h*** no
Interestingly enough, mobility in Europe is increasing, partly because of the emergence of a rental culture in countries where it used to be nonexistant (add another one to “good things to come out of the busted housing bubble”), whereas I’ve seen mentions both in these boards and in American media of how one of the consequences of the recent crises is that people who used to purchase houses sequentially now can’t, so mobility is lower.
Not for a whole country, but for a banking group, see Rumasa (sorry, google-fu is weak right now).
Either you are dismissing Sage Rat’s question, or I am not understanding you. Alabama and California are geographically distant and economically dissimilar, yet there is some direct trade and each they have many mutual traditing partners.
Isn’t that exactly the same as, say, Japan and India? In other words, it seems that declaring that different countries should have different currencies, but enormous countries should have one, is an arbitrary argument. The Eurozone isn’t any larger or more economically diverse than the US, is it?
I don’t know if what I’m asking is clear. It may be true that currency zones and nation-state borders should be coterminous, but your explanation doesn’t tell me why that is so. I don’t see why a large currency zone would be any worse than the US situation: you can’t tell me a dollar has the same value in Mississippi as in Hawai’i, yet they trade 1:1 without difficulty.
BrightNShiny’s excellent post #10 gives the formal economic reasoning behind this and the answer to your question.
I think this question is sufficiently complex that it’s better suited to Great Debates than General Questions.
Colibri
General Questions Moderator
Thanks for drawing my attention to that. The first time I read it, my eyes glazed over, as this is interesting but a difficult subject for me.
In his quoted box, can you or he explain #2 & #3? I understand each word, but I can’t parse them in context.
A world currency that arose on the free market backed by 100% gold would be a great idea. If not backed by gold the issuing authority would use it to benefit certain groups. Bubbles would arise worldwide from the central bank’s inflationary policies.