Towards a global currency?

In an article reviewing the success of the Euro, the WSJ attributes at least some of the finiancial instability of recent months to currency volatility between the US and Europe.

The Euro has had numerous benefits:

Travel was made easier, as was trade and investment. Interest rates fell. Prices for labor and goods were suddenly transparent across the bloc, increasing competition. As important, the creation of a single European Central Bank (ECB) has better insulated monetary policy from political manipulation. Politicians could no longer attempt to inflate their way out of their employment or fiscal problems. National central banks could no longer finance fiscal deficits, removing a source of economic instability.

The single economic space anchored by the euro has also forced European policy makers to compete for people, goods and capital with improved policies. While we had hoped to see more reform by now, the pan-European reduction in corporate tax rates is one fiscal benefit of the euro. Even Germany has cut corporate taxes, after its efforts to harmonize rates across the European Union failed.

The current financial storm has also shown the benefits of a common currency. Some countries have been harder hit than others, and we hear again that a monetary policy conducted by a multinational ECB favors big states like France and Germany and will push the eurozone to the breaking point. Yet in the panic of the last year the Continent would have suffered more without the euro -- from currency devaluations and wildly diverging interest rates. This is the reason so many other EU countries want to join, and Italy for all of its economic problems stays in. Membership brings too many privileges.

Likewise, that the US and Europe have different currencies and hence different monetary policies has contributed to the dust-up in the economy over recent months:

The monetary trauma of the last 10 years hasn't come from the euro but instead from its volatility against the dollar. The nearby chart tracks this movement from the euro's birth at 1.18 euros per dollar to its close New Year's Eve at 1.39. Like most currencies, the euro declined during the strong-dollar era of the late-1990s, only to soar against the greenback as the U.S. Federal Reserve made its historic mistake of flooding the world with dollars earlier this decade. It declined mid-decade as the Fed belatedly tightened, only to soar again in late 2007 and early 2008 as the Bernanke Fed gunned the money supply once more. After an even briefer decline, the euro has climbed sharply again since Mr. Bernanke cut rates virtually to zero last month and signaled his new policy would be "quantitative easing" -- i.e., printing as much money as it takes to revive the U.S. economy.

While it is rarely discussed in the financial press, this volatility imposes huge costs on global commerce. The greenback's 18% decline against the euro in the last 10 years is effectively a 18% price increase on all goods to the U.S. from the eurozone. Sharp and unpredictable exchange-rate movements lead to the misallocation of capital and mistaken business judgments. The excessive depreciation of the dollar against the euro in late 2007 and early 2008, followed by its spectacular recovery in the third quarter of 2008, led to the overshooting in both directions of oil prices.

Robert Mundell, the Nobel laureate and intellectual father of the euro, has argued plausibly that a major catalyst for the escalation of the financial panic in September and October of 2008 was the sudden if temporary rise of the dollar against the euro after a year of rapid decline. The deflationary impact presented banks with larger losses on their dollar assets.

One irony of the current moment is that Europeans seem to understand the dangers of floating exchange rates better than Americans do. ECB President Jean-Claude Trichet said in 2008 that the responsibility of a central bank is "to avoid additional volatility in already highly volatile markets." As its strong record on fighting inflation shows, the ECB lives by this mantra. The Fed has not during this decade, with tragic results.

Some individuals have suggested a solution in the form of some global currency. I can't deny that the idea is appealing much for the same reason the Euro is appealing.

First, when you have a global currency, the central bank can't inflate the currency to solve one countrie's fiscal woes. You can't have places like Zimbabwe. Second, no central banker could possibly believe that they could engineer stable growth using monetary policy in the world economy. It is simply just too large and too complicated. Hence, the temptation to use monetary policy to secure full employment would lessen, leaving only the goal of limiting inflation. Third, there are the benefits of corporate tax reduction, competition between firms, and ease of travel. Finally, it would probably be a force for political stability as well. You can't go around invading countries willy-nilly when you have the same money. It would throw your financial markets into a panic.

In essence, a global currency achieves many of the goals of gold standard advocates by preventing governments from tampering with their money while effecting fewer of the downsides -- deflation, the possibility of a gold corner, etc.

I would be skeptical of any plan to put it into practice because the libertarian in me would want to see that the power to change the currency was vested in a group that was both transparent and accountable. (Not that the Fed really has either of these traits now, but that is another story...) However, the idea itself is pretty appealing. Maybe as a transitional plan, we could have some fixed exhange between the Euro and US currencies also including other G8 countries -- some sort of New Breton Woods like Sarkozy has been suggesting.