A Common Currency Creates More Wealth
Before World War I, gold was universal money. The US dollar, British Pound, French Franc, German Mark, and the other major currencies were defined as a number of ounces of gold. They therefore had a fixed conversion rate between them. The real money was gold coins, and paper currency was convertible into coin.
by Fred E. Foldvary, Senior Editor
The amount of gold did not limit trade, because much trade also took place with the paper currency, which was a substitute for gold, a money substitute. Unfortunately, in most countries, the government issued the paper currency, controlling its supply. So the supply of currency did not adjust flexibly to the demand.
In a few countries, such as Scotland and Canada, private banks issued the paper money, and this system of free-market banking did provide a flexible and stable currency. All that came to an end during World War I and the Great Depression of the 1930s.
The world now has fiat money based on nothing, and the various currencies fluctuate against one another, making it difficult for international trade, since the profit from trade depends in large part on the value of foreign currencies when one receives funds.
That's why several countries in Europe have switched to a common currency, the euro. In Latin America, several countries have adopted the US dollar as a currency. Theoretically, this should boost trade and increase efficiency. But does it really?
Yes. A study by Frankel and Rose on currency unions found that a single currency does indeed increase trade and productivity. For example, if Canada and the USA were a single country, one would expect as much trade between the Canadian provinces and US states as among the provinces. But in fact Canadian provinces trade among themselves 12 to 20 times more than with the United States, after adjusting for distance and size.
This is not all due to trade barriers, which have fallen with the free-trade treaty between Canada and the USA. Data from 200 different countries provide similar results. Countries with the same currency trade over three times as much with each other as countries with different currencies.
If national economies are more productive when they have currencies in common with trading partners, this implies that the global economy could be much more efficient and productive if the whole world adopted a common currency. The most likely global money would be gold, based on both its historic use and the fact that its supply is not based on the political interests of any government.
Gold would determine the value of currency units, but most trade would not use physical gold, but substitutes such as paper money, and checking accounts. Nowadays, many transactions would be electronic, conducted with computers.
But it would not be enough just to base money on gold. When government controls the supply of money substitutes, that leads to shortages or surpluses of money, creating economic instability. The way to have neither too much nor too little money is to let the money supply adjust to the demand, with free-market banking. The private banks then issue the bank notes, not the government.
With free-market banking, bank notes are convertible into gold, limiting the supply, but a bank is free to issue as many notes as the public demands, letting the quantity of money adjust to demand. This worked well in Scotland and other countries.
But free banking and golden money are also not sufficient for economic stability. Investment must be stable also, and the key investment is always related to real estate. Those dot.com firms need office space, furniture, and energy that comes from land. The only way to stabilize the real-estate cycle is by using land rent for public finances rather than taxing wages and profits.
Free banking and the public collection of rent, these are the policies that always lead to maximum prosperity. Challenge your government representatives with this question: since free banking and rent collection are the keys to prosperity with stability, why are you not studying and implementing them?
"Gravity, Trade, and Currency Unions," Economic Intuition, Fall 2000; http://www.economicintuition.com
NCPA Policy Digest 1-5-01, National Center for Policy Analysis http://www.ncpa.org/pi/internat/intdex2.html
Jeffrey A. Frankel and Andrew K. Rose, "Estimating the Effect of Currency Unions on Trade and Output, National Bureau of Economic Research, Working Paper No. w7857, August 2000
Andrew K. Rose, "One Money, One Market: Estimating the Effect of Common Currencies on Trade," Economic Policy, April 2000.
George Selgin, The Theory of Free Banking: Money Supply Under Competitive Note Issue. Rowman & Littlefield, 1988, USA.
Lawrence White, Competition and Currency: Essays on Free Banking and Money. New York University Press, 1989.
Lawrence White, Free Banking in Britain, New York: Cambridge University Press, 1984.
-- Fred Foldvary
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Copyright 2001 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.