Creating money: link between currency and geographical area

Money is more than just a tool for transactions. The issuer of currency gains significant advantages. Even historically, when money was made of gold or silver, a portion was kept by the mint for the ruler. Today, the issuer of paper money gains valuable benefits like liquidity, low transaction costs, and stability. A widely used currency reflects a country's prestige because people trust and admire the nation behind it.

In the 1800s, something new was happening with money: national borders were becoming important for where a currency could be used. This was different from earlier times. Back then, coins from places like Rome, Greece, or Spain were widely accepted far beyond their home countries. For example, Spanish coins were used to buy goods like fur and whiskey in North America. In the past, money wasn't tied to specific territories like it started to be in the 19th century.

The Global Currency Shift

Money today is becoming more globalized due to instant communication, trade, and frequent travel. This is changing the landscape of currencies worldwide. Although many countries still have their own money, the international monetary system looks like a "Currency Pyramid" with a few dominant currencies at the top and many others below. These top currencies compete to be used in global trade and finance.

• The U.S. Dollar: The dollar dominates global currency trading, being involved in about 90% of transactions worldwide.
• The Japanese Yen:  This currency's influence peaked alongside Japan's economic boom in the 1980s but declined in the 1990s as Japan's economy faced setbacks.
• The European Euro:  The euro, a relatively new currency, has the potential to challenge the dollar's position in global markets. However, uncertainties must be resolved for its future success.

Some economists predict that market forces could lead to a reduction in the number of currencies globally, with one currency potentially dominating and others becoming less significant. However, this hypothesis overlooks key aspects of monetary systems. Countries benefit from issuing their own currencies and are unlikely to give up this control easily. Additionally, new private-sector currencies like airline miles and e-money are emerging to meet specific needs and gaining popularity. Therefore, while the idea of currency contraction is debated, it's important to acknowledge the enduring benefits of national currencies and the innovative developments in private-sector currency creation.

Countries have four strategic choices to choose from

1. Leadership: When a country wants to take charge in the financial market, it will aggressively compete to make its currency more popular and gain a larger market share.
2. Preservation: Some countries aim to maintain and protect the importance of their currency. For instance, Japan is actively trying to encourage the use of the yen, possibly to uphold its currency's status.
3. Followership: If a country realizes it lacks the necessary qualities for a strong and widely accepted currency, it might choose to align with a stronger currency issuer. This could involve methods like dollarization or currency boards.
4. Alliance: Countries can join together to form a currency alliance, a successful approach notably seen in Europe and also being considered in regions like Africa. This strategy involves countries combining their authority to strengthen their currencies collectively.

Many countries find themselves unable to achieve global monetary leadership due to their limited size and influence. As a result, they often must give up control over their currency. This can happen by aligning with a dominant currency like the dollar or euro or joining a regional currency group with neighboring states.

Understand currency hierarchy and its geographic distribution

Money has a rich history, with coins circulating in Greek city-states around 500 BCE and in China's Chou dynasty from 1022 BCE. Rulers of that time did not always mandate the exclusive use of their currency, and coins from different regions were commonly accepted. Gresham's Law, named after an advisor to Queen Elizabeth I, describes how people tend to keep and use good-quality currency while circulating less reliable money. Despite its limitations, this law highlights the eventual dominance of more stable currencies like the Athenian drachma, the Byzantine solidus, the Mexican silver dollar, and the Dutch guilder, each having its period of prominence and trust among users.

The concept of monetary territoriality emerged significantly after the Peace of Westphalia in 1648, which established the sovereignty of European states within their borders. This sovereignty included control over currency, leading each state to adopt its own money as the only legal tender within its domain. For instance, in North America around 1793, laws were enacted to safeguard the use of various coins like the Mexican dollar and gold coins from Britain, France, Portugal, and Brazil that were in circulation. By the mid-1800s, there was a strong movement to establish the dollar as the exclusive legal tender in the United States, a status achieved by 1861. By the 20th century, it became customary for states to have their own currencies. Following World War II, as colonial powers relinquished their empires, each new nation swiftly introduced its own national currency as a foundational step towards independence.

The Dominance of Currencies

However, not all currencies are created equal. The strongest ones gain global acceptance, bringing significant political and economic benefits. Three main factors determine this strength.

• Reliability Boosts Confidence: Users trust currencies that consistently maintain low and stable inflation rates.
• Ease of Use and Predictability: People prefer currencies that can be easily bought or sold without hefty fees, and whose value is relatively predictable.
• The Power of Network: The more widespread a currency's use, the more appealing it becomes. A currency gains strength when it's supported by a major trading economy. For instance, the U.S. dollar dominates global currency trades and a significant portion of international transactions.

Monetary sovereignty provides significant advantages to a state. Beyond serving as a medium of exchange, a nation's currency embodies its identity and can evoke strong emotional ties, evident in the reluctance of many Britons to adopt the euro. Additionally, having control over the money supply enables a government to manage economic activity by adjusting circulation levels. Furthermore, seignorage, the profit from currency creation, serves as a valuable revenue source, allowing governments to mobilize resources economically. Overall, monetary sovereignty influences economic policies, reflects national identity, and offers financial benefits through seignorage.

Shift Currency Dynamics

Deterritorialization implies that several nations currently enjoying monetary sovereignty may lose this privilege as a few dominant currencies become prevalent, undermining local monetary control. The Contraction Contention theory predicts that economic pressures will compel most countries to abandon their own currencies, which seems plausible when examining the factors driving currency demand. However, this theory overlooks the motivations behind currency creation by nations and fails to consider that private entities can also establish their currencies.

• Coupons offering price reductions: In Great Barrington, Massachusetts, Frank Tortoriello, a deli owner, faced challenges securing a bank loan for relocating his shop. To solve this, he introduced Deli-Dollars”discount coupons that customers could buy in advance to save on purchases. These coupons essentially act as a currency since they are used to buy goods.
• Ithaca Hours: In Ithaca, New York, activist Paul Glover launched "Ithaca Hours," a unique currency where each hour is valued at $10 of labor. People can trade these hours within a 20-mile radius of Ithaca. Similar local currencies have also appeared in places like Vermont, California, Japan, and Italy.
• E-money: Smart Cards and network money are examples of electronic currency. Smart Cards have a chip storing value, while network money stores value on computer drives. Although companies like Flooz and Beenz, popular in the 1990s, failed, new independent electronic currencies are now poised to gain popularity. PayPal, though widely used, still relies on traditional banking systems for transactions.

What needs to be accomplished?

In today's global financial landscape, countries no longer possess the same level of monetary autonomy they once did. To ensure stable values and efficient transactions, most nations are expected to align their currencies with a dominant global currency such as the dollar, euro, or yen a process termed vertical integration. The most extreme form of this integration is dollarization, where a country adopts a dominant currency like Panama's use of the U.S. dollar, while a less drastic option is a currency board, requiring a nation to issue currency only when adequately backed by the dominant currency. Although currency boards offer more flexibility, they demand substantial discipline and commitment, as highlighted by notable failures such as those seen in Argentina, underscoring the challenges inherent in integrating national currencies into the global financial system.

Vertical integration might seem advantageous for countries struggling with currency management issues, but it poses significant political drawbacks. One notable concern is that a nation loses a part of its identity when it adopts a shared currency system. This loss of control over its money means losing the ability to print money (seigniorage) and adjust policies to suit its own economy. Essentially, when subordinate currencies rely on dominant ones, decisions made by central bankers of the dominant currency may not prioritize the economic needs of the others. This can lead to diminished economic sovereignty and flexibility for countries adopting such integration.

The Path to Currency Unions

Pooling sovereignty with other countries to form a currency union might seem appealing. This approach involves relinquishing some national control, although not as extensively as with vertical integration. Currency unions like the euro can be successful when all participants recognize the advantages. However, the euro's achievement can be deceptive because it required many years of careful preparation and dedicated implementation of economic convergence plans before its introduction.

The situation is tough and quite clear. While demand-side economic factors push towards having fewer dominant currencies, the reality of supply-side factors means we'll likely stick with multiple currencies for a while. This setup leaves us vulnerable to currency crises like the one in East Asia in 1997. To manage this chaotic currency world effectively, everyone especially the major players needs to cooperate on money matters and stick to responsible spending.