International Currency

International hierarchies are pervasive.

— David Lake

This book is about currency and power. But before we can explore the details of their relationship, we must first establish a clear understanding of each of the two concepts considered separately. What do we know about currency internationalization? What do we know about international power? These are the essential building blocks for the discussion to follow.

Power analysis will be the subject of chapter 2. This chapter focuses on currency, outlining the nature and implications of international money as generally understood by social scientists today. The aim is to provide a baseline and context for the analysis to follow: a consensus perspective on the basics of currency internationalization. Several critical questions are addressed. What drives the process of currency internationalization, what determines which currencies will become internationalized, and what does the universe of international currencies look like? Elsewhere I have referred to this last question as the "geography of money." Most importantly, what are the presumed implications of the process for the countries that issue an international currency?

Motivations

Currencies, if attractive enough, may be employed outside their country of origin for any of a number of monetary purposes. The standard taxonomy for characterizing the roles of international money, which I can take pride in originating, separates out the three familiar functions of money — medium of exchange, unit of account, store of value — at two levels of analysis — the private market and official policy — adding up to six roles in all. Specialists today generally speak of the separate roles of an international currency at the private level in foreign-exchange trading (medium of exchange), trade invoicing and settlement (unit of account and medium of exchange), and financial markets (store of value). At the official level, we speak of a money's roles as an exchange-rate anchor (unit of account), intervention currency (medium of exchange), or reserve currency (store of value). Each of the six roles is distinct in practical as well as analytical terms. The taxonomy is summarized in table 1.1.

Currency internationalization alters monetary geography by accentuating the hierarchical relationship among currencies, expanding the domains of a few popular moneys well beyond the jurisdictions of the countries that issue them. The outcome is produced by a sort of a Darwinian process of natural selection, driven above all by the force of competition — much like Gresham's Law, except in reverse. Instead of "bad" money driving out "good," as Gresham's Law traditionally holds, the good money drives out bad. There is nothing irrational about the process. On the contrary, internationalization may be regarded as a quite natural demand response to prevailing market structures and incentives.

Analytically, the motivations for internationalization can be easily appreciated. The incentive derives from the economies of scale, or reduced transactions costs, to be gained from concentrating cross-border activities in just one or at most a few currencies with broad transactional networks. To do business in each country in a separate money is analogous to barter and clearly inefficient. Within any single economy, monetary exchange — rather than barter — reduces the expenses associated with search and bargaining. So too between states. The costs of transactions are narrowed by making use of one or just a few currencies rather than many. In the words of one study: "The necessity of 'double coincidence of wants' in a decentralized foreign exchange market may be overcome by using indirect exchange, through a generally acceptable medium of exchange instead of direct exchange of currencies." The greater the volume of transactions that can be done via a single currency, the smaller are the costs of gathering information and converting from one money to another. Monetary theorists describe these gains as money's "network externalities" or, simply, the network value of money. Network externalities may be understood as a form of interdependence in which the practices of any one actor depend strategically on the practices adopted by others in the same network of agents.

In fact, currency internationalization improves the usefulness of money in all its roles. International standing enhances a currency's value both as a commercial medium of exchange and as a unit of account for the invoicing and settlement of trade; and these effects in turn also broaden its appeal as a store of value, by facilitating accumulation of wealth in assets of more universal purchasing power. At a minimum, it will pay market agents to hold some level of working balances in a popular international currency. Depending on cross-border variations of interest rates and exchange-rate expectations, it will pay them to use it for longer-term investment purposes as well.

Moreover, once a money comes to be widely used by private actors, it is more likely to be employed by governments too, as a reserve currency, intervention medium, and anchor for exchange rates. Public actors too can benefit from the economies of scale offered by a broad transactional network. Historically, the typical pattern of internationalization is adoption first by the private sector, with the public sector then following.

Choices

Why are there so few international currencies? Within individual countries, the role of a single money can be promoted by the coercive powers of the state. Sovereign governments can deploy legal-tender laws, exchange controls, and related regulatory measures to force residents to make use of the national currency for all legitimate monetary purposes. Inside their borders, states enjoy a de jure monopoly on the creation and management of money. But at the international level, the capacity for coercion is more limited. Compulsion is of course possible in colonial or quasi-imperial clientalistic relationships. But in the more normal case, in relations among independent nations, monopoly is replaced by competition, and actors must be persuaded rather than compelled to make use of one currency rather than another. Rivalry for market share, as a rule, is the essence of the process of internationalization. Typically, to gain standing, a money must be competitive.

And what makes a money competitive? What determines which currencies will prevail in the Darwinian struggle? The principal qualities required for competitive success are familiar to specialists and hardly controversial. Both economic and political factors appear to be involved.

On the economic side, demand seems to be shaped most...