Toward a global monetary order.

• Author: O'Driscoll, Gerald P., Jr.
• Position: Essay

Throughout virtually all of human history, up until 1971, money was some form of valuable and durable commodity, or a claim on such a commodity.

--Steil and Hinds (2009: 67-68)

I will begin by disputing that there is a global monetary system. We do not have a system in any meaningful sense. There are 182 independent currencies in the world. Some currencies are fixed in relation to other, larger currencies (e.g., the Hong Kong dollar to the U.S. dollar). Some currencies move within a band against other currencies (e.g., the Singapore dollar and the Chinese yuan). Many currencies float on foreign exchange markets, but few float freely. Four major currencies float against each other: the U.S. dollar, the euro, the pound, and the yen. Countries also change their foreign exchange regime (e.g., Mexico in recent decades).

The multiplicity and changeability of arrangements defies the use of "system," certainly not in comparison to arrangements of the past or possible arrangements of the future. Stability and certainty of expectations are not possible. The dollar still dominates, and one might suggest that "the Fed rules." But the Federal Reserve follows no rule, and is not the source of stability or certainty.

No one designed the global flat monetary arrangements; the world stumbled into them. Global flat money came about because of flaws in the prior global monetary arrangements and political considerations in the United States.

There certainly were advocates for the current system. They believed that fiat monies would work better than the gold standard. The problem is that all the supposed advantages have proved elusive, and the predicted deficiencies have been realized in practice. The issues were debated in the 1930s, and that debate remains surprisingly modern.

Monetary Nationalism

The theory behind current global monetary arrangements is monetary nationalism. It argues that each country should have its own money, and that the size of the national money stock should not be determined in the same way that money is distributed in different regions within a country. In the case of the United States, trade and capital flows among the states determine the share of the total money supply held by residents in each state. A truly global monetary order would work the same way across countries. That was basically how the classical gold standard worked in the 19th century (Hayek 1937: 4).

The world has not experienced the operation of the classical gold standard since the eve of World War I. Countries suspended convertibility during the war, that is, they denied their citizens and foreigners the opportunity to exchange national currencies for gold. Central banks financed government wartime spending by printing money. Consequently, prices rose.

After the war, there were price deflations of varying magnitudes. These were exacerbated by the decision of some countries, notably the United Kingdom, to return to gold convertibility at the prewar parity. Economists as diverse as Ludwig von Mises and John Maynard Keynes, as had David Ricardo 100 years before, advised against the return to convertibility at prewar parity. Their advice was ignored (Hayek 1937: 44).

The post-WWI system was a form of the gold-exchange standard. Central banks economized on their gold reserves, which created chronic payments problems among the central banks. Creditor countries were pressured not to demand gold reserves from debtor countries (Meltzer 2003: 137-270). The fundamental problem was not gold, but its undervaluation relative to national currencies. The amount of undervaluation differed in different countries. Gold constrained but did not determine the supply of national currencies. There were already elements of monetary nationalism within the system. Gold flows were often "sterilized"--that is, offset by changes in national money supplies independent of the gold flows (Friedman and Schwartz 1963: 284-85, 291).

The system collapsed in the wake of the Great Depression. Country after country suspended convertibility. In the past, such suspensions were limited to wartime and viewed as temporary. In the 1930s, the breakdown of international trade and investment flows mimicked what happens in wartime. Some view that breakdown as prelude to the next war.

The world (or at least the United States and Europe) found itself with fiat currencies. The question was whether there would be a return to a gold standard. There were efforts for such a return. Some economists preferred to make virtue out of necessity and made the case for monetary nationalism as...