Fiat Currencies Hurt Everyone

The world has around 175 different currencies. It probably needs no more than three. That, in a nutshell, is the problem plaguing international business. If our political leaders are paying attention, they will realize that all the hard work done on lowering tariffs and harmonizing standards stands to be for naught if we can’t prevent these currency crises that are springing up with unacceptable regularity.

The Thai baht, the Russian ruble, now the Brazilian real – the collapse of each currency, in turn, has kicked off a crisis that has lead to the scurrying of international monetary officials, disruption in business patterns and serious losses of wealth.

The actual cost of currency fluctuations is far more severe than this, though. It consists of untold amounts of investments that are never made because of the fear of currency devaluation. As it stands now, one party in any transaction either has to decide to speculate on currency fluctuations – an often expensive proposition that makes otherwise perfectly doable business and investment nonsensical. The opportunities lost for economic growth to this problem are simply staggering.

It wasn’t always so and it needn’t be that way. Prior to the First World War, virtually the entire world was on the gold standard. In effect, the whole world had one currency – gold. The paper passed around was symbolic because most currencies could be redeemed for a set amount of gold.

By and large, this regime was quite successful. The gold standard created a discipline for policymakers in each country. If a country followed flawed economic policies or was perceived as unstable, people wouldn’t want to hold the currency and would convert it to gold. This was especially true of foreign holders of the currency. In any case, gold would wind up leaving the government’s hands and, in many cases, leaving the country altogether. Because the gold standard requires the currency to be backed by gold, the fact that gold left the government’s hands meant that the volume of currency in circulation would decline. Without enough money around, interest rates would usually zoom, which could easily lead to an economic decline. Of course, since all this was very predictable, the gold standard created a powerful straightjacket, disciplining the activities of policymakers.

The large economy of today may make gold problematic. But there is another policy option that can provide many of the benefits of the gold standard: The Currency Board.

A Currency Board functions just like a gold standard except, instead of establishing a fixed conversion with gold, it establishes a fixed conversion with another currency. Generally speaking, that currency has been the U.S. dollar or the German mark. There has also been talk of using the Japanese Yen in a Currency Board for certain Asian countries.

Argentina was one of the first countries to adopt the Currency Board, in this case tying the Argentinean peso to the U.S. dollar on a one-to-one basis. The Argentine Central Bank cannot print more pesos unless its reserves of dollars also increase. Locals and foreigners can freely exchange one for the other. More recently, both Estonia and Bulgaria have begun Currency Boards tying in with the German mark.

Now, of course, printing the local currency is completely unnecessary. It continues only as a matter of national pride.

The adoption across the world of Currency Boards aligned with three currencies would create tremendous pressures for the currency-originating countries to follow prudent policies. If a currency started to dip, it would be a clear sign that policies needed to be adjusted.

Currency boards are so eminently practical that the failure to adopt them more widely can only be due to two factors: First, there is a misplaced concern that in some way a Currency Board diminishes the sovereignty of a country.

Second, politicians hate Currency Boards as they hated the gold standard. Why? It ties their hands. If a politician proposes economically irresponsible policies for politically expedient reasons, he will be caught almost instantly.

The bottom line is that the current system of fiat currencies hurts everyone but especially the poorest countries. It is here where the risk of devaluation is greatest that the currency board would most readily encourage new investment and trade. The poor people of these countries, whose life savings are regularly confiscated by inflation, would finally get a chance to begin to accumulate some capital.

Oh, and by the way, you know those currency speculators that are always being attacked by politicians as the root of all evil? The Currency Boards put them right out of business.