A universal currency would not be viable and that the biggest issues with using such a currency is not purely political.
Matthew Hillebrand, a fellow classmate of mine, wrote a really interesting blog post today arguing for the use of a universal currency. In his post, he stated that the world would greatly benefit from the implementation of a global currency because the world would be economically united, and that a system similar to the United Nations and Eurozone could work as the governing body of this currency. Furthermore, he stated that the biggest challenge to this system is political. However, I would like to argue that a universal currency would not be viable and that the biggest issues with using such a currency is not just political.
One of the biggest disadvantages from the use a global currency is in fact, the unification of our monetary systems. To implement a universal currency, we would first have to establish a fair entity that oversees the creation and regulation of the currency. The key difficulty with such an entity lies in the word “fair”. It is difficult to determine what country would hold how much power within this organization. Matthew argues that we should have countries with large economies hold permanent decision power while smaller economies will rotate. This would not only be unfair to the small economies but would incite backlash from many of them; then they certainly would not willingly adopt the currency. But if every country in the world held equal power within the organization, that would not be fair the large economies either.
If we somehow overcame these differences and created a fair regulatory body for the currency, to adopt a single global currency means for every country in the world to relinquish the ability to conduct their own monetary policy. A country would no long be able to attract investment through interest rate manipulation. There would be no foreign exchange tools for boosting one’s export potential. There would also be nothing to control the flow of capital in and out of a country. Perhaps the governing entity of the universal currency would intervene to assist certain countries in certain situations, but in doing so would undermine its impartiality. Because most actions to moderate the flow of capital leads to winners and losers, it would always undermine the organization’s “fairness”.
Another big problem that arises with the unification of our monetary systems is that economic crises from one country would have a much greater impact on other countries. This is a story we are all too familiar with in Europe. European countries with bad financial reputations have been scrutinized by their neighbors and have made headlines over and over since the adoption of the Euro; Greece has for years been painted by media as a ticking time bomb for the Eurozone (Washington Post). If we had a global currency, how many ticking time bombs would we have?
All of the above problems would give incentives for countries to either kick financially unstable countries from the currency zone, or voluntarily leave to regain power over a domestic currency. It is not only difficult to implement a universal currency, it is also extremely easy for the system to fall apart. For such a currency to work, our world would have to first be run under a single utopian government.
In a stunning move on Friday, the Swiss National Bank removed its currency peg to the Euro. Prior to the announcement, the Swiss Franc had a price ceiling relative to the Euro that aimed to keep the currency at a .833 exchange rate. Such a policy kept the price of the Swiss Franc lower than if it were truly free floating due to the country’s status as a safe haven. Furthermore, foreign countries such as Russia had been stockpiling the Swiss Franc due to falling oil prices and the significant depreciation of the Russian Ruble. So naturally, with excess demand and the price ceiling lifted, the Swiss Franc soared. Obviously this has serious implications for both holders of the currency and debts payable in Swiss Francs. But who else really suffered from such a drastic move by the Swiss National Bank.
According to the Wall Street Journal, the movement in the Swiss Franc triggered hundreds of millions of losses between banks, brokers, and individual investors. The article goes on to mention the severe losses that one of the United States’ largest retail brokers FXCM faced. I have had a forex account with FXCM for a couple of years now and am pretty familiar with how their business model works. FXCM serves as a broker that executes trades for its clients and provides leverage. In a Bloomberg quote, the CEO of FXCM explains that without leverage, people would not trade forex because the moves in currency pairs are so small. I would agree with such a statement in my experience. For example, only a 1% move is considered a pretty volatile day for currency pairs. After the Swiss National Bank announcement, the Swiss Franc appreciated in value by 23% against the Euro and 21% against the U.S. dollar according to the Wall Street Journal.
So if FXCM acts as a broker for its clients then how could it be in such a dire financial position? The answer is leverage. The leverage that FXCM provides to its clients is normally not an issue during typical trading days. Currency trading tends to be mean reverting and there are buyers and sellers on both sides. However, after the Swiss National Bank decision, there were only buyers of the Swiss Franc, and lots of them. FXCM provides up to 50 to 1 leverage on common currency pairs. So with $2,000 of capital on can place a $100,000 trade. The $2,000 is leverage and FXCM can require its clients to put up more money as margin if the position declines in value and may ultimately close the position. But with 50 to 1 leverage, a 2% move in a position would eliminate all of the posted margin. So when the Swiss Franc moved 23% against the Euro, the individual investor lost the first 2% of the trade, and then FXCM was liable to cover the remaining 21% of the trade.
The U.S. dollar has been absolutely surging in recent months. To understand the strength of the U.S. dollar one must look no further than the monetary policy stance of that nation. In an article posted in the Financial Times, Edward Luce describes the monetary policy of many nations: “This will become more pronounced as the Fed moves towards its first rate rise in almost a decade. Most others are cutting theirs. In the past three weeks, Canada, India, and Singapore have all reduced their lending rates. Australia and Turkey are expected to follow suit. The European Central Bank and Denmark are moving into negative nominal territory. It is probably a matter of time before the euro reaches parity with the dollar.” It is worth noting that the Euro/USD conversion was trading at over 1.35 last summer. But what effect does a strong U.S. dollar have on the economy?
One might think that the U.S. dollar being strong relative to peers is a good thing. In many ways, it is. Purchasing power is up as you get more bang for your buck and having a strong currency is a sign that your country is in a better economic state than its peers. However, there are also many negative implications to having a strong currency. The most notable is that exports look more expensive to foreign nations. And that is exactly what many blue chip companies are reporting this earnings season. In an article published by the Wall Street Journal detailing the effects of a strong U.S. dollar on U.S. firms, the CEO of Caterpillar Doug Olberhelman was quoted as saying “The rising dollar will not be good for U.S. manufacturing or the U.S. economy.” Caterpillar serves as a good leading indicator for the U.S. economy since its core businesses are very cyclical in nature and tend to boom when the economy is recovering or doing well, while sales are typically depressed during down times or a recession.
the Wall Street Journal article also points out another key way in which firms’ profits are harmed by a strong U.S. dollar: “The strong dollar can hurt U.S. companies in several ways. The most typical is the so-called translation effect: Companies’ sales in overseas markets may keep growing in local terms, but they look smaller when converted back into stronger dollars. It also can lead to big mismatches between costs and revenues and make it harder for export-oriented companies to compete.” In foreign markets, the local prices of goods will remain the same. When big firms convert their sales from the foreign currency back to the U.S. dollar, they will take a foreign currency loss. It is worth noting that only larger companies who export goods to foreign nations experience this problem, but it is a large problem nonetheless. Furthermore, companies are able to hedge their currency losses using derivatives to lock in a fixed foreign exchange rate. This will diminish profits, but also protects the company from too much downside risk. As the dollar remains strong, I would advise firms to protect themselves from excessive foreign currency losses by fixing their exchange rates, giving price stability and confidence to their investors.