International Money and Common Currencies in Historical Perspective

Abstract

Abstract: The authors review the history of international monies and the theory related to their adoption and use. There are four key characteristics of these currencies: high unitary value; relatively low inflation rates for long periods; issuance by major economic and trading powers; and spontaneous, as opposed to planned, adoption internationally. The economic theory of the demand for money provides support for the importance of these characteristics. The value of a unit is arbitrary for a fiat money, but the other characteristics are likely to be important for determining any fiat money that will be the international money in the future. If the euro continues to exist for the next half century or so and has a relatively stable value, the authors conclude that the euro is likely to be serious competition for the dollar as the international money. JEL classification: E42, F33, N10 Key words: euro, international money, fiat money, dollar, search theory 1. Introduction Is the euro likely to supplant the dollar as an international money? Such a question might seem premature, especially since the euro physically has been in existence only for a few months. We are inclined to think that it is not too early to start to think about this issue seriously since the implications are large for the world's monetary landscape. The move to a circulating euro on January 1, 2002 has been followed by little or no difficulty in the twelve countries involved. By most prognostications, moreover, the future for the new currency looks very good. That was not the case at all a decade ago, as devaluations and widened currency bands shook the Exchange Rate Mechanism (ERM). Skepticism with regard to the future of a single currency abounded among both economists and financial professionals. A major reason for this shift in opinion has doubtless been the change in the underlying economic environment in the countries involved, in particular the greater convergence in monetary policies that took place during the intervening period. The purpose of this paper is to review the historical evidence on the question of international monies. In contrast to other studies, we adopt a very broad temporal perspective, beginning with a discussion of the Byzantine gold solidus or bezant that was introduced by the Emperor Constantine and that served as a world currency for the next seven centuries. We continue with a review of medieval monetary history and the international currencies of the Italian city states. (1) We then turn to a discussion of the various international monies that have existed from the early modern period to the present. Using this review of the historical evidence as a background, we go on to discuss the theory surrounding this issue. The underlying questions of interest are with the factors affecting the establishment of common currencies and, more important, their longevity. Here we return to the earlier analyses of Carl Menger (1892) and a century later Friedrich A. Hayek (1978). In both analyses, the key distinction using some terminology borrowed from Hayek (1967) is between monetary institutions that are the result of human action but not human design and institutions that are planned and orchestrated from on high. 2. Historical Overview 2.1. The Early Middle Ages International monies, monies that circulate for use in transactions across national boundaries, begin with the silver drachma first coined in ancient Athens in the fifth century B.C. (Chown, 1994). Judged on the basis of the hoards that have been uncovered, not just within the Mediterranean region but throughout Europe and well into Asia, the coinage of Rome--first the gold aureus and the silver denarius after the currency reforms of Augustus--became the drachma's successor. (2) Beginning with Nero (A.D. 54-68) and continuing into the early fourth century, currency debasement and inflation became the rule. …