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Transcript of an IMF Book Forum
Can Central Banks be Outsourced? Issues in Money & Sovereignty

Tuesday, May 11, 2004
Washington, D.C.


Benjamin J. Cohen, University of California, Santa Barbara
Kathleen McNamara,
Georgetown University
Ashoka Mody
(Moderator), International Monetary Fund
Catherine Pattillo, International Monetary Fund
Carmen Reinhart, University of Maryland

(Photo credits: Denio Zara, IMF.)

MODY: Welcome. I'm Ashoka Mody from the IMF's Research Department. The future of money is a topic of enormous policy importance we should all be interested in. Around the table are some of the world's leading experts in this area. I'm going to set the agenda quickly and then leave it to them.

Photo of Pattillo, Mody, Cohen, Reinhart, McNamara (left to right)
Pattillo, Mody, Cohen, Reinhart, McNamara (left to right)

Professor Cohen's book starts with the observation that having as many currencies as we do today is not efficient from a purely economic point of view. There are great economies of scale in the use of money, and so if we just went by the economics of it, it is a puzzle that we have seen an explosion of the number of currencies in the world. The book predicts this tension between scale economies and other factors is not going to be resolved and that we will continue to see a lot of currencies in the future. Professor Cohen also puts forward a structure to make further predictions about what will happen to the G-3 currencies, which are at the top of the currency pyramid, and what will happen to currencies at the bottom, where there are a number of currencies that appear particularly suspicious and possibly dysfunctional. Professor Cohen?

COHEN: I really appreciate this invitation from the IMF. Thanks to the organizers, to the participants on the panel for taking the time to be here, and, of course, to all of you in the audience. I was told the audience would be both very well informed and highly enthusiastic, which is welcome. It reminded me of a talk I once went to when I was in college many years ago. The talk was advertised as "The Problem of the World." The speaker got up and said, "The problem of the world is humanity. Humanity has two problems: ignorance and apathy." And he sat down.


I wasn't sure if I had missed something, so I turned to the fellow next to me, and I said, "What did the speaker say?" And the fellow next to me said, "Buddy, I don't know and I don't give a damn."


So it's good to know this is an audience that does know and does give a damn.

Photo of Benjamin J. Cohen
Benjamin J. Cohen

Let me explain what it is that I tried to accomplish in this book, and I'm highly flattered to have the opportunity to do so in such a setting. The book is called "The Future of Money," perhaps pretentiously, without a certain degree of humility. But, nonetheless, what I'm talking about in the book is the future of the number of currencies in the world.

The number of currencies as an issue is important because it bears directly on the governance of money, the management of money, which in turn is a fundamental determinant of the distribution of wealth and power in the world. And so the number of currencies really does matter for us.

The traditional assumption with which most of us live, certainly outside the IMF if not inside the IMF, is that the number of currencies is roughly set by the number of countries in the world; that is to say, there's a close correlation between money and national sovereignty, the territorial sovereignty of the nation state. That's well illustrated by the "Money & Sovereignty" exhibition downstairs that I had a chance to look at before coming up here. This is the notion of one nation, one money; one country, one currency. There are always exceptions, of course-the Panamas of this world, a couple of monetary unions in the Caribbean and Africa-but the basic assumption is that each country has its own currency. Not only that, but each country has an exclusive national currency over which the state, the government, or its agent, the central bank, exercises monopoly powers-monopoly powers within the territorial frontiers of the individual state. Monetary governance, in other words, consists of a series of national monopolies. Money can be described as territorial in this traditional assumption.

But there is an emerging new view to which Ashok alluded to that the number of currencies in the world, is about to contract sharply, dramatically, in coming years. The view is that the traditional correlation between money and sovereignty is being eroded. Many states are going to give up their national currencies, either adopt a popular foreign currency like the dollar or the euro, or join together in a monetary union on the model of Europe's EMU. Monetary management, in effect, will now for many countries no longer be national, but outsourced. It will be delegated, either to a foreign supplier, like the U.S. or EMU, or to the joint institutions of the monetary union. And it is assumed that this will mean that monetary governance will be concentrated and it will be simplified.

Now, in the book, I refer to this, to provide a shorthand, as the "contraction contention"--the contention that the number of currencies in the world will contract. And the main argument of the book is that this contention is wrong, that this view is wrong. I argue that this is a misleading representation of what is likely to happen in coming years.

I do agree that the correlation between money and sovereignty is being eroded. In fact, I argued that in a previous book called "The Geography of Money" from which this book springs. But I disagree that the number of currencies will contract. I would argue quite the contrary, that the number of currencies is more likely to expand than contract. Monetary governance will not be concentrated but diffuse. It will be not simplified but more complex.

Now, I argue this with a certain degree of humility because the contraction contention, after all, has been very popular among monetary specialists and has been promoted by some very prominent figures, the likes of Robert Mundell, the late-lamentably, the late-Rudi Dornbusch, Stanley Fischer, who was Rudi's colleague and then was your colleague here at the IMF, even Michel Camdessus. I have a quote from Michel Camdessus in the book saying that, "In the long run, we are moving toward a world of fewer currencies." A definitive statement.

Some expect that many countries will emulate EMU, forming monetary unions. One prominent economist in this country, George von Furstenberg, in fact, has written several times, "This is inevitable." A quote, "Inevitable, the wave of the future." Others expect that many countries will emulate states like Ecuador or El Salvador that have formally dollarized, that is to say, adopted the currency of a foreign country. And I have a quote from an article that appeared in Foreign Affairs: "By 2030, the world will have two major currency zones--one European, the other American. The euro will be used from Brest to Bucharest, and the dollar from Alaska to Argentina."

The logic underlying the contraction contention is clear. The process of globalization, more specifically the process of financial globalization, has involved the breakdown and disintegration of formal or informal barriers to the movement of money across national frontiers. This has led to a growing competition among national monies. The IMF noted the beginning of this phenomenon 10 or 15 years ago in a series of papers on currency substitution. In my book called "The Geography of Money," I refer to this as the "de-territorialization of money." What's happening here is that users in many countries have a choice between local currency and a popular foreign currency, and these two currencies compete, like Pepsi-Cola and Coca-Cola. And the argument, the logic of the contraction contention is that this will eliminate less competitive currencies in the same way that competition among soft drinks eliminates weaker competitors. States faced with the loss of their territorial monopolies will give up defending national currencies; they'll outsource in either dollarization, formal dollarization, or monetary union.

The logic stems from the familiar economies of scale associated with monetary use, the network externalities that we associate with money. From the point of view of market actors, the users of money, whose concern is obviously to minimize their transaction costs, the fewer number of currencies the better, because then economies of scale will be maximized.

George von Furstenberg says, "Small really is beautiful in matters of money." Rudi Dornbusch said, "Fewer monies will mean better monies." The only question from this point of view is how many currencies would remain after this competitive reduction in the number of currencies. Robert Mundell suggested that in this context that, "The optimum number of currencies is like the optimum number of gods: an odd number, preferably less than three."


Most others who believe in a contraction contention, from Friedrich von Hayek onward, don't go quite so far and talk, rather, about a small number of currencies remaining. Paul Krugman put a number to it; he said maybe 20 or 30.

Now, my response in the book is that the logic of the contraction contention is not wrong, but it's incomplete. It focuses only on one side of the market-on the demand side-and ignores the supply side where very different considerations are at work.

On the demand side, efficiency considerations or scale economies clearly do suggest a rational preference for a small number of currencies, if not one. So the logic is not wrong. But we also have to look at the supply side of this market, and there preferences can be expected to run very much the other way, toward preservation of existing currencies and even a proliferation of new currencies in circulation around the globe. These preferences should not be ignored, and the purpose of my book is to highlight the considerations on the supply side of the market.

On the supply side, there are two sets of actors that matter. I do this with my students. I'll say there are two factors, and I'll hold up three fingers.


So there are two sets of actors that matter on the supply side: first, state actors, the traditional sources that we associate with money, and, secondly, the private sector, private actors. My argument is that, as suppliers, both sets of actors will prefer more, not less. For them, fewer monies are not better. Small may not be beautiful. The bulk of my book is given over to state actors, but there is also a long chapter on the private sector as a supplier of money.

With respect to state actors, my argument is based on two points. Point number one, states will rationally resist giving up their national currencies. Point number two, they are not forced to give up their national currencies, even if their currencies are uncompetitive, because they have other choices than suggested by the contraction contention.

The first point: States will rationally resist. Resistance by states is not irrational. Quite the contrary. It's important to put into the calculus more than just efficiency considerations--that is, more than scale economies and transactions costs. If we put in the full range of considerations of states, both economic and political, we see that governments derive major benefits from the existence of the national currency. It's no accident that as nation states consolidated their authority in the 19th century and into the 20th century, one of the ways in which they did this was by consolidating exclusive national currency.

What are these benefits? Exclusive national currency, or localized monopoly within the territorial frontiers of the state, provides four major benefits, the first of which is seignorage--the opportunity to use that monopoly control of the money supply to supplement government revenue or to finance public spending. Second, it provides an instrument, a very effective instrument for the management of the macroeconomic performance of the economy, what we otherwise call monetary policy, of course. Third, in political terms, an exclusive national money provides a very important symbol of national identity, a daily reminder that everyone is a member of the same national community. And fourth, having your own national money provides you with a degree of political insulation. It means that you're not dependent on somebody else for command over purchasing power, command over real resources. So it's not at all unreasonable to expect that governments will seek to preserve these benefits for as long as possible.

In this connection, let me quote from the opening remarks by Anne Krueger ( when she opened the Monetary and Sovereignty Exhibit downstairs. She spoke about how deep-rooted the relationship between money and sovereignty is:

"Are countries-both their governments and their populations-willing to see their national currency disappear in return for apparently intangible benefits such as greater efficiency and access to a larger market? Governments are often torn, because the ability to print money can offer important advantages, especially for those who want to avoid fiscal discipline ... the right to issue a national currency has long been jealously guarded by states, and sought after by those seeking national independence. Currency is seen as a symbol of national sovereignty which is why the prospect of abandoning a national currency is so painful a prospect to many people."

That is one statement of the difficulty of persuading governments to give up a national currency. The second point is that states, even if their currencies have reached the status of what one Canadian economist used to call "junk" currencies, have other choices. The reason they have other choices is because they don't have to go to the extreme of either a full monetary union, on the model of EMU, or to full formal dollarization, on the model of what Ecuador or El Salvador has done. There are other arrangements that represent a degree of delegation of monetary authority that are not quite so extreme and do allow governments to retain their national currencies and, therefore, to preserve at least some of the benefits of those national currencies.

In other words, choices are really nuanced, much more nuanced than the contraction contention suggests. There are degrees of delegation, degrees of outsourcing possible. Currency boards, as we know, are remarkably plastic in how they can be designed. Or even a lower degree of commitment delegation would be bi-monetarism, simply recognizing a foreign currency as a second legal tender.

Likewise, monetary union is an extreme choice. Countries can make choices short of that to join together in a pegging arrangement or to just simply have mutual payment arrangements or settlement arrangements. It's not necessary for governments to go the whole hog, and, consequently, most governments, even faced by very overwhelming competition from a foreign currency, even with the junkiest of junk currencies, are likely to choose an arrangement which allows them to keep at least some of the benefits of a national currency.

Then there are the non-state actors. In the Money & Sovereignty Exhibit downstairs you will see that there's a section there that points out the fact that even at the height of the system of one nation, one money, there were always, there have always been private issuers of money. I argue in this book that we can expect privately issued currencies in the modern era to proliferate greatly.

At one level, we have local community currencies--local currencies, local currency systems, community currency systems, which are growing by leaps and bounds. They individually involve very few people, but there are thousands of them now, in Europe, North America, Australia, Argentina. They are growing in number and more and more transactions are being conducted in these local currencies, each of which involves a devolution of a degree, of a portion of monetary authority down to the level of the community.

But even more important is the emergence of electronic money, as this new phenomenon of cyberspace, the Web, electronic commerce, all of which is leading to the incentive for creation of viable currencies that can be described as electronic. My favorite example of this is airline miles. Airline miles serve all the functions of money-store of value, unit of account, medium of exchange-for a network of transactors, which increasingly involves not only the opportunity to use these to buy airline flights but also to rent a car, pay for a hotel, and the like. This is genuine money, even if it is not for general circulation, and my prediction is that we will see more and more of that.

The result, I argue, is that with the resistance of national governments and with the proliferation of privately issued monies, the world faces a governance issue in which the governance of money will be more difficult, not less, more complicated, not simplified.

The last chapter of the book offers some suggestions of how governments collectively and the IMF can try to deal with this, but I've run out of time so I'm going to have to stop.

MODY: We can come back to that in the discussion. Your use of the phrase "symbol of national identity," reminded me of a story that has been handed down by Rudi Dornbusch's students. He is supposed to have said that when countries became independent after the Second World War, they adopted a new flag, a new currency, and a new airline. The airline has become obsolete, and most countries are giving it up. It's time to give up their money, and the only reasonable symbol of national identity is the flag at this point.

COHEN: And the national anthem.

McNAMARA: I may have a rebuttal to that. Actually, I also just want to mention that my airline miles seem to be depreciating. I can't fly anywhere anymore on Continental,


so we've got a little problem. Make it an independent airline or something.

COHEN: Why shouldn't private money depreciate as much as state money?

MODY: Let me turn the floor over to Kate McNamara, who will offer a sociological perspective on the future on money. She is an expert on European integration and may draw on some of that work as well. Kate?

McNAMARA: Thank you. The book is a tour de force, and I really recommend it to everyone. One thing about Jerry Cohen's work is he's really able to deeply integrate politics and economics because of his training and his outlook; it really is a seamless discussion bringing together these two disciplines. It makes it very difficult for a discussant to find fault though I tried very, very hard. So instead I decided that there was an alternative perspective that was not in this book that I want to briefly talk about today, and that is the perspective of money as a social construct, a sociological perspective on money.

Obviously, economic factors, political factors are very important, but I'd like to argue that when we think about the material world and these material factors, we also have to remember that they need to be interpreted and given meaning. This interpretation of markets, of political power and so on, will vary not only across individual actors--everyone in this room will look at the world in a slightly different way--but across groups, across organizational cultures, across ethnic cultures, across national cultures; and that those different groups will shape interpretation in very patterned and systematic ways that we can look at and predict from; and that it's not just individuals but, rather, their social interactions that generate meaning over time.

So if this is true, if this perspective is correct, we should think about markets not only in the sort of political economy manner, but also think about them as culturally and historically bound, not ahistorical, universal phenomena that everywhere and always are the same but, rather, phenomena that have specific logics depending on the specific place and time in which we find them. So let me throw out just a few examples.

For example, there's some fascinating work on Japanese consumers, which you guys might know about. Steve Vogel and other people have looked at Japanese consumers, and they don't seem to sort of act exactly the way that many of the sort of microeconomic models might tell us they should be acting. They do things in ways that actually tend to vary depending upon cultural norms.

Look at things like corporate strategies over time. At any particular given point in history, corporations have thought about their interactions, say, with labor markets, with financial markets, and thought of markets in different times based on the sort of cultural strategies at a particular point in time.

Another example: orthodoxy about capital controls. Over the past hundred years, we've sort of swung back and forth between thinking about capital controls as something that are necessary and important, or as something that actually are detrimental and inefficient.

So I think it's important to think about situating markets and situating these discussions in a specific logic of the culture of the time and place. And I would argue that you actually can't understand how markets function unless you have this sort of perspective.

All right. That's all very well and good. But what about the future of money? How might this perspective help us understand the questions of the future of money?

Well, I have studied money for some time. Money to me is the ultimate social construct because money is about creating value through inter-subjective agreement. Right? If I hold up a dollar bill, it only has value because we all agree it has value. It's just a piece of paper, right? And so it's created in a social interaction, the notion of money as holding value.

And so I would argue that the future of money will depend on how actors, private and public, view the different types of money that Professor Cohen has been proposing in his book. So let me throw out a couple of examples of how this has interacted on the ground in the monetary area.

Well, we all know that financial markets can reward or punish state actions in severe ways, but what's interesting to me is if you look at the different cultural frameworks in which those markets are acting, we can better understand why is it that certain states do very well with certain types of actions and others do not.

Let me give you an example from EMU. I was doing some work on the run-up to EMU, looking at how it was that these states that had these huge deficits were able to actually "meet" the targets for entry into EMU. I saw a very interesting positive circle occurring with financial markets where the states that had promised to try to meet the 3-percent budget deficit and 60-percent public debt targets started to sort of get a break from financial markets. Their interest rates started to go down over time, which then made it easier for them to actually meet those targets because their debts were reduced. The debt charges, debt payments were reduced. And so simply by promising to meet this target over time and being believable--right?--markets interpreted that as a signal that these countries were actually going to, you know, have good housekeeping and meet the targets. And, voila, they were able to meet the targets, in large part because of the sort of self-fulfilling prophecy sort of interaction.

But we also see, of course, some countries falling into a much more negative cycle where the markets don't believe them and punish them, and it makes it harder for them in reality to meet these types of goals.

The point is that orthodoxy becomes reality, even if it's not functionally true or functionally necessary, because it's filtered through these social beings who act as if it's true. Okay? So that's one example, thinking about markets and punishing and rewarding.

We might also think about currency as a social institution when we're trying to figure out questions us as whether the euro become the top currency in international markets. Will it become the key currency? Will it rival the dollar? Will we see unipolarity in the dollar, or will it be bipolarity? Well, economic fundamentals are obviously very important, but I would argue that we also need to think about things such as status, and to understand status we need again to talk about these social interactions. We need to look at things like practice and habit. We need to look at how people through social interactions go about deciding whether they view a currency as truly the supreme currency and as a currency of value.

My sense from looking a little bit at the sort of history of currencies changing over time, say from pound sterling to the dollar and so on, is that new forms of money may face an uphill battle because status tends to lag reality. But once a currency is adopted, it tends to be very, very sticky, right? So the euro may take a long time to catch up to the dollar, but if it is adopted, it will be sticky beyond the EU's power in the international system.

So let me just actually stop there and just say that I think that adding the sort of sociological perspective might help us explain some of the puzzles and anomalies that we see if we just stick to sort of a political economy perspective. So I would argue that it might be another type of tool that we might want to put in our tool kit as social scientists.

MODY: Any reactions?

COHEN: Well, I fully appreciate what Kate McNamara has to say about the sociological elements of money. Money is by definition something that exists only on the basis of social psychology, on the basis of what scholars call inter-subjective understandings. I mean, I'm not going to accept a currency unless I think there are at least some people out there who are going to accept it from me. Otherwise, why in God's name would I ever take currency in payment for anything? It just isn't going to happen. I have to assume that there are some people out there that trust this currency, that are prepared to accept this currency.

But as Kate pointed out, trust or acceptability for currency is not an easy thing to achieve. She might have also added it's very easy to lose, as many of you here at the IMF, I am sure, can testify better than I.

One scholar has distinguished stages of this growth of acceptability or trust where there's momentary trust based on attractiveness or circumstances at the moment; reputational trust where over time some confidence is accorded just on the basis of reputation; and then finally effective trust where it is simply unquestioned, that trust in a currency is unquestioned.

These things take time to develop. As a result of--this is one of the reasons why there is such inertia in the changes that occur from one currency to another. We know about that. Some IMF economists wrote about hysteresis in currency choice. There is a great deal of stickiness in these kinds of things, and that's precisely why I have written elsewhere that I doubt the euro is going to surpass the dollar any time in my lifetime. I won't say your lifetime, but in my lifetime, which is as far as I'm prepared to predict.

McNAMARA: I've been doing some work on the relationship between currency and state building. In the 19th century, when a lot of modern states actually developed a single standard currency, there was a very intimate connection between the development of the currency and broader political projects. So I agree, the currency it's not really just a symbol like a flag; it is intimately connected to the concentration of political power. For example, the creation of the greenback during the Civil War was done for expressly political purposes. So we shouldn't sort of be too quick to kind of assume that currency is merely symbolic-it is actually is very intimately connected with the concentration of political authority and political power.

MODY: Thank you very much, Kate. We will go next to my IMF colleague Cathy Pattillo, who has recently completed a book, forthcoming from the Brookings Institution, on monetary unions in Western Africa.

Photo of Pattillo, Mody, Cohen (left to right)
Pattillo, Mody, Cohen (left to right)

PATTILLO: Thank you. I'm an author, together with Paul Masson, of a book called "The Monetary Geography of Africa." Professor Cohen's earlier book, "The Geography of Money," was really the inspiration for the work that Paul and I have been doing on Africa.

I'm going to talk about our work as an application of the type of thinking that was in Cohen's earlier book, and in this one, to a specific region, to Africa, where a lot of the currencies have been, as Professor Cohen said, sort of "junk currencies." There's been a lot of interest in that region in monetary union projects, both because of recognition that the currencies have completely deteriorated as stores of value and means of payment, and also because of political reasons. So our inspiration then follows Professor Cohen in interest in the de-territorialization of money and a focus on the political economy of these projects.

In the new book, then, Professor Cohen sets out a model for looking at this tripartite choice between countries having an independent currency or dollarization or joining a monetary union. And he argues that monetary sovereignty, the choice by countries that want to continue to keep their national currency, can be defended either by persuasion, by sustaining demand for this currency by having credible policies and commitment to sound monetary management, or by coercion, that is, by rules and regulations that prevent individuals from holding other attractive foreign monies.

Africa is really trying to transition away from coercion to having its citizens interested in the national currency through governments' commitment to good policies. The costs of defending national currencies have really increased now because a lot of these coercive policies have been liberalized in the 1990s.

Another similarity of our work with Cohen's is the attention to political economy. There tend to be two extremes in the way researchers discuss monetary unions. One is a very discursive approach to the politics of monetary unions, and the other resorts to economic models of optimum currency areas that look very narrowly at the traditional criteria that we look at in optimal currency area models: transactions costs, asymmetry of shocks, mechanisms to mitigate these asymmetries, labor mobility, fiscal transfers, or mechanisms that reduce the likelihood of asymmetric shocks, diversified production structures. So you've got either a discursive political approach to monetary union or a very strict economic approach.

The approach that Paul Masson and I take is somewhere in the middle. We set up a model which includes these optimal currency area criteria, the transaction costs and efficiency aspects of having a monetary union. But we add, I think very importantly for Africa, the fact that there are a lot of fiscal distortions that emanate really from political factors. This is very likely to influence the desirability or disadvantages of countries joining a monetary union.

Let me elaborate. As I mentioned, the model that we set up has traditional optimal currency area features. So we look at the advantages of joining a monetary union, which would depend on the savings through reduced transactions costs. That's going to depend on the extent of interregional trade, and in Africa that is typically low. But, on the other side, monetary unions are very constraining. The more dissimilar countries are, the more asymmetric their shocks are. And in Africa, a lot of people would look and say we've got very asymmetric external shocks, which are the most important kind of supply shocks. Countries are exporting all different kinds of commodities, so asymmetric terms of trade shocks, maybe monetary unions don't make sense.

But even more importantly than these exogenous shocks, which countries can't do anything about, are the differences in the amount of fiscal discipline and in fiscal distortions across countries. As I mentioned, in our view these fiscal differences are related to political considerations. There are differences in the amount of corruption across countries. There are differences in the amount that governments want to or feel the need to, you know, siphon tax revenue away to support their cronies. This creates a lot of differences in fiscal discipline across countries.

So obviously countries that are more disciplined are not going to want to join in monetary unions with countries that are less disciplined because the common central bank then will have an incentive to have more of an inflation bias and there will be less stability for this regional currency. In our view just creating a monetary union doesn't necessarily mean that the regional institution that you create would be independent; it's more likely, particularly in the context of Africa, that this new regional institution will still reflect the preferences of the members. Any one individual country's power is diluted, but it's not as if just by joining a monetary union you're all of a sudden going to get a completely independent regional central bank.

We apply this kind of model to looking at monetary union projects in West Africa, East Africa, Southern Africa. There's also a proposal from the African Union to have a single African currency. We find, echoing some of the messages from Professor Cohen's work, that basically a lot of these projects are not sensible from the perspective of our model. But we do agree that monetary union is not an all-or-nothing proposition. There might be scope for more looser forms of regionalization that would transfer some monetary policy functions to a regional organization and get some benefits of peer pressure and mutual groupings without a full monetary union.

How could all these arrangements come about? As Professor Cohen indicated, he suggests in the last chapter of this book that the IMF might step in as mediator in a lot of the discussions that countries will have about what their currency regime will be. So he suggests that the IMF could extend its surveillance from exchange rate policy to currency regime surveillance. I wonder about that. I was at a recent birthday party for Jacques Polak, the former head of the IMF Research Department and founder of financial programming here. Mike Mussa, another former head of the Research Department, was there discussing the IMF's Articles of Agreement, one of which states that the IMF should exercise firm surveillance over exchange rate policy. Mussa's reading was that the IMF has not had firm surveillance; in fact, he characterized IMF surveillance as very squishy, like an avocado without a pit.


PATTILLO: And so my question to Professor Cohen is: Why do you think that moving from surveillance over exchange rate policy, which has been incredibly difficult, to the further step of surveillance over the entire currency regime is not something that countries would resist even more on the grounds that it violates national sovereignty?

MODY: Cathy, thank you. We'll give Professor Cohen a chance to answer your question.

COHEN: Well, first, I welcome the fact that your case studies in Africa confirm the general point that I was making in this book. Now on your question: Mike Mussa is absolutely right that, particularly for the larger members of this organization, IMF surveillance of exchange rates is pretty nominal and results in relatively little change in what they do. But as we go down the scale to countries with currencies that are lower in the currency pyramid, there's correspondingly a little more influence. I don't deny that for a moment that it's asking a lot to expect that countries that are not prepared to accept IMF direction on the choice of exchange rate regime would accept IMF direction on the much broader issue, the deeper issue of monetary sovereignty of a choice of a currency regime as a whole, not just a matter of exchange rate.

Having said that, however, my only response can be: But what's the alternative? We have to face up to the fact that countries-and we have over 190 of them-have to make these choices under the pressure of this intensifying competition, and that there's a classic collective action problem. We face the prospect that the decentralized decisions made at the national level, with each government making a decision among these choices on the basis of its own unique circumstances and its own estimation of the economic and political costs and benefits for its own country, could add up to mutually inconsistent choices, could add to instability, could create considerable volatility in monetary matters.

So what I was suggesting here is faute de mieux, as the French would say, for want of anything better, the IMF ought to at least try. The other possibilities that we could think about to provide coordinating mechanisms to ensure some degree of mutual compatibility of national choices strike me as highly unrealistic. A world central bank, as some have been advocating, seems like a non-starter, as far as I can tell. Likewise, there could be coordination among the major countries or issuers of major currencies, like the U.S., EMU, Japan; then if others would follow their lead in individual patron-client-type relationships, there might be some coordinating mechanism there. But even there what about all the countries that are unlikely to want to be part of some kind of a dollarization or quasi-dollarization scheme?

So that leads me to the IMF as the provider of the coordination mechanism. I didn't argue that the IMF should be given supernational authority. I didn't argue that the IMF should even be given the power of arbitration. But I did suggest that the IMF can play a useful role as a mediator in these discussions, and while it's not perfect, we shouldn't let the perfect be the enemy of the good. One can only hope that there might be some possibility for this.

MODY: And, finally, and not the least, let me turn to Carmen Reinhart, who was our colleague here until very recently. She has worked recently on all of these topics-on the G-3 currencies, on dollarization and exchange rate regimes. So I'm not going to hazard a guess on what she's going to talk about, except to say that even though until a few months ago she was also my boss, if she takes too long I'm going to cut her off ...


COHEN: This is Ashok's retribution.


REINHART: Okay. Well, first, it's a real pleasure to be here to comment on Professor Cohen's "The Future of Money." I commend it to you highly because I think the book recognizes the many complexities that determine ultimately how many currencies we have in the world. Much of the earlier work, such as by the likes of Mundell, who is my former thesis adviser and with whom I disagree on this matter, looks at the number of currencies from the vantage point of what it ought to be. What this book does is bring realism into the table, and it deals with what it is likely to be.

The decision of how many currencies we have and whether a country chooses to give up its currencies is analyzed in the book from different perspectives. An important perspective that is brought into the table is the perspective of the issuer. And, also, there's discussion of the perspective of the potential holders of the currency and of the competing foreign issuers.

Looking at the complexities of the decision of the issuer is very important because, if you look historically, Professor Cohen is right on the mark in arguing that countries are going to be very reluctant to give up their own currencies.

Why? Because, to state it very broadly even though such blanket statements are bound to be wrong, most countries' currencies tend to depreciate over time versus the major reserve currencies. So what many countries are really holding on to is that ability to depreciate.

Countries are not really holding on to their ability to conduct countercyclical monetary policy. Let me mention in passing that I have looked at very recently, with Carlos Vegh and Graciela Kaminsky, the cyclical pattern of monetary policy in developing countries. We would like to think that prudent monetary policy means you lower interest rates in recessions and you raise interest rates in recovery. What we observe in most developing countries is quite the opposite. We observe procyclical monetary policy. So it's not like monetary policy is doing a great job in most emerging markets.

So why do they keep on their own money? Well, it's a form of taxation, and this is pointed out in the book. So from the perspective of the issuers, it's a symbol of sovereignty and it provides a way of financing. But it's a form of taxation that some countries have used to the point where they've made their currencies incredibly undesirable. So from the perspective of the holder, the story is different because if the government has repeatedly, for lack of a better term, debauched its currency by multiple depreciations and hyper- and high inflation, users don't want necessarily that currency.

How can we reconcile all this? I think the way-and here I may be going too far in suggesting that that this perhaps is what Professor Cohen has in mind-is to recognize a distinction between de jure currencies and de facto currencies. De jure, I agree completely that, as the book says, we are going to have lots of currencies. It's true that Europe is coming together and reducing the number of currencies in that region. It's also the case that dollarization or a high degree of dollarization, which was limited to a handful of the very chronic high-inflation Latin American countries, is cropping up in different places, including China. But elsewhere, small countries, for example the ones that used the South African rand, have introduced their own currencies. Argentina at the height of its recent crisis had provincial currencies; so not only did it have the peso, but each province had its own currency. So there are a number of counter-examples to the trend toward increased dollarization, which I'm using loosely to mean the use of a foreign currency.

What I see is that we are going to wind up with lots of domestic currencies. But the question is, de facto, will those currencies really be demanded? And there I think the picture is much more blurred. Greater capital market integration may mean that, de facto, we use really a limited number of currencies and that, you know, some of the national currencies exist mostly in a de jure sense.

Like Kate, I don't want to characterize their existence as "symbolic". That would be inappropriate because, as I argued at the outset, some emerging markets have historically used their currencies for more than just symbolic purposes, in particular to engineer a gradual depreciation over time. Of course the process has its ups and downs. But it you look at periods of good times, what do countries do? They try to fight the appreciation. I mean, we're seeing it in Asia right now, and this is what Guillermo Calvo and I have called fear of floating, that when the currencies are tending to appreciate, countries fight the appreciation tooth and nail. If the currencies depreciate too quickly, they're also afraid of that because often their debts are denominated in dollars. So there's this tendency to resist big currency swings either way.

But, broadly speaking, if you look at the long-term pattern, what you see is a gradual depreciation of developing countries' currency. And for that reason alone, I agree that there's going to be enormous resistance to giving up sovereignty over its own currency, even if that currency is not wanted by its citizens, as is the case in many of the emerging markets.

So what I'd like to put on the plate is the following notion: yes, de jure, we're going to have lots of currencies, but, de facto, globalization may lead to the effective use of fewer currencies, such as the euro and the dollar.

MODY: I'm tempted here to step outside the bounds of my own knowledge and suggest an analogy with languages. It might be argued that in the best and most efficient world we all should speak the same language because that would allow us to communicate in the most efficient way. There would be economies of scale, network externalities, et cetera, et cetera. But in reality, obviously that does not happen for a variety of reasons. Indeed, I think it is possible for those who study it to document that the number of languages has increased. But then if you take seriously what Carmen said at the very end, what has also happened is the following: despite the proliferation of languages, as globalization has proceeded a few languages like English and Spanish which have come to dominate the way international commerce and international interactions have occurred. So you have efficiency reasons dictating a reduction in the number of languages, national symbolic reasons pushing in the other direction, and a compromise in which, in a de facto sense, only a small number of languages are used a lot.

Photo of Cohen, Reinheart
Cohen, Reinhart

COHEN: Yes, I think Carmen makes an extremely important point. This book is primarily concerned with government reactions to a market phenomenon. But in "The Geography of Money" book, I did talk at great length about the de facto circulation of currencies, and I developed there--I also replicated it in the first chapter of this book--the notion that the competition among currencies, the de facto competition among currencies, is leading to a very hierarchical relationship among currencies. I describe this in terms of a currency pyramid, with a small number of currencies at the top-the dollar at the very top, the euro, the yen, a few others-which genuinely are in wide circulation, and then levels of that pyramid down below, down to what I call the permeated currencies and the quasi-currencies. And what Carmen is describing is what I meant by permeated and quasi-currencies.

And I think that with the constant intensification and acceleration of currency competition, both within individual countries and across larger and larger numbers of countries, what we're getting is a kind of steepening of the pyramid and more currencies settling down into those lower rungs of the currency pyramid. I think that's absolutely true, and that's, of course, what puts pressure on governments to face up to this tripartite choice that I talk about in this book. The more countries' currencies are being relegated to this junk status, the more they are under pressure to make these choices. My point in this book is that, despite that, there will be great resistance and a greater likelihood of accepting lower degrees of what I call regionalization, that is to say, lower degrees of dollarization or monetary union than the polar alternatives.

MODY: As a moderator, I am delighted that everyone has kept to their time. We have a really nice group of people in the audience so I hope we can some questions.

Photo of audience at the Book Forum
Audience at the Book Forum

QUESTIONER: I'm Bob Samuelson from Newsweek. Could you follow up on your thoughts on electronic money and how that represents an expansion in the number of currencies?

COHEN: The world of cyberspace and the growing world of electronic commerce has created a situation in which there is both an opportunity and an incentive for entrepreneurs of various kinds to develop electronic units of payment. The opportunity is simply the volume of transactions going on out there. The incentive is the old issue of seignorage. You know, as I tell my students, you can make a lot of money by making money. And so there's an incentive there.

Now, there was a first generation of what people called electronic money, but which are really

are only electronic payment systems. They use existing state currencies but facilitate the transactions, and so affect velocity but not stock of money. The most outstanding example of that is PayPal, which is a very successful payments mechanism. There was a second generation, what The Economist Magazine called e-money Version 2.0, which was represented by attempts to develop new units of electronic money, but they failed with the dot-com bust.

But I personally feel, given the opportunity that's provided by electronic commerce and the incentive that exists in terms of seignorage, that there will be more such attempts. Others have written along the same vein, not the least of whom is Benjamin Friedman at Harvard. And to the extent that new electronic units of payment are developed like frequent-flyer miles, operating in circuits of payment that do not go through the standard banking system, to that extent that erodes the effectiveness of traditional monetary policy. It doesn't affect the ability of a central bank to control the aggregates and the interest rate on their own money. But it does make it more difficult for them to influence the aggregate level of spending when more and more spending is taking place through circuits that are not under the direct control of the central bank.

I'll be happy to talk afterwards, if you'd like, at greater length. Or you can read Chapter 7.

QUESTIONER: I'm Haidy Ear-Dupuy from World Vision. I just have a simple clarifying question. When you use "money," I wonder if you're using it more loosely than, for example, the writers you had mentioned in the past? When you use frequent-flyer miles as a frequent example, I'm wondering if your definition is a larger, broader definition of money?

COHEN: I'm using the standard definition as money as anything that serves the three functions of money: means of exchange, unit of account, store of value. The traditional definition says money is anything that is "generally accepted" for these three functions. I have qualified that to say that money is anything that serves those three functions for some identifiable group of transactors, some network of transactors. It can be as small as a couple of hundred people in Ithaca, New York, using a local currency called "Ithaca Hours." There are several hundred of these around the country, including one in Isla Vista, the student community right next to the campus of Santa Barbara, U.C.-Santa Barbara. So the definition I'm using is one that is defined by the functions for an identifiable group of transactors. In some cases, these are strictly available in cash form, like these local currency systems, and it would be M0. In other cases, they're in deposit form, like frequent-flyer miles, and so it would be a broader definition.

QUESTIONER: Just to follow up on your analogy with languages and so on, has there been any research on the volume of transactions? Are they limited to one or two currencies like the U.S. dollar and the euro as opposed to a variety of currencies?

COHEN: You know, it's difficult to get the data on the circulation of currency in any form beyond the borders of the issuing state. There are really no numbers at all on the circulation of paper currency outside countries of issue, though we do have estimates. And for the U.S. dollar, the estimates that have come out of the Fed and the Treasury suggest anywhere from 50 to 70 percent of all dollar bills are in residence abroad, and something like 90 percent of all $100 bills that are printed in the United States these days go directly abroad. It's an indirect indicator. There's no way that we can identify the volume of transactions outside the country of issue in a currency, but we have these indirect indicators, estimates of currency in circulation, and also from the IMF, we have data on foreign currency deposits in broad money definitions in various countries. And that is, I think, where you're seeing that great spread of use of a few currencies.

REINHART: Dollarization has been a phenomenon in Latin America a long time, then you saw it in the Eastern European countries, you see it in the former Soviet republics, you see it in pockets of Asia. Don't forget also the amount of stockpiling of reserves that's going on in Asia right now; so there are different forms of dollarization. And, also, one new dimension that has sprung up in the 1990s is the issuance of domestic debt that is linked to the dollar or to a foreign currency. That's become quite pervasive.

MODY: We've finished just in time. Thank you all very much.



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