The Federal Reserve, the Bank of England, and the Rise of the Dollar as an International Currency, 1914–1939

This paper provides new evidence on the rise of the dollar as an international currency, focusing on its role in the conduct of trade and the provision of trade credit. We show that the shift to the dollar occurred much earlier than conventionally supposed: during and immediately after World War I. Not just market forces but also policy support—the Fed in its role as market maker—was important for the dollar’s overtaking of sterling as the leading international currency. On balance, this experience challenges the popular notion of international currency status as being determined mainly by market size. It suggests that the popular image of strongly increasing returns and pervasive network externalities leaving room for only one monetary technology is misleading.     

The failure of OCA analysis

Conclusion In this paper I have tried to show that OCA theory fails to advance the case for independent fiat currencies. It does so both because of its empirical irrelevance, and because of its internal inconsistencies. Therefore, from the perspective of international monetary economics, there is no theoretical justification for the present monetary organization. Rather other factors, more related to political interests than to sound economics, should be held responsible for it. It is perhaps interesting to consider the mainstream economists’ systematic reaction when they discover there is no scientific justification for a fluctuating fiat currency system. They simply throw away the whole analysis and return to “common sense” propositions. Some of them even go so far as to recognize the merits of a world currency, eventually pegged to gold, but then dishonestly dismiss the case on the basis of “beliefs,” or popular wisdom. All remaining errors are my own.     

Comments on R. Cooper, M. Bordo and H. James: Exchange rate arrangements and disarrangements: prospects for a world currency

This note evaluates the prospects for a world currency, using as a departure point the papers by Bordo and James (2006) and Cooper (2006). The note argues that a world currency is unlikely in the foreseeable future and probably undesirable. Although more evidence is needed, there seem to be no strong forces towards the creation of new monetary unions among the countries with major currencies or between those countries and the periphery. Based on recent experience, the note also argues that one of the main benefits to establish a world currency, the elimination of exchange rate uncertainty, is likely less important than commonly believed. No matter how rigid a currency arrangement is, initiatives to dissolve it tend to appear as bad times arise. Still, the present equilibrium of no world currency leaves unresolved many difficult issues related to the functioning of the domestic and international monetary systems. Sergio L. Schmukler has prepared this note as a comment to the papers “Proposal for an OECD Currency” by Richard N. Cooper and “One World Money, Then and Now” by Michael Bordo and Harold James, presented at the conference “Regional and International Currency Arrangements,” February 24 and 25, 2006, Vienna, Austria, organized by the Bank of Greece and the Oesterreichische Nationalbank (Central Bank of Austria). I thank conference participants for useful comments. I am also grateful to Jose Azar and Francisco Ceballos for excellent research assistance. The views expressed in this paper are entirely those of the author and do not necessarily represent the opinion of the World Bank.     

Unique Equilibrium in a Dynamic Model of Speculative Attacks

A main challenge of understanding currency crises is explaining their puzzling timing. Most “second generation” currency crisis models are static models with multiple equilibria, and exogenous shifts between equilibria are interpreted as shifts of sentiments on financial markets leading to crises. This article develops a dynamic, continuous time model with a payoff structure similar to second generation models. We derive endogenous conditions under which shifts in sentiment occur over time, characterise them in terms the strategic risk associated with speculation, and provide comparative statics. Moreover, we show that the findings correspond almost exactly to the implications of global game currency crisis models, which are often used for equilibrium selection in the static context.     

Sectoral Interests and Global Money: Renminbi, Dollars and the Domestic Foundations of International Currency Policy

In deciding whether to support an international role of their country’s currency, national policymakers are often influenced by lobbying from domestic sectoral groups. While these groups will be consistently more interested in some implications of international currency issuance than others, their specific preferences are likely to be highly context specific. Looking at the cases of the United States and China, we anticipate that domestic sectoral lobbying is unlikely to pressure either the US government to defend the dollar’s international role vigorously or the Chinese government to internationalize the renminbi fully. From this domestic sectoral perspective, the future looks to be characterized by reluctant monetary leaders rather than increasingly aggressive currency competition between the United States and China.     

Testing the Unstable Middle and Two Corners Hypotheses About Exchange Rate Regimes

The recent rash of international currency crises has generated considerable interest in the role that exchange rate regimes have played in contributing to these crises. Many economists have argued that efforts to operate adjustably pegged exchange rate regimes have been a major contributor to “the unstable middle” hypothesis and some have argued that this unstable middle is so broad that only the two corners of hard fixes or floating rates will be stable in a world of high capital mobility—the two corners or bipolar hypothesis. Two recent empirical studies by researchers at the International Monetary Fund reach opposing conclusions on these issues. We examine the issue further and show that conclusions can be quite sensitive to how exchange rate regimes are grouped into categories and the measures of currency crises that are used. In general we find that the dead center of the adjustable peg is by far the most crisis prone broad type of exchange rate regimes, but that countries need not go all the way to freely floating rates or hard fixes to substantially reduce the risks of currency crises.

The Russian foreign exchange market: Achievements on the path to liberalization

The paper analyzes Russia’s macroeconomic conditions and main trends in its foreign exchange market under financial liberalization. Structural changes in the Russian foreign exchange market are juxtaposed with major trends and proportions in the world’s forex market such as swap and futures operations and the increased role of the single European currency in the economy and finances. In the examination of the initial results of the dual currency basket policy of the Bank of Russia, the accent is on the foreign exchange market infrastructure, i.e., exchange business, clearing and settlements, as a necessary condition for Russia’s integration into the world’s financial system.     

Deciding to Peg the Exchange Rate in Developing Countries: The Role of Private-Sector Debt

We argue that a higher share of the private sector in a country’s external debt raises the incentive to stabilize the exchange rate. We present a simple model in which exchange rate volatility does not affect agents’ welfare if all the debt is incurred by the government. Once we introduce private banks who borrow in foreign currency and lend to domestic firms, the monetary authority has an incentive to dampen the distributional consequences of exchange rate fluctuations. Our empirical results support the hypothesis that not only the level, but also the composition of foreign debt matters for exchange-rate policy.     

Asian Currency Baskets: An Answer in Search of a Question?

This paper considers whether an intra regional currency basket and the associated divergence indicators could play a useful role in official exchange rate surveillance. Recently, proponents of an Asian currency basket have referred to the role the European Currency Unit played in constructing exchange rate divergence indicators as evidence of the usefulness of intra regional currency baskets for exchange rate monitoring. The paper shows that such indicators have a number of features that can lead to them obscuring underlying changes in exchange rates and that the signals they emit will often be difficult to interpret. In addition, the use of regional currency baskets for surveillance can lead to potentially serious N − 1 problems in circumstances when there is not agreement about which regional currencies will be the anchor currencies.

Exchange-Rate Policies in Emerging Countries: Eleven Empirical Regularities From Latin America and East Asia

In this paper I discuss some of the most important lessons on exchange-rate policies in emerging markets during the last 35 years. The analysis is undertaken from the perspective of both the Latin American and East Asian nations. Some of the topics addressed include: the relationship between exchange-rate regimes and growth, the costs of currency crises, the merits of “dollarization,” the relationship between exchange rates and macroeconomic stability, monetary independence under alternative exchange-rate arrangements, and the effects of the recent global “currency wars” on exchange rates in commodity exporters.     

Currency transactions and Customs flows in the foreign economic relations of a region (Based on the example of Rostov oblast)

The paper considers currency and financial transactions in Rostov oblast in the peroid 2000–2010. The change in the composition of bank sector operators is analyzed. Methods are suggested for analyzing the interrelation between currency and Customs operations and commodity flows that allows one to reveal the role of a separate region within the Russian Federation as a transit territory for exported and imported goods in foreign trade supplies of other regions.     

The Benefits and Costs of an International Currency: Getting the Calculus Right

Does it pay to issue an international money? Should a government promote internationalization of its currency? And if so, how might policy makers shape cross-border use to maximize net gains? The aim of this essay is to address these old questions anew, in hopes of providing clearer insight into the strategic calculus involved. Scholars have debated the net benefits or costs of currency internationalization for decades. Yet despite much sound and fury little analytical consensus exists. The conventional literature is marred by at least three critical defects, which might be called the three M’s—Misconceptions, Misplaced Concreteness, and outright Mistakes. A proper appreciation of the three M’s, I endeavor to show, can take us a long way toward getting the calculus right.     

Comments on S. Edwards: “Monetary unions, external shocks and economic performance: a Latin American perspective”

I discuss Sebastian Edwards’ most recent paper with great pleasure. As so much of the work of this distinguished economist, this paper provides new insights on a burning issue in international economics. Here Edwards provides empirical evidence on the resilience to external shocks of countries that lack a national currency (“monetary-union” or MU countries). The paper starts by reviewing the issues and literature relevant on exchange-rate regimes, dollarization, and MU in Latin America, with an emphasis on the question if countries in the region satisfy key optimal currency area criteria. Then the paper provides extensive new evidence on economic performance in MU countries, in comparison to countries with a national currency, using a large world panel sample. Performance tests are conducted for the comparative likelihood of MU countries of sudden stops in capital flows (SS) and large current (deficit) reversals (CAR), as well as their ability to absorb terms-of-trade shocks, SS, and CAR. The results are generally negative and significant for the comparative performance of MU countries. To set the stage, I start my comments by documenting first how country selection of exchange-rate and monetary regimes is quickly evolving in the world during the last decades, discussing subsequently how economists’ views follow suit (Section 1). Then I discuss some aspects of Edwards’ paper, focusing in particular on the data and model specification (Section 2). I end with brief implications for exchange-rate and monetary regime choice in Latin America.     

The Declining Impact of Exchange Rate Volatility on Trade

The introduction of the euro in 1999 eliminated exchange rate volatility between the members of the eurozone. Despite the elimination of currency risks, trade flows within the eurozone hardly increased (Bun and Klaassen in Oxf Bull Econ Stat 69:473–496, 2007, Santos Silva and Tenreyro, 2009). Using a standard gravity model, we find that nominal exchange rate volatility has had a negative effect on trade before 1985 but that this effect disappeared in later years, coinciding with the introduction and rapid diffusion of over-the-counter currency swaps. The estimated coefficient for the euro dummy does not change when we include nominal exchange rate volatility as an additional regressor. This confirms our finding that the impact of exchange rate volatility on trade has been small in more recent years.     

The Determinants of the Secondary Market Price of Less Developed Countries’ Debt

A present-value model of less developed countries’ (LDC) debt is developed to understand the factors that affect the discount on the secondary market. LDC debt trades at a substantial discount on the secondary market. This paper investigates the determinants of the discount for a sample of 13 countries over a 9 year period. The findings show that debt–exports, foreign currency reserves–imports and total debt service to exports ratios are significant determinants of the secondary market prices of LDC debt. The discount is higher in countries where debt–exports ratios are higher and is lower for those with lower foreign currency reserves–imports ratios. Concentration of debt with money center banks has a positive and significant effect on the secondary market price of debt.

Monetary policy and EMU enlargement: Issues regarding ERM II and adoption of the euro in Estonia

The aim of the paper is to give an overview of the issues related to Estonia's entry into ERM II. For that purpose the article describes the official position of the Estonian authorities regarding entry into ERM II and the adoption of the euro, explains the rationale for early entry into ERM II, and presents the reasons for maintaining the currency board arrangement until full membership in EMU. Also, the challenges of the adoption of the euro are discussed. The article concludes that early entry into ERM II is appropriate as the perceived costs—short-term costs of fiscal consolidation and the cost of giving up independent monetary policy and flexible exchange rates as stabilization tools—are practically non-existent in Estonia. The paper argues that the high level of exchange rate stability and nominal convergence, relatively high flexibility of the economy, and integration with the euro area support the rationale for maintaining the currency board arrangement and adopting the euro early.     

An Interpretation of the Collapsing Process of the Bretton Woods System

This paper attempts to determine the environments that market confidence might play a significant role in the collapse of the Bretton Woods system. We build a game-theoretic model of currency crises where a continuum of small speculators can decide their market confidence and trading positions. In the model, the convertibility of dollar is assumed to exhibit a long-term downtrend due to Triffin’s dilemma. The problem is analyzed on the grounds of both certainty and uncertainty. In the certainty case, we find that if the convertibility of dollar is low enough, a dollar crisis is inevitable, but if the convertibility is in an intermediate range with multiple equilibria, the Bretton Woods system is vulnerable to self-fulfilling speculation. In the uncertainty case, the incidence of the confidence crises will disproportionately increase as the convertibility of dollar falls. Lastly, this paper shows that the Federal Reserve Bank’s secrecy may extend the maximum lifespan of the Bretton Woods system.     

Strong Currency and Weak Currency

This paper presents a two-country model in which two currencies compete with each other. There exists an equilibrium in which the two currencies with different rates of inflation circulate as media of exchange despite neither currency being required to be used for transactions. Taxes payable in local currency and asymmetric injection of fiat money by the government through purchases of a certain good generate demands even for the currency with a higher inflation rate. In such an equilibrium, the government that issues the currency with a lower rate of inflation collects seigniorage not only from its own residents but from the residents of the other country provided that the rate of inflation is positive. The strong currency in the sense of a low inflation rate becomes an international medium of exchange. Policy games, in which the two governments simultaneously choose and commit to tax rates and inflation rates, are also examined. We show, among other things, that the equilibrium rate of inflation is zero in this policy game. In other words, unlike a common argument, the rate of inflation does not go below zero. This result is due to the fact that a negative rate of inflation induces a negative amount of seigniorage andvice versa. Some alternative currency regimes are examined. Even for a country with a weak currency, abandonment of its currency leads to a lower level of welfare. Monetary unions are briefly discussed as well.J. Japan. Int. Econ., Dec. 199812(4), pp. 305–333. University of Tokyo, Tokyo, Japan; University of Tsukuba, Ibaraki, Japan.     

Do international shocks affect small wholesalers and retailers?

Previous research has suggested that the smallest firms are those most vulnerable to international competition, as measured by exchange rate fluctuations and import shares. However, that work—and the overwhelming bulk of the empirical literature on determinants of exit or firm survival—dealt entirely with the manufacturing sector of the economy. This paper analyzes annual US data for 1989–2005 for about 50 wholesale and retail sectors to explain small firm exit rates in several employment size categories. The main result is that wholesalers respond negatively to a stronger currency in a manner similar to that of manufacturers, while retailers are generally unaffected.     

Currency unions and trade: The special case of EMU

In this paper, the impact of the adoption of the euro on the commercial transactions of EMU countries is investigated. It seeks to disentangle the effects of eliminating exchange rate volatility — and those of other policy factors that promote integration — from the influence of the emergence of the European currency union. Since EMU is a relatively new phenomenon, a panel estimation of the gravity equation in a dynamic framework is used in order to capture effects like trade persistence. The main finding is that the adoption of the euro has had a positive but not an exorbitant impact on bilateral trade between European countries (ranging between 9 and 10 per cent). The impact is much lower than that shown in the recent literature on a larger and heterogeneous set of countries. One reason for this divergence seems to be that the euro was adopted after decades of integration policies had already worked through in Europe. JEL no. F4, F15, C230