Published by EH.Net (August 2018)

Barry Eichengreen, Arnaud Mehl, and Livia Chiţu, How Global Currencies Work: Past, Present, and Future. Princeton, NJ: Princeton University Press, 2018. xv + 250 pp. $39.50 (hardcover), ISBN: 978-0-691-17700-7.

Reviewed EH.Net by Christopher M. Meissner, Department of Economics, University of California, Davis.

Currencies that have wide economic and financial use beyond the borders of the home country are called international currencies. There are relatively few of them today – likewise in the past. The uses of international currencies include trade finance, bond finance, and official reserve holding. Not all currencies have been used internationally to the same extent. In fact, at any given time there appears to be only a small set of currencies that account for the vast majority of transactions in the domains previously cited.

How can this be explained? Why wouldn’t the Turkish Lira, or the Bangladeshi Taka be on an equal footing with the U.S. Dollar and the Euro today? Why was sterling deemed vastly superior to the Yen or the Ruble prior to 1913? Obviously a currency has to satisfy some necessary conditions including delivering stable value, offering sufficient liquidity and so forth. Can multiple currencies satisfy all of these requirements at once, and if so can all of them be used concurrently? Barry Eichengreen (professor of economics at the University of California, Berkeley) along with Arnaud Mehl and Livia Chiţu (two economists at the European Central Bank) tackle this question in this book.

There are two main theoretical views of international currencies according to the authors. The first, an older view, holds that an international currency is a natural monopoly, such that one currency reigns supreme at any point in time. This view is most often associated with the idea that there are network externalities in international currency use. Moreover, the factors driving agents towards a particular currency include the liquidity of local financial markets, the availability of trade finance and the interest rate at which new debt can be financed. Once a standard is established, it becomes difficult to dislodge because these characteristics (and their benefits) are a positive function of the number of users. Persistence and inertia are a defining feature of the traditional view. Competing standards do not have the “installed user base” of the incumbent.

A competing view argues that monopoly and dominance have been over-stated. This is the view favored by the authors. There is in fact, according to them, nothing preventing multiple currencies from concurrently holding international status — each of them accounting for a significant share of international transactions. A corollary of this new view is that inertia and persistence are weaker than the traditional view would hold. While not wholly rejecting the idea that strategic complementarities exist, a significant portion of the book is devoted to arguing, and showing, that these complementarities are not so strong as to prevent agents from moving to use other currencies. When economic conditions dictate, there are many benefits from doing so. In order to show this, the authors take a long run approach, which almost by definition the only way such claims could ever be tested.

Indeed, the authors assemble a range of new, comprehensive historical data ranging from the early twentieth century to the present. The authors demonstrate an impressive ability in locating, collecting and organizing a large amount of scattered and fragmentary archival data from the early twentieth century on reserve holdings, the share of trade finance by currency, and currency denominations of bonds. After many, many hours in the archives and significant analysis, the data reveal that the U.S. dollar and pound sterling were concurrently in use in the 1920s and 1930s in all of these domains. This historical evidence is supportive of the “new” view.

The data collected are also analyzed with the help of regression analysis. Chapter 5 presents a series of regressions in an effort to determine the reasons for the rise of the dollar especially in the realm of trade finance in the 1920s. The hand-collected data used include balance sheet data for a large number of American banks, yield spreads on various asset classes and many other relevant control variables. In terms of trade finance, U.S. banks were strictly prohibited from international activity by law prior to 1914. A lack of backstop support from a central bank was also a key issue. However, American banks were finally authorized to engage in international activity with the advent of the Federal Reserve in 1914. The regression results point to the importance of large bank activity and also to the role of the Federal Reserve in providing support for the market. Additional data on spreads comparing the sterling and the dollar markets substantiate the argument.

Chapter 5 is the analytical heart of the book and it is the most technical. The chapter is preceded by a series of mostly narrative chapters detailing the institutional, political and economic reasons for the rise of the dollar and the fall of sterling. Special attention is paid to the Genoa Conference and to the issue of international reserves in the interwar period. Chapter 5 is followed by an interesting set of case studies on the decline of sterling after World War II, the quick rise and then fall of the yen in the 1980s, the emergence of the euro after 1999, and of course the incipient rise of the Chinese Renminbi. Each chapter blends thorough discussion of the historical record with reference to the relevant data. Each chapter brings to bear the real world complexity of establishing a dominant currency but also deftly relates to the more abstract theory and to the master narrative of the book. In the end, the authors find further support for the idea that multiple currencies can and will be used internationally when economic conditions are appropriate.

Throughout the book, the authors (by necessity) survive off their uncanny ability to locate disparate fragmented sources on currency use. Central bank reports, periodicals, bankers’ gazettes, evidence cited in formal hearings and secondary sources are all used to support their arguments. Tracking reserve currencies is notoriously tricky due to confidentiality as witnessed by the fact that the IMF COFER data at the country level remain confidential even for historical periods. The authors make a valiant and ultimately convincing attempt to deal with the data difficulties inherent in the project. No one, at this stage, has done it better. It is unlikely that in the near future anyone will improve upon it either.

This book takes a largely positivistic approach to the issue of international currency. The authors assume that financial actors wish to maximize returns and minimize costs. In addition the international diplomatic and power dimensions of international currency are explored (especially as regards sterling and the Renminbi). Evidence consistent with these and more elaborate arguments is marshalled. The authors construct the foundation for a new theory of international currency based on an accurate and thorough interpretation of the historical record.

Some readers might have wished to have an answer to normative questions. These might include the following: What determines the socially optimal number of international currencies? Is a policy to internationalize a currency beneficial for the issuer only or for all users as well? What are the welfare implications of international currency competition? Under what conditions are both parties (users and issuers) better off than under a status quo ex ante? That is, is there a way to order and rank different equilibria in terms of welfare? These are questions that can only be answered with the further development of solid economic theory. In the meantime, for economists who want to contemplate these issues and to make some effort in that direction, How Global Currencies Work offers some tentative answers. There is no better place to start thinking about these issues than with this book.

Christopher M. Meissner’s recent papers (with co-authors) include “Austerity and the Rise of the Nazi Party,” “Geography, Income, and Trade in the Twenty-first Century,” and “Upstart Industrialization and Exports, Japan 1880-1910.”

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