A full-fledged monetary union replaces its members’ national currencies with a single currency (the euro in the European case) and establishes a single central bank (such as the ECB) to pursue a single monetary policy for the whole union. If its members’ economies experience large idiosyncratic shocks, the union’s monetary policy will not always be optimal for each member. It follows that the benefits of monetary union are more likely to outweigh the potential costs, the greater is the degree of real economic integration among its members. Yet the adoption of a single currency is apt to foster further integration, including the integration of the financial sector, as is now occurring in Europe.
The creation of a supranational central bank calls for political cooperation too. There must be agreed arrangements for choosing the bank’s leadership and holding the bank accountable for its monetary policy. There is also the need for constraints on the members’ fiscal policies, even the harmonisation of those policies.
In a new book, we survey the prospects for regional monetary integration in various parts of the world.1 We are, of course, at risk of drawing general conclusions from a single case – the European experience – but believe that our conclusions are robust enough to provide a framework for assessing the likelihood and potential benefits of monetary integration elsewhere in the world. Although we do not predict rapid change in the monetary landscape, it is worth asking which regions might gain most from monetary integration and what obstacles they would have to overcome.
When examining other country groups, we focus in particular on the amount of intra-regional trade, the possible broadening and deepening of regional financial markets, and the possible costs arising from the loss of separate national monetary policies. We also dwell on the character and strength of regional institutions, noting that Europe benefitted from having well-developed institutions before it moved to monetary union. Finally, we consider the relative sizes of the countries in a regional group, asking whether country groups more asymmetric than the European Union are less likely to form monetary unions.
Looking back at the currency unions of the 19th century – the Scandinavian and Latin unions and the German Zollverein – we argue that they were not really monetary unions as we define them. They did have a common currency standard – rules governing the coining and exchange of specie – but never sought to pool monetary sovereignty or create a supranational central bank. Thereafter, we examine the prospects for full-fledged monetary unions in western Africa, and the Middle East, North America, Mercosur, and East Asia. We find that those groupings have characteristics that make monetary union unlikely in the near term.
Africa and the Middle East
The countries of Western Africa are contemplating a monetary union (ECOWAS) that would combine the CFA franc zone in Western Africa with several other countries, including importantly Nigeria, the largest country in the region. We note that the intra-regional trade of the CFA franc zone is very small compared to its trade with France and other EU countries, and that is also true of the larger ECOWAS group. We also note that the countries involved have repeatedly postponed their monetary union.
The Gulf States are likewise contemplating monetary union. Although their intra-regional trade is very small, they have similar economic structures and share a common dominant export. In their case, moreover, the development of a single financial market would seem to be the main goal of a monetary union. Weighing against progress, however, is the huge difference in country size: Saudi Arabia accounts for more than half the region’s GDP. Although the Gulf States have followed closely the European model in their thinking about monetary union, obdurate issues have arisen, including disagreement about the location of the union’s central bank. Furthermore, the recent depreciation of the dollar has posed new challenges, as Kuwait has moved from a dollar peg to a basket peg. Here, as in Western Africa, a move to monetary union is not likely in the near term.
What about a North American monetary union? A union comprising Canada, Mexico, and the United States does not seem feasible politically or institutionally. Relative to the euro area, North America has a greater disparity in per capita incomes and would be relatively closed to trade, pointing to large efficiency gains. Yet the United States would likely insist upon a dominant role for the Federal Reserve System and the US dollar, and the US Senate would presumably insist on retaining its right to ratify appointments to the Board of Governors. For Canada, moreover, the issue is intricate economically, because of its economic geography – the concentration of manufacturing in Ontario and Quebec, and the concentration of commodity production elsewhere in the country. Nevertheless, the recent appreciation of the Canadian dollar has revived debate in Canada about a North American monetary union (at a more “reasonable” exchange rate).
The radicalisation of some Latin American countries, reflecting inter alia, the anti-American stance of Hugo Chavez, has led some to predict monetary union in South America’s Mercosur – a prediction supported by the recent growth of intra-regional trade. Yet the Mercosur countries are still rather closed economies, and much of their trade is with countries outside the region. Finally, the region is still vulnerable to volatile capital flows, and we cannot identify a single country from which a monetary union could borrow credibility. We do discuss the possibility of dollarisation as an alternative to monetary union, but conclude that it would not be appropriate for the larger countries of the region. Yet dollarisation may be appropriate for the small countries of Central America, which have strong trade links with the United States and receive large worker remittances from it.
The Asian financial crisis of the late 1990s generated a flurry of interest in monetary cooperation, but it was aimed chiefly at reducing Asia’s dependence on the IMF, which had imposed intrusive policy conditions during the Asian crisis. Thus, the only immediate outcome was the Chiang Mai Initiative, a network of bilateral currency swaps involving the ten ASEAN countries plus China, Japan, and South Korea. And though it was inspired by Asian dissatisfaction with the IMF, it used the IMF to cover for the lack of Asian institutions able to formulate policy conditions analogous to those of the Fund. Under the rules adopted initially, a country could not draw more than 10% of the financing potentially available to it unless it had reached or was close to reaching an IMF agreement.
The absence of Asian institutions able to formulate common policies reflects a basic tenet of ASEAN itself – non-interference in its members’ internal affairs. This principle is utterly inconsistent with monetary union, which transfers the control of monetary policy to a supranational institution and thus ‘interferes’ with the internal affairs of its members. Indeed, the very notion of supranationality is foreign to the conduct of economic relations among the ASEAN countries. There are, however, looser forms of monetary cooperation that may appeal to the East Asian countries. We pay close attention to the possibility of pegging Asian exchange rates to a common basket but distinguish between two sorts of baskets – an external basket containing only the currencies of outsiders, and an internal basket containing the currencies of the participating countries. The need to distinguish between them does not arise when a single country adopts a currency basket; all of the currencies in that basket are, by definition, external. It arises importantly, however, when countries adopt a common basket.
When countries adopt a common external basket, they undertake to stabilise their national currencies within a band surrounding the agreed target value of the basket. But they will thereby limit fluctuations in the relative values of their own national currencies. If countries agree instead to adopt a common internal basket, they will again stabilise the values of their currencies in terms of the currencies in the basket, but they will not stabilise the values of their currencies in terms of the dollar, euro, and yen (unless, of course, the yen is part of the internal basket).
There is another difference between the two baskets. Countries adopting a common external basket import to some degree the monetary policies of the United States, the Euro Area, and Japan – the countries whose currencies are most likely to comprise the basket. But when they adopt an internal basket, they have no obvious anchor for their monetary policies. The Europeans adopted an internal basket as the basis for the European Monetary System – the regime that preceded the move to monetary union. But the monetary policy of the Bundesbank constrained and thereby anchored the monetary policies of the other participating countries, and there is no Asian counterpart to the Bundesbank.
Other monetary concerns
Our book concludes with a chapter on the implications of monetary integration for the international monetary system, the reserve role of the dollar, and related issues. We express particular concern at the failure of the Chinese authorities to permit a more rapid appreciation of the renminbi. Combined with the depreciation of the dollar vis-à-vis the euro and other major currencies, the relatively rigid renminbi-dollar rate threatens to produce a second-best solution to the problem of global imbalances. It substitutes a large appreciation of the euro and the pound vis-à-vis the dollar and renminbi, threatening Europe’s prosperity, for the first best solution – a substantial appreciation of the renminbi vis-à-vis the dollar and the euro. In a world of floating exchange rates, a single rigidity, the dollar-renminbi rate, hugely distorts the global adjustment process.
1 Regional Monetary Integration, Cambridge University Press, November 2007.