Back to Portfolio for the Future™

World Currency: Who Needs a Numeraire?

One startling fact about the new book, How Global Currencies Work: Past Present and Future, is to be found in the index.

One would normally expect, from a title and subtitle like that, that there would be a lot of pages enumerated at the index heading “Bretton Woods.” After all, the Bretton Woods Conference in the eponymous town in New Hampshire established a new post-war monetary and financial system, officially declaring the US dollar the world’s numeraire, the medium of the various media of exchange. That was an important event in the usual accounts of, well, how global currencies work.

But if you look up “Bretton Woods” in this book’s index, you find exactly one reference. And that one reference seems in context rather dismissive.

What gives?

How Global Currencies Work is the work of Barry Eichengreen, Arnaud Mehl, and Livia Chitu. Mehl and Chitu are both economists at the European Central Bank. Eichengreen is a professor of economics and political science at the University of California, Berkeley. Their hypothesis is that it is perfectly possible for a plurality of currencies to share the global stage.

This is an important thesis, to which currency traders and speculators might want to pay attention. It means, among much else, that the PRC’s renminbi and the US dollar are not necessarily engaged in a sort of iron-cage death match. The rise of the former need not mean the demise of the latter.

Further, this new take on global currencies doesn’t make the Bretton Woods Conference out to be as earth shaking an event as is often thought.

Conventional Wisdom

Conventional wisdom, as the authors see it, is as follows (and so far as I can tell, many speculators and traders are conventional in this sense): Britain’s sterling conducted the international monetary orchestra through the 19th century and well into the 20th. Britain’s “status as a leading foreign lender and home to the world’s deepest financial markets gave its central bank unmatched influence over the operation of the international monetary and financial system.

But two world wars and the great toll they imposed on the United Kingdom forced a passing of the torch of monetary/financial leadership across the North Atlantic even before that ocean was entirely clear of U-boats. This is the significance of Bretton Woods in the usual account, and of its only mention in this book. Since then, the dominance of the dollar (backed by gold until Nixon decreed otherwise, backed merely by fiat since then) has “given the Federal Reserve System singular leverage over global financial conditions” which “persists to this day.”

The story extrapolates from this: the rise of China means, in time, the hegemony of its currency. The twenty-first century will see the development of a global monetary system regulated by the People’s Bank of China. Due to network effects, exporters and investors around the world will be drawn to the renminbi in ways that will lock in that dominance, since on this view international currency status is a natural monopoly.

A Contrary View

These three authors contend that the above view is based more on theory than on evidence.

There is for example, no database on the composition of foreign exchange reserves between 1913 and the early 1970s. If this data existed, would it show that the pound remained the dominant reserve currency for the first three or four decades of that period? Perhaps, but that is guesswork.

There does exist data for the period 1899-1913, but this data does not show quite the London-centered financial world presumed by the conventional account. At the beginning of that period, sterling accounted for 64% of reserves, with Germany’s mark and France’s franc also constituting “non-negligible shares.” Sterling’s share slipped a bit over the following years, so that it was down to 48% of reserves in 1913, when the database created by Peter Lindert goes silent. Although sterling clearly had the leading role, it was never the only player on the stage.

From other evidence we can infer that the rise of the US dollar to an important status on that stage was a rapid and took place between 1913 (when it was “used hardly at all” on the international scene) and 1923 (by which time the transformation was accomplished). For a new player to take central stage within a decade indicates, to these authors, that the lock-in or network effects are not as powerful as they are sometimes made out to be. They were not working for the pound.

I will leave the particulars of the argument for the readers of this book to discover on their own.

Final Thoughts

I will, though, register a complaint about the graphics. Many of the graphs in this book are designed to show us the respective role of various currencies ... as shades of gray on a bar. It would have been far better to use colors, otherwise these bars fail to convey their message as the darker gray is generally difficult to distinguish from the lighter gray without more effort than ought to have to go into such a task.

The conclusion, though, is clear enough: “multiple considerations point to a future in which several national currencies will serve as units of account, means of payment, and stores of value for transactions across borders,” and financial technology will continue to evolve in a direction that will support this.