International Currencies Past,
Present and Future:
Two Views from Economic History
Barry Eichengreen
November 2014
1
• The history of the international economy is
often told in terms of the rise and fall of
leading powers.
– Angus Maddison told it in terms of leaders and
followers and the moving technological frontier.
– Charles Kindleberger told it in terms of the changing
identity and but unchanging importance of the lead
economy.
• This story is typically told in terms of British
hegemony in the 19th century (the imperialism
of free trade, the availability of cheap cotton,
with Britain still the leading trading and
exporting nation as late as 1913) and U.S.
hegemony in the 20th – followed by Chinese
hegemony in the 21st?
2
The same story is often told through
the lens of currencies
• The 19th century international economy (first age of
globalization, era of the gold standard) was organized
around and dominated by sterling.
– As in Marcello de Cecco’s work on the gold standard.
– As in Keynes’s Treatise, where the Bank of England was
“conductor of the international orchestra.”
• The 20th century international economy (or at least the
international economy of the second half of the 20th
century, sterling remaining dominant as late as WWII) was
organized around and dominated by the dollar.
– As in Ronald McKinnon’s writings on the “gold-dollar system”
and “global dollar standard.”
• Suggesting that the 21st century international economy will
be organized around and dominated by the Chinese RMB.
– As suggested in Arvind Panagariya’s recent writings.
3
This view is supported by theory
• Network externalities are powerful.
– It pays to use the same currency that others also use.
• It follows that international currency status is a natural monopoly.
– There is room in the global economy for only one consequential global
currency (first it was sterling, now it is the dollar, in the future it will be the
RMB).
• First mover advantage is strong.
– Advantages of incumbency flow from network increasing returns.
• It follows that persistence is strong.
– Thus, an international currency can retain its dominance long after the issuer
has since lost its economic, fiscal and political capacity to provide international
currency services on the scale required by an expanding global economy,
reflecting the hold of network effects.
• Resulting in liquidity shortages in the 1920s and 1930s?
• Resulting in global imbalances and doubts about the dollar after the turn of the century?
• This perhaps helps us understand the chronic fragility of the international
monetary system, something that has long intrigued economic historians
(and troubled policy makers).
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This view is supported by a considerable
body of theoretical literature
• Krugman, Paul (1980), “Vehicle Currencies and the
Structure of International Exchange,” Journal of Money,
Credit and Banking 12, pp. 513-526.
• Krugman, Paul (1984), “The International Role of the Dollar:
Theory and Prospect,” in John Bilson and Richard Marston
(eds), Exchange Rate Theory and Practice, Chicago:
University of Chicago Press, pp.261-278.
• Matsuyama, Kiminori, Nobuhiro Kiyotaki and Akihiko
Matsui (1993), “Toward a Theory of International
Currency,” Review of Economic Studies 60, pp. 283-307.
• Rey, Hélène (2001), “International Trade and Currency
Exchange,” Review of Economic Studies 68, pp. 443-464.
– These theoretical contributions influence, for better or worse
(and I will suggest, not entirely better) what economic historians
write.
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But that work is based on a limited
empirical foundation
• We know something about the currency
composition of foreign exchange reserves in the
decade leading up to WWI, courtesy of Peter
Lindert.
– “Key Currencies and Gold, 1900-1913,” Princeton
Studies in International Finance (1969).
• We know something about this since 1973
courtesy of the IMF’s COFER data base.
– http://www.imf.org/external/np/sta/cofer/eng/
• But we know little if anything of a systematic
nature in between.
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In this lecture…
• …I will report on a research project in which I
have been engaged for some years (with
collaborators like Marc Flandreau, Arnaud Mehl
and Livia Chitu) that seeks to fill in the gaps.
• The results challenge the conventional wisdom as
I describe it above.
• They suggests replacing the traditional (or “old”)
view of international currencies with a new view.
– You can see from this terminology which view I favor.
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Two views from economic theory
• Old view: network effects
– It pays to do what everyone else
is doing.
– Once a standard is widely
adopted, it becomes locked in.
– First-mover advantage is strong.
– Because of increasing returns,
only one global currency can
exist at a point in time.
– The dollar’s dominance for the
last 50 years is evidence of this.
– The old view suggests that dollar
dominance will continue.
• New view: open systems
– Interchangeability costs are
not that high.
– Hence increasing returns are
not that strong.
– First-mover advantage can be
overcome relatively quickly.
– Multiple international
currencies can coexist.
– The new view suggests that
the dollar will have rivals
sooner rather than later.
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There is theoretical support also for
this new view, but a different kind
• Joe Farrell and Paul Klemperer,
“Coordination and Lock-In: Competition
with Switching Costs and Network Effects,”
Handbook of Industrial Organization
(2007).
• Paul David and Julie Bunn, “The Economics
of Gateway Technologies and Network
Evolution: Lessons from Electricity Supply
History,” Information Economics and Policy
(1988).
• David Clark, “The Design of Open Systems”
(2003).
– Though not much application previously to
international monetary relations.
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More importantly to us, there is
historical support
• Practice of holding foreign
exchange reserves was largely
ad hoc before 1913.
• Nonetheless, courtesy of Peter
Lindert we know something
about their composition.
• Lindert had to make a number
of heroic assumptions,
admittedly, when constructing
these estimates.
• But the result, for what it is
worth, is not obviously
consistent with the “old” or
“natural monopoly” view.
10
More important, there is historical
support
• Practice of holding foreign
exchange reserves was largely
ad hoc before 1913.
• Nonetheless, courtesy of Peter
Lindert we know something
about their composition.
• Lindert had to make a number
of heroic assumptions,
admittedly, when constructing
these estimates.
• But the result, for what it is
worth, is not obviously
consistent with the “old” or
“natural monopoly” view.
11
We also have detailed case studies
• Courtesy of Stefano Ugolini
(European Review of
Economic History, 2012), we
know something about the
foreign exchange portfolio
of the National Bank of
Belgium at mid-19th century,
for example.
• NBB was one of the first
central banks to accumulate
a substantial foreign
exchange reserve portfolio.
• The composition is not
obviously consistent with
the natural monopoly view.
12
Then the 1920s
• Some might dismiss the
preceding evidence on the
grounds that forex reserves
played a relatively limited role
before 1913.
• But this was no longer true in the
1920s.
• Formalization of previous ad hoc
practice of supplementing gold
with forex reserves.
• Response to perception of global
gold shortage.
• This indeed facilitated some
increase in the share of forex in
total reserves relative to the
prewar period.
– To some 30% of total central bank
reserves on the eve of the Great
Depression.
13
What do we know about the
composition of forex reserves in this
period?
• The answer is: remarkably
little.
• We have assertions by Robert
Triffin that sterling continued
to dominate as late as 1938
and, indeed, during World
War II.
– Robert Triffin, Gold and the
Dollar Crisis (Yale 1960).
• But these are assertions, not
historically documented facts.
– Motivating the EichengreenFlandreau –Mehl-Chitu research
project.
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What we find is inconsistent with the old
or natural monopoly view
Global forex reserves, 1929
• Here is our reconstruction
of the global picture circa
1929.
– Notice very similar shares of
dollars and sterling.
– Note also how the franc and
the mark essentially
disappear from the picture.
• Entry still is not free.
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• We can buttress this view by considering also
the other roles of an international currency (in
addition to its role as a form of international
reserves also as an international unit of
account, means of payment, private store of
value).
– Unit of account, means of payment and store of
value being the three core functions of “money.”
16
Evidence on currency denomination of
trade credit
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Evidence on currency denomination of
international bonds
18
Currency denomination of
international oil market transactions
19
So why wasn’t this appreciated
previously?
Thank you Spain!
For Norway, Italy, Spain and
Switzerland we have a continuous run
• This picture provides a
sense of how quickly the
dollar rose to prominence
(from a standing start).
– Appears to overtake sterling
by the mid-1920s.
• Why wasn’t this
appreciated?
– Perhaps because much of the
ground it gained in the 1920s
was then lost in the unstable
1930s, as central banks
liquidated their forex
reserves.
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Data for a larger group of countries
shows same thing
• Again we see the dollar’s
overtaking sterling by 1925, the
maintenance of diversified
central bank forex reserve
portfolios in the second half of
the 1920s, and liquidation in the
1930s.
• We see also how subsidiary
currencies were not very popular
(though the French franc gains
some ground in the 1930s).
• Speaks to the question of
whether they might be popular
now (or whether scale, network
effects, and liquidity favor largecountry providers).
Ten major reserve holders
21
The Leverage Cycle
• Also illustrates the procyclical
nature of this kind of monetary
system.
• When confidence is rising, central
bank reserves are being
augmented, enabling to expand
credit.
• When confidence is shocked, the
reserve liquidation that follows
leads to an endogenous
contraction of credit, further
undermining confidence.
• Again we see why there was and
is dissatisfaction with this system.
Ten major reserve holders
– See Ben S. Bernanke, “The
Macroeconomics of the Great
Depression,” Journal of Money,
Credit and Banking (1995).
22
France is indicative of the forex
liquidation that followed
• The Bank of France of
course being a big player in
the accumulation of forex
reserves starting in 1926
and a big player in the
liquidation first of sterling
and then of dollars.
23
This period also sees some
regionalization of forex holdings
4 Scandinavian countries here
• Sterling remaining more
popular in the Sterling Area,
the dollar in much of Latin
America.
• Relates to the question of
whether we should see the
emergence of the RMB as a
reserve currency as mainly a
regional phenomenon
affecting Asia or a global
phenomenon.
24
What then happened after WII?
• Again, the picture is a bit opaque.
• Typically, analyses start in the 1970s, when the
IMF’s COFER data become available.
– For example Jeffrey Frankel and Menzie Chinn,
“Will the Euro Eventually Surpass the Dollar as
Leading International Reserve Currency?” NBER
Working Paper no.11510 (2005).
• But, using archives, it is possible to do better.
25
This may be the first continuous series
on reserves since 1945
• Note sterling’s
immediate postwar
dominance but also
subsequent decline.
• Dollar’s rapid rise
through mid-1960s but
then leveling off.
26
This makes it look like there was a change in
reserve management in mid-to-late 1960s
Now at constant exchange rates
• Dollar share stabilizes and
shows some signs of decline.
• One sees the appearance of
the deutschmark, the French
franc and eventually other
rivals to the dollar and sterling.
• 1968 saw the collapse of the
gold pool, agreement on the
SDR.
• 1971-3 then saw the final
collapse of the Bretton Woods
System, which contemporaries
anticipated as heralding a shift
away from dollar pegs and
dollar reserves.
27
This makes it look like there was a change in
reserve management in mid-to-late 1960s
Now at constant exchange rates
• If we estimate conventional
models relating reserve shares to:
– Issuing country size as a measure
of network effects
– Lagged shares as a measure of
inertia
– Inflation and depreciation as
measures of policy credibility
• The Chow Test statistic reaches a
peak in 1968.
– Before the breakdown of BW,
although not before the
breakdown of BW was foreseen.
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The dominant impression is one of
stability, though there are small changes
• Network effects grow
weaker.
– Consistent with the “new
view” of reserve currency
competition.
• Inertia grows stronger
– Habit formation? With
sterling’s decline, absence
of alternatives?
• Policy credibility becomes
more important.
– Though change from preto post-1973 period is
insignificant.
29
First continuous series…
• The other point evident from
the figure is how the absence
of alternatives continues to
support the dollar.
• One can also see why the euro
was seen as a potential
challenger to this hegemony.
• And also how the euro crisis
has represented a setback.
• The other thing that comes
through is the very limited role
played by other, subsidiary
currencies.
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• A point that is perhaps
more clearly evident here…
31
So what does this history imply for the
future?
• Strong persistence (habit formation)
means a continuing role for the
dollar (absent steps that undermine
U.S. policy credibility).
• But that network effects are not
everything suggests that there can
be supplementary sources of
international liquidity, like the RMB.
• That’s good, given the inability of
the U.S. to continue to be the sole
supplier of international liquidity to
a global economy that is expanding
more rapidly than the U.S.
• And 1920s history suggests that such
supplementary sources of liquidity
can acquire a role quite rapidly
(contrary to the “old view”).
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But what alternative sources?
33
This one?
34
And this one?
35
In its latest annual report, the ECB reported that
the euro’s reserve-currency role was eroding
• The euro’s share in world
currency reserves declined has
declined from 28% at its peak in
2009 to 24% in the most recent
quarter.
• It accounts for 25% of
international debt securities,
again down slightly from prior
years.
36
For this to change, Europe will have to
draw a line under its crisis
• Will it?
• I have my doubts.
• We may want to pursue this in the Q&A.
37
China, too, faces challenges
• An attractive international currency has three essential
attributes: size, stability and liquidity.
• The dollar could rise quickly in the 1920s because the U.S.
had:
– Size (U.S. financial markets being larger than British financial
markets – see Rousseau & Sylla).
– Stability (no financial crises between 1915 and 1929 – though
what came after was proof by counterexample).
– Liquidity (establishing a central bank to backstop domestic
financial markets and provide liquidity to the market in dollardenominated trade credits in 1914).
• Chinese financial markets currently lack the requisite size,
stability and liquidity – the country will have to work hard
to attain them.
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Finally, one can ask whether China’s politics are
compatible with its monetary ambitions
• All reserve currencies in history have been the
currencies of republics or democracies.
• Both Britain and the U.S. had contested elections and
political systems that limited arbitrary action by the
executive.
• That was important for fostering investor confidence
(on the part of both domestic and foreign investors).
• Freely contested elections and limits on the
prerogatives of the executive are not exactly
characteristics of China’s political system.
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Might China be able to establish limits
on arbitrary executive action?
• The general secretary of the Communist Party is
increasingly constrained by the National People’s
Congress and its diverse interests.
• Other bureaucratic decision makers are increasingly
constrained by requirements of transparency and
disclosure.
• Internet-based movements are forcing Chinese policy
makers to strengthen labor and environmental
standards. Why not creditor rights?
• Key policy makers (the PBOC) could be given
independence from politics.
– Will this be enough? Only time will tell.
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• Thank you very much.
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