Only a short time ago, economists were predicting that the number of currencies in the global monetary system would fall from more than 150 to perhaps three or four. In 2001, Harvard's Kenneth Rogoff wrote in the American Economic Review, "It appears likely that the number of currencies in the world, having proliferated along with the number of countries over the past fifty years, will decline sharply over the next two decades." While a domestic currency had traditionally been conceived as part of a nation's sovereignty and tied to its political existence, there was no reason for that to persist. Leaving politics aside, the consolidation of currencies could be seen as a logical next step in the globalization process, one that followed quite rationally from the increasingly globalized pattern of trade.
Today's vantage point is very different. While we suffer through the aftermath of the subprime crisis, its effects on financial markets, and potentially the largest economic downturn since the Great Depression, it is difficult to imagine greater monetary integration in the form of new monetary unions as part of the solution--for reasons that I will outline below. Indeed, currency consolidation, as it was discussed a decade ago, seems remote. But there are ways in which our monetary relationships are deepening, as the response to the current crisis has required increased coordination among existing central banks and supervisory authorities, something that is unlikely to disappear any time soon. In the remainder of this article, I discuss key aspects of monetary integration: how it has evolved over time, the different forms it can take, the benefits and potential drawbacks associated with it, and what the subprime crisis bodes for global monetary relationships.
Monetary Integration Before the Subprime Crisis
Just a decade ago, the world appeared to be on the verge of currency consolidation. As a result of the financial crisis that originated in Asia in the late 1990s and spread to other countries around the globe, emerging market countries had abandoned their fixed or pegged exchange-rate systems in favor of floating exchange rates. Understanding that floating exchange rates can be very volatile and that this volatillity can have important repercussions when a country is heavily exposed to international trade, it seemed likely that developing economies would eventually seek an alternative monetary anchor, one that could provide the stability and credibility that a fixed exchange-rate system had been intended to provide. This alternative monetary anchor involved the surrendering of the sovereign currency and the adoption of another currency, either through a monetary union or through outright currency replacement.
There were several notable examples of this behavior. In 1999, eleven countries in the European Union formed a full-fledged monetary union, complete with a new central bank and currency. Today, this union now comprises sixteen countries (Slovenia, the newest member, was welcomed just this year). Its central bank, the European Central Bank, is one of the world's most influential institutions, and its currency, the euro, is one of the world's most prominent. In 1998, Argentina proposed to replace its domestic currency, the peso, with the US dollar.
This proposal received substantial attention not only in Argentina, but also in the United States, where the Congress held hearings on the implications of so-called dollarization. Dollarization is not new; Panama, for example, has used the dollar as its currency since 1904. Although dollarization never took place in Argentina, it did in Ecuador and El Salvador (in 2000 and 2001, respectively) and, for a time, economists debated the circumstances under which this was an appropriate policy choice.
Monetary integration, it was thought, would advance along regional lines, complementing already-existing unions designed to promote intra-regional trade. …