Imagining a world without the dollar
By Barry Eichengreen,
The dollar doesn’t have much clout these days. The greenback has lost 12 percent of its value against foreign currencies since the chaotic period after the failure of Lehman Brothers in 2008, and nearly 5 percent since the end of 2010.
Economists are debating the end of the era of the dollar, while news organizations paint it as a 98-pound weakling. Our so-called “fiat” currency, backed only by the full faith and credit of the government, no longer commands respect. So wouldn’t we be better off without it?
Imagine you woke up tomorrow and the dollar had vanished. The Federal Reserve was out of the business of supplying money. How would you go about your affairs?
The obvious answer is that life would become one big swap meet. It would be like your local farmers market, except that instead of a vendor selling carrots in exchange for dollars, she would have to trade them for the onions in the neighboring stall or for the paring knife of the cook with no vegetables at all. The problem with this is what economists call “non-coincidence of wants” — the carrot seller may not want onions, and those onions may rot before she finds someone who does.
This highlights the convenience of currency as a medium of exchange and a store of value. It follows that in a world where the United States no longer had a currency, there would be an incentive to use someone else’s.
Just look to our history. Britain’s 13 North American colonies were prohibited from operating a mint or otherwise coining money. So the colonists turned to Spanish silver coin, which they obtained by exporting dried fish and whale oil to the West Indies. Were the dollar to magically disappear, Americans would again resort to using other monies. When Ron Paul says “end the Fed,” he presumably doesn’t realize that he would be giving a valuable franchise to the Bank of Canada.
Realistically, our currency needs could be met only by another large economy, and Canada might be too small an issuer of currency. But the only other potential candidates — Europe and China — both have drawbacks. Europe is bogged down in a debt crisis, while China limits the use of its currency abroad partly to prevent its exchange rate from rising.
So imagine instead that we do not start using another country’s money. Figuring out how many carrots to offer for an onion, how many onions to offer for a potato and how many potatoes to offer for a paring knife would be complicated without a common measuring rod. We would therefore gravitate to one commodity as the standard by which the value of all other commodities was expressed.
In colonial Virginia, tobacco initially served this purpose. The next step was to settle transactions using not actual tobacco but warehouse receipts for stored tobacco. This was more convenient, but it was also riskier. The operators of the warehouse had an incentive to issue more receipts — to themselves, of course — than they had tobacco in storage. As a result, Virginia’s tobacco warehouses were highly regulated, and the penalty for issuing fraudulent receipts was death.
In a world without dollars, it follows, the right to issue notes would have to be limited to a set of regulated entities — call them banks. This was how currency entered circulation before the Civil War. Banks printed up and lent out engraved bank notes. State legislatures required them to hold gold or securities sufficient in value to redeem their notes.
The problem, predictably, was that not all states enforced their regulations vigorously. Some allowed banks to carry government and railway bonds on their books at full value when they were worth only cents on the dollar. If there was a rush to redeem bank notes, the issuer would find it impossible to do so.
Hence, not all bank notes were created equal. It mattered greatly by whom they were issued. Sensing a need, specialized collectors of financial intelligence leapt into the breach, publishing newsletters known as “note reporters” that listed the prices at which different bank notes traded, reflecting the issuer’s good reputation or lack thereof.
The 21st-century analog would be our local farmer scanning each individual bank note with a smartphone to see exactly how many carrots it was worth before taking it in payment. Doable, perhaps, though this would certainly slow down the payment process.
More generally, it is tempting to imagine technology filling this void. In a world without dollars, every ambitious Internet company would build a platform for transactions, featuring an electronic currency in which prices were expressed, payments made and receipts accumulated. It’s no stretch to imagine the Facebook credits now used to purchase items in games evolving into a more widely used electronic currency (perhaps nicknamed “Facebacks”).
While there have already been some attempts to create a true electronic currency, such as Bitcoin, these have had difficulty getting off the ground. It is not hard to see why. If it is possible to imagine one private electronic currency, then it’s possible to imagine several, and there would be no guarantee that other people would accept the particular electronic money you use.
Moreover, these payment systems would be only as reliable as the individual companies’ software and servers, which would be impossible for end users to judge. Also, nothing would ensure that the electronic money you accumulate would hold its value, and nothing would prevent the operators of the platform from issuing more, in the first instance to themselves. If people worried that their electronic money was losing value, they would rush to convert it into merchandise; others might simply refuse to accept it as payment. The whole scheme would come crashing down.
That’s why we have the Fed. It regulates the supply of money. It supports the payments system, providing the exceptional liquidity needed for its smooth operation in turbulent times such as those following Lehman Brothers’ failure. It inspects the banks and works with the Federal Deposit Insurance Corporation, which provides deposit insurance to bolster confidence and prevent bank runs.
Critics of the dollar are having a field day. But when I think about our current monetary arrangements, I am inclined to paraphrase Winston Churchill on democracy: Ours is the worst possible system, except for all the others.
Barry Eichengreen is a professor of economics at the University of California at Berkeley and the author of “Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System.”