currencyIgnoring the fact that the current financial system has grown over many years and different currencies developed over time naturally, I wonder if an artificial system with a single currency world wide would be possible and stable. One might think that things would be much easier with a single currency, but I guess that’s shortsighted.
Does the financial system require different currencies to work properly or could a single currency work out? I am aware of the concept of the optimum currency area in a world of many currencies, but does this concept hold true in a world with a single currency?
See the post by Paul Krugman here.
The gist of the argument is that absent factor mobility across political boundaries (e.g. people moving between states in the U.S.), a single currency negates many of the policy responses that policymakers have to economic shocks.
So you have Germany preaching austerity just when that's the last thing in the world that Spain needs, and Spain can't inflate its way out of its issues because it uses the Euro (and Spanish workers can't move to Germany because they don't speak German).
=== UPDATE ... New explanation from Krugman on why States within the US show what's required for one currency to work ===
States that share currency may also share central bank policy: central-bank interest rates may apply across the currency zone, as would the total money supply. That assumes no barriers to the movement of money throughout the zone - an assumption that does hold, for example, for the Eurozone.
The difficulty, as the Eurozone illustrates, is what happens when different local economies are at different points in their economic cycles. Normally, inter-economy adjustments can take place through a combination of monetary policy, fiscal policy, and exchange-rate variations. In a currency union, the first and last of these are removed, which means that two-thirds of the toolkit is gone, leaving only fiscal policy.
And that leads, in some parts of the currency union, to fiscal policy pulling in very different directions; and gives individual states no opportunity to temporarily relieve the strain on national debt through quantitative easing or other devaluation of their currency relative to the other states.
There may also be other barriers to movement, of capital or people. It’s not easy for an aluminium smelter to up sticks and move to another country for a year or two; and different languages and cultures within a currency zone can impair movement of labour too.
At the other extreme, we couldn’t function with today’s economy with a different currency in every town: the frictional costs of doing business would be preposterously high.
The main concept you want to keep in mind is:
Low interest rates expand the economy, high interest rates contract it.
If two countries’ economic cycles are related (they expand together and contract together) sharing a currency has no drawbacks.
But if one country expands while another contracts central bank policy will penalize one country at the expense of the other.
Now imagine there was a single world currency. US unemployment is stuck at 9%, Brazil inflation is 7% and rising.
The central banker now has to choose: do I stimulate US economy and overheat Brazil or cool-down prices in Brazil and create further unemployment in the US?
Both are terrible choices.
That is, I believe, the easiest way to see why a single currency would be impractical.
That’s how optimal currency area works.
If I interpret your question literally, then I have to point out that finance strictly speaking is the business of redirecting surplus savings into efficient investments. In this sense, the answer to your question is "no". The principles of finance (NPV, for example) will work even if there is only 1 currency in the world.
But I have to assume that you really asking if "international economics" would work with a single currency.
The reason why a common currency doesn't work across heterogenous economies is due to modern monetary theory. During economic slowdowns, modern central bankers attempt to stimulate demand by increasing money supply. But if you're the president of the ECB, increasing the money supply to boost demand in Greece means you're also increasing money supply in Germany where demand is already normal.
However, if we take away the assumption of a currency that is issued and/or controlled by a central authority, then it seems reasonable to think that a single global currency might work. If we replace the Euro with gold, for example, then there would be nothing for Greece and Germany to fight over because the ECB can't conjure up gold out of thin air.
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