Introduction

The dollar became the greatest currency of the 20th century because it was comparatively stable. The financial dominance of United States and its delivery system that is dollar killed the gold standard. It was happened because US came to dominate international monetary system. But as time passed the new currency euro has appeared as a potential rival to the dollar. The most important thing about euro is that it has the potentiality to change the power configuration of monetary system. International monetary arrangements make a big difference to the success or failure of the world economy. Another important matter is Globalization, which has been facilitated by the dollar just now and previously it was facilitated by pound and gold standard. But now Globalization is much less efficient because of some of its defect in International monetary system.

Considering Dollar, Pound and Gold standard we see that Gold provided a highly efficient International monetary system. So we should follow this system with latest alternative.

The Pre-Eminence of the Dollar

The International monetary system of 20th century had played a vital role in different political events and US economy and US dollar also played an important role in this action. The US economy was the star performer of the 19th and 20th centuries and had become the superpower in 1920s. But US economy lost some of its luster during post-war period. By taking the advantage of this event European economies developed outstandingly. During this time the economy of Europe and Japan was soaring but US economy began to decline. But in 1970 the International monetary system had broken down, which ended the fixed exchange rates anchored to gold. The result of this event was lax monetary and fiscal discipline all over the world. In 1979-81, the US had three years back to back two digit inflation. After a short but sharp recession, the US economy moved into a long expansion in which employment revived and inflation subsided. The US economy has been now expanding for 18 years.

The Fate of the Gold Standard

The Gold standard after World War 1 was nothing like the gold standard of earlier years. The stability of Gold now depended increasingly on the policies of a few central banks, such as Federal Reserve System, the bank of England and the bank of France. The creation of Federal Reserve System in 1913 was one of the most important events of the 20th century because it enabled the paper dollar to become the most important currency in the world. After the second year of World War 1 the dollar took over the role of important currency from pound sterling. The future of the gold standard came to depend on the policy of US with regard Gold. During World War 1 the value of Gold had fallen in half as the US dollar, which is not the actual Gold standard. So the Federal Reserve shifted to a policy of stabilizing the price level. Gradually other countries got rid of Gold from their monetary systems. Because of dollar now the status of Gold became just a question of US economic policy.

Currency Areas and Currency Unions

The growing importance of the dollar was a little-noticed event at the start of the 20th century. When the euro was created gradually it become the second most important currency in the world. Judging by its monetary mass euro is more important than yen but less important than dollar. The euro area and the dollar area are getting bigger. The euro area has eleven countries now. In ten years there could be as many as 28 member countries in the European Union. The euro area could easily contain as many 50 countries with a population exceeding 500 million. There is another currency area based on yen but the European model of single currency would not fit at the present time in Asia. The single currency project is possible in Europe because it became a security area. An Asian currency area would be possible in the future by correcting the political disequilibrium. The dollar area will also expand over next ten years. It might even possible to establish some kind of currency unions for all Americans, a kind of Latin Dollar. There are many models for currency areas. The tightest form is a single currency monetary union. Dollarization represents a hegemonic approach to a single currency monetary union. The less tight form is multiple currency monetary union, which success depends on credibility. There are many ways to buy credibility for the exchange rate commitments and one of them is to build reserves. Another way to achieve credibility is through a bilateral approach.

The Importance of Monetary Rules

There is a difference in between “pegged” and “fixed” rates, which lies in the adjustment system. A fixed exchange rate is the monetary rule that contains an equilibrating mechanism of the balance of payments. The gold standard was a good example of fixed rates. Countries defined their currencies in terms of weights of gold and exchange rates represented the ratios of the weights. This system got into trouble very rarely, as during war, countries turned to finance deficit etc. Success of gold depends on fiscal prudence. A country fixes the exchange rate between its currency and an important foreign currency. A currency board works automatically to preserve equilibrium in the balance of payments. Some writers now speak of a “currency board” in order to describe a fixed exchange rate system because there is a common confusion between pegged and fixed exchange rate. A fixed exchange rate is a monetary rule that gives the country the monetary policy of the partner country. On the other hand pegged rate is an arrangement whereby the central bank intervenes in the exchange market to peg the exchange rate but still keeps an independent monetary policy. A flexible exchange rate is consistent with any monetary policy at all hyperinflation. Some countries don’t have the option of fixing the exchange rate because some countries are too small but one of the countries is too large to fix, such as United States. This is because there is no currency to fix the US dollar. In this case the only choice is inflation targeting or monetary targeting, which depends on inflation rate. Stability of the inflation rate is an important policy and low inflation rate produce more stable inflation rate. It is very important that monetary aggregates contain important information about the economy. So from all of these discussion we see that how monetary rules affect the economy and its importance in fixing the exchange rate.

Monetary Arrangements in Free Trade Areas and Customs Unions

Free trade areas and currency areas reinforce one another. But uncertainty over exchange rates affects trade directly because it affects profit margin and small changes in exchange rate can completely wipe out expected profits. For this reason different countries are using the same currency in the trade area to minimize the risk. Free trade area has some problem, such as uncertainty over exchange rate, devaluation by a partner country etc. It is important for a currency area to be large. According to the journal there could be a basket of three currencies, such as dollar, yen and euro. But there is a problem with using a currency basket is that it is usually not a transparent target for monetary policy. Another problem of this currency basket is that it is not possible to get capital market integration. Besides that there is an advantage for multiple-currency basket is that it does not suffer from the possible defect of a single-currency basket. Now the question is about exchange rate. Under fixed exchange rate there is no problem of the adjusting process between two areas of a common currency area. But one thing is that the problems of slow-growing and poor countries are greater than fast-growing and rich countries because they lack the prospect of improving themselves as rapidly as fast-growing country.

Central Banks, Dollarization and the Maastricht Conditions

Central Banks are in most countries a comparatively recent event and most central Banks in the world were the creature of the twentieth century. The broken down of international gold standard also help to build up these central banks. Central banks were introduced to full-fill a deeply-felt need. Under the gold standard there was a periodic crises, which created a demand for elastic monetary system and central Banks became an instrument of that elasticity. Now let us consider Dollarization. Dollarization is an option open not only for Latin America but also for other countries with substantial trade and connections to the United States. The gains from Dollarization are substantial because it implies a better monetary policy in addition to gain of world class currency. Prices all over the world would be denominated in the same unit and be kept equal in different parts of the world.

There are three costs of Dollarization. Such as, (1) The loss of seignior age, (2) The loss of a national symbol and (3) The loss of sovereignty. But Dollarization will increase the trade and investment a lot. Here we see that complete Dollarization is not good because of inflationary rate. There might be 50% Dollarization and other 50% will be local currency convertible into US dollar. The costs and benefits of Dollarization are not independent of the number of countries that participate. Here we see that the gains are larger when more countries participate in the Dollarization. This is about central bank and Dollarization. Now the question comes to whether there is a need for Maastricht-type condition or not. There is no need of Maastricht-type condition in a better economy. In the better economy Government has less chance to make any mistakes. It can borrow and run a deficit but it can’t run an inflationary deficit. The Maastricht-type conditions are needed to strap down ministers of Finance. Some time they kept running deficit and forcing the central bank to buy Government bond when the market no longer wanted them.
 
Exchange Rate Volatility and Internal vs. External Stability

The dollar, euro and yen areas make up nearly sixty percent of the world economy because there is a high degree of price stability in each area. But the exchange rates of these currencies are very volatile. The change of these currencies creates the problem on those countries, which are doing business with both currency areas. And this volatility creates a big problem on third countries. The volatility between dollar and yen is terrible for countries that are doing business with Japanese and American markets and this volatility played a big role in the so-called Asian crisis. The crisis was so-called because it creates problem only on four countries like Thailand, Malaysia, Indonesia and Korea. Their currencies were pegged and not very efficient to the dollar. And as a result of appreciating dollar they lost their market in Japan because they had debt fixed in dollar. Volatility of the exchange rates aggravates instability of the financial markets, disrupts trade and the efficiency of capital flows. Now we are going to discuss about Internal and external stability. Internal stability refers to a stable price level and external stability refers to a stable exchange rate and equilibrium in the balance of payments. According to Keynes internal stability is more important than external stability but it is better to have both.
 
Towards a World Currency

Currency is a medium of exchange. Dollarizing the world economy is the quickest and most effective way to produce a world currency. But the arrival of the euro makes the question for the need and possibility of a world currency. Once a moment in 19th century, England rejected the effort of France and America to produce a world currency. Now the creation of euro diminishes the monopolistic position of the dollar and at the same time US power in the international business also has to be shared. It is possible for United States that they will produce a genuine international currency in the future. The international monetary fund could be turned into a world central bank and granted the authority to produce a world currency. Then each participating member in the union would fix its local currency to the world currency. The world currency itself would be backed by the currencies of the three largest central banks. In this case the world central bank would stand ready to buy and sell the world currency on demand so that it would not add to or subtract from the world money supply. There would not be currency crises in participating countries as long as they adhered to the rules for fixed exchange rates. A world currency would provide a universal unit of account for transmitting values. Finally we can say that a common world currency is the second most important currency in every country because it has the magnificent power to develop international business.