Currency Statecraft: Monetary Rivalry and Geopolitical Ambition
208
Currency Statecraft: Monetary Rivalry and Geopolitical Ambition
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Overview
In a comprehensive review that ranges from World War II to the present, Cohen convincingly argues that one goal stands out as the primary motivation for currency statecraft: the extent of a country’s geopolitical ambition, or how driven it is to build or sustain a prominent place in the international community. When a currency becomes internationalized, it generally increases the power of the nation that produces it. In the persistent contestation that characterizes global politics, that extra edge can matter greatly, making monetary rivalry an integral component of geopolitics. Today, the major example of monetary rivalry is the emerging confrontation between the US dollar and the Chinese renminbi. Cohen describes how China has vigorously promoted the international standing of its currency in recent years, even at the risk of exacerbating relations with the United States, and explains how the outcome could play a major role in shaping the broader geopolitical engagement between the two superpowers.
Product Details
| ISBN-13: | 9780226587868 |
|---|---|
| Publisher: | University of Chicago Press |
| Publication date: | 11/15/2018 |
| Sold by: | Barnes & Noble |
| Format: | eBook |
| Pages: | 208 |
| File size: | 1 MB |
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CHAPTER 1
From Currency to Capabilities
All statecraft starts with capabilities. If influence is the ultimate aim of statecraft, power resources are its raw material. For currency statecraft, the raw material is a nation's money. The more a national currency gains international appeal, the greater is the potential degree of political leverage that may be made available to the issuing authority.
But what exactly is the relationship between currency internationalization and state power? The aim of this book is to understand how currency statecraft may — or may not — convert potential into action, and what the consequences of currency statecraft may be. But first we must understand where that potential comes from. This introductory chapter explains how, in practical terms, state capabilities are affected by an international money. The leverage derived from currency internationalization, we shall see, stems directly from the broader patterns of international monetary power.
Currency Internationalization
We begin with some basics. What precisely is an international money, what drives the process of currency internationalization, and what does the universe of international currencies look like?
Roles
An international money is a national currency that is used internationally. Typically, at any given moment in history, a number of national currencies may gain international appeal. Indeed, as Barry Eichengreen and colleagues (Eichengreen, Mehl, and Chitu 2018) have convincingly demonstrated, there has never been a time when only a single money has dominated in the global economy to the exclusion of all others. Absolute monopoly may exist in theoretical models but not in the real world. More commonly, two or more moneys coexist and operate simultaneously.
International currencies, however, are not all alike. Currency internationalization is not a monolithic concept. The universe of international money is in fact highly variegated. As a practical matter, international currencies may differ significantly along two key dimensions. First, they can differ in terms of geographic reach — what is referred to as their domain. Circulation of some currencies may be limited to just a handful of economies, while others may be used far more widely. And second, they can differ in terms of the range of roles they play — their scope. Currencies may be employed outside their country of origin for any of a number of purposes, and different currencies may play very different combinations of roles.
The standard taxonomy for characterizing the diverse roles of international money separates out the three familiar functions of money — medium of exchange, unit of account, store of value — at two levels of analysis, the private market and official policy, adding up to six roles in all. Specialists today generally speak of the separate roles of an international currency at the private level in foreign-exchange trading (medium of exchange), trade invoicing and settlement (unit of account and medium of exchange), and financial markets (store of value). At the official level, we speak of a money's roles as an exchange-rate anchor (unit of account), an intervention currency (medium of exchange), or a reserve currency (store of value). Each of the six roles is distinct in practical as well as analytical terms. The taxonomy is summarized in table 1.1.
In foreign-exchange trading, an international currency acts as an intermediary — a "vehicle" — for most wholesale trades, in order to minimize transactions costs. The idea is to take advantage of the economies of scale afforded by the broad market for the vehicle currency. In moving between less widely circulating moneys, it is actually more efficient to use one peripheral currency to buy the vehicle currency, and then to use the vehicle currency to buy the other peripheral currency. In cross-border markets for goods and services, an international currency provides a common medium for invoicing and settlement — often referred to simply as its trade role. And in capital markets, an international currency provides a convenient venue for storing financial wealth — its investment role. Similarly, at the official level, an international currency can provide a convenient numéraire for pegging exchange rates (its anchor role), an efficient medium for managing exchange rates (its intervention role), and an attractive asset for backing a national currency (its reserve role).
Competition
No matter what role we may be talking about, the driving force behind currency internationalization is competition. Within individual economies, the coercive powers of the state are typically deployed to create a de jure monopoly for a national money. Means toward that end include legal-tender laws, exchange controls, and related regulatory measures. Currency choice is meant to be determined on the supply side of the market. Sovereign governments enjoy considerable latitude to seek exclusivity for their national money inside their own borders.
At the international level, however, where there is no overriding sovereign authority, the capacity for coercion in monetary affairs is more limited. Instead, it is competition that rules. Compulsion may be possible in dependent territories or quasi-imperial clientilistic relationships. But in the more normal case, in relations among independent states, monopoly is replaced by competition, and actors must be persuaded rather than compelled to make use of one particular money rather than another. Currency choice is determined more on the demand side of the market. To gain standing, a money must be competitive.
And what makes a money competitive? Overall, historical evidence suggests that both economic and political capabilities are deeply involved (Cohen 2015, ch. 5). Five types of power resource stand out as particularly salient. These are economic size, financial development, foreign policy ties, military reach, and effective governance.
First is economic size — the heft of the issuer's national economy and importance in world trade. Above all, a money must promise a broad transactional network, since nothing enhances a currency's acceptability more than the prospect of acceptability by others. Historically, this element has usually meant an economy that is large in absolute size and well integrated into world markets. A big economy that is a major player in trade creates a naturally ample constituency for a currency. No money not initially backed by a leading economy has ever risen to a position of international preeminence. The greater the issuer's weight in global commerce, the stronger will be the "gravitational pull" of its currency.
Second is financial development — the sophistication and openness of the issuer's banking and capital markets. To be competitive, a money must also promise the qualities of exchange convenience and capital certainty — a high degree of transactional liquidity and reasonable predictability of asset value. The key to both is a well developed financial sector, unburdened by high transactions costs or formal or informal barriers to entry or exit. Markets must offer considerable depth, breadth, and resiliency — the three most fundamental characteristics of an efficient financial sector. Depth means the ability to sustain relatively large market orders without impacting significantly on an individual asset's price. Breadth means trading volumes and enough market competition to ensure that the spread between ask (sell) and bid (buy) prices is small. And resilience means the ability of market prices to recover quickly from unusually large sell or buy orders. Secondary markets must be fully operational for most if not all financial claims.
Third are foreign policy ties, which are especially likely to influence the currency preferences of governments. In an uncertain world, geopolitical leadership can also exercise a form of gravitational pull, encouraging use of the leader's currency. Links to a geopolitical leader may take many forms, ranging from traditional patron-client relationships to linkages based more on cultural, linguistic, or historical affinities. Ties may also be more or less institutionalized. The deeper the relationship, the more likely it is that friends and allies will feel comfortable using the leader's money as an anchor or reserve asset. In monetary matters, familiarity breeds not contempt but confidence, encouraging a currency's acceptance and making its use come to seem part of the natural order of things.
Fourth is the factor of military reach — the security dimension of international relations, which is often neglected in discussions of currency internationalization. For nervous investors, a militarily powerful nation can provide an appealing "safe haven." A strong defense structure ensures a more benign climate for storing wealth. Likewise, currency preferences of governments may be influenced by security guarantees in one form or another. A leading country's ability to project power abroad will exercise yet more gravitational pull — though only so long as the issuer is seen as a guardian of peace and stability. The opposite effect is more likely if the issuer is seen as a destabilizer or aggressor. Eichengreen and colleagues (Eichengreen, Mehl, and Chitu 2017) estimate that a formal military alliance will boost the share of a currency in a partner's foreign reserves by as much as thirty percentage points.
Finally, last but not least, is effective governance. In narrow terms, this means a proven track record of successful macroeconomic management — a policy regime capable of sustaining relatively low inflation and inflation variability over time. No currency is apt to come into widespread use for cross-border purposes if its purchasing power cannot be forecast with some degree of assurance. More broadly, effective governance means political stability, adequate protection of property rights, and genuine respect for the rule of law. Market actors will not be naturally attracted to a currency whose home government cannot be counted upon to faithfully enforce contractual obligations.
Together, these five types of power resource make a formidable package. Few nations can claim them all. More typically, countries exhibit at most just one or a few of the necessary elements in varying combinations, resulting in considerable differences among currencies in terms of both scope and domain. In effect, each economy may be said to have a natural comparative advantage in some dimension or dimensions of the competitive struggle among currencies. Overall, therefore, the competition that drives internationalization is likely to produce highly differentiated results. For example, an economy that looms large in international trade but lags in financial development is likely to find its money used more for invoicing and settlement than as an investment or reserve asset. Conversely, a country with a more advanced financial sector will attract greater interest from investors and central banks even if its share of world trade is smaller. Currency domains are apt to be less extensive geographically if an issuer's trade or financial links are concentrated in a particular region. Use at the official level will probably be more extensive if an issuer has widespread foreign policy ties or military reach.
With such variance in terms of capabilities, is it any wonder that we observe such a pronounced hierarchy among the world's moneys?
The Currency Pyramid
Nearly half a century ago, the noted British scholar Susan Strange (1971a, 1971b) introduced the first systematic taxonomy of the world's most widely used currencies. Strange distinguished four types of international money: neutral currencies, top currencies, master currencies, and negotiated currencies. Neutral currencies are moneys that appeal to market actors for purely economic reasons (economic size, financial development, stable value, and the like). Add dominance by the issuing country in related political or military structures and a money may be described as a top currency. Master currencies derive from formal dependency relationships, such as colonial ties, and rely on a degree of coercion. Negotiated currencies, by contrast, rely more on persuasion and result from diplomatic bargaining or informal understandings to promote or sustain foreign use.
More recently, I built on Strange's foundation by introducing the image of a currency pyramid to more fully represent the hierarchy of moneys around the world (Cohen 1998, 2004). The currency pyramid is narrow at the peak, where one or a few moneys dominate; and increasingly broad below, reflecting varying degrees of competitive inferiority. The moneys at the top include the four currency types that Strange identifies in her taxonomy. The advantage of the pyramid image is that it reaches further down to take account of other, lower rungs in the hierarchy as well.
The seven categories are:
Top currency. With a nod to Strange's use of this same label and with the same meaning in mind, this rarified rank is reserved only for the most esteemed of international currencies — those whose use dominates for most if not all types of cross-border purposes, and whose domain is more or less universal, not limited to any particular geographic region. In the last two centuries just two currencies could truly be said to have qualified for this exalted status: Britain's pound sterling before World War I, and the US dollar since World War II. In principle, more than one top currency might be in favor simultaneously, as were the pound and dollar together during the interwar period before sterling went into what proved to be a long and irreversible decline. Today, however, America's greenback alone occupies the highest stratum of the currency pyramid. No other money comes close.
Patrician currency. Just below the top rank we find currencies whose scope, while substantial, is something less than comprehensive, or whose popularity, while widespread, is something less than universal. Historically, some of the moneys in this category, corresponding to Strange's category of neutral currency, have appealed simply because of their inherent economic qualities; others have resembled more her remaining categories of master currency or negotiated currency. Today the patrician category comprises two major currencies: the euro, which stands second to the greenback in most categories of cross-border use, and the Japanese yen, which, though not as popular as it once was, is still widely used for investment and reserve purposes. Many observers expect this tier to be occupied soon by China's yuan as well. Some even believe that the yuan is destined one day to eclipse the dollar as top currency.
Elite currency. In this category belong currencies of sufficient appeal to qualify for some degree of international use but with only limited scope or domain. Here we find the more peripheral of the international currencies, little more than bit players on the currency stage. These moneys, too, may be considered to correspond to what Strange meant by neutral currencies. Today the list of elite currencies would include, among others, Britain's pound (sadly, no longer a top currency or even a patrician currency), the Swiss franc, and the Australian and Canadian dollars. All these currencies are used to some extent in global currency and financial markets because of their inherent economic qualities. In addition, the Australian dollar and South African rand play significant roles as exchange-rate anchors and reserve currencies in their respective neighborhoods in the southern Pacific and southern Africa.
Plebian currency. One step further down from the elite category are plebian currencies — more modest moneys of very limited international use. Here we find the moneys of the smaller industrial states, such as Norway or Sweden, along with some middle-income emerging-market economies (e.g., Singapore, South Korea, and Taiwan) and the wealthier oil exporters (e.g., Kuwait, Saudi Arabia, and the United Arab Emirates). Within their own sovereign borders, plebian currencies retain a more or less exclusive claim to all the traditional functions of money. But outside those borders they carry little weight (like the plebs, or common folk, of ancient Rome). They tend to attract little cross-border use, except perhaps for a certain amount of trade invoicing.
Permeated currency. Included in this category are moneys whose competitiveness is effectively compromised even at home, through what economists call currency substitution — adoption by residents of a popular foreign currency as a preferred alternative to the national currency. Although nominal monetary sovereignty continues to reside with the issuing government, foreign money supersedes the domestic alternative, particularly as a store of value, thus accentuating the local currency's degree of inferiority. Permeated currencies confront what amounts to a competitive invasion from abroad. To judge from available evidence, it appears that the range of permeated currencies today is in fact quite broad, encompassing many economies of the developing world, particularly in Latin America and Southeast Asia.
(Continues…)
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Table of Contents
List of TablesAcknowledgments
Abbreviations
Introduction
ONE / From Currency to Capabilities
TWO / From Capabilities to Statecraft
THREE / A Theory of Currency Statecraft
FOUR / Youth
FIVE / Maturity
SIX/ Decline
SEVEN / When Statecrafts Collide
EIGHT / Conclusion
References
Index