A unified currency will mean prosperity

fedgaztte Editoral

Arthur J. Rolnick | Senior Vice President and Director of Research, 1985-2010

Published October 1, 1992  | October 1992 issue

The road to a unified currency: Two views

The current upheaval in international money markets has focused increasing attention on the proposed creation of a single European currency. In opposition to such a proposal, Robert Barro, a contributing editor of The Wall Street Journal, argues that a centralized currency is a precursor to centralized government.

In the response below, Minneapolis Fed Research Director Arthur J. Rolnick disputes Barro's claim and says a unified currency—or a fixed exchange rate system—will promote international trade and bring prosperity to participating countries. Rolnick, along with Minneapolis Fed Senior Research Officer Warren E. Weber, argued for fixed exchange rates in the bank's 1989 Annual Report.

Robert Barro's argument that an agreement among European countries to unify their currencies would lead them down the "Road to Serfdom" is not persuasive.

Barro bases his argument largely on a weak analogy between currency and language. The analogy may at first seem to work because a shift to a common language, like a shift to a common currency, would obviously simplify transactions among citizens of different countries. But the analogy snaps when Barro stretches it to assert that both types of shifts would be a step toward a centralized government.

The idea makes some sense for a unified language. As Barro points out, history has shown that people are willing to fight to keep their own distinct language. Obviously, they care about losing this part of their unique cultural heritage. Unifying languages thus would significantly erode national identities, and that logically would increase the odds of a centralized government.

But how could this be true for a unified currency? Unifying currencies essentially means switching to a fixed exchange rate system. Now, I agree that people may be culturally—even emotionally—tied to their language, but I doubt that most care a whit about whether or not the price of their country's currency is fixed or floats. So why would a unified currency lead to a centralized government?

And history does not support Barro's assertion. For roughly 25 years before 1971, the exchange rates of the major world currencies were fixed by the Bretton Woods agreement. In 1971, when the United State went off the gold standard, exchange rates were freed to float. By Barro's reasoning, 1971 should have been a watershed year for centralized governments. The evidence for that is hard to find.

A better way to think about an agreement to unify currencies is as an agreement to lower trade barriers. Under standard trade agreements, the barriers in question are things like import taxes. Under currency agreements, they are unexpected fluctuations in the value of different currencies.

Under both types of agreements, individual countries give up some unilateral power. With standard trade agreements, it is the power to impose things like import taxes; any such trade barriers must be agreed on by all the countries involved. With currency agreements, countries give up the power to unilaterally impose the inflation tax; all countries involved must agree on the overall rate of inflation and how much revenue each country will get from it.

For these sacrifices, however, all the countries involved can gain. Lowering trade barriers means lowering the costs for people to do business across national borders—a powerful way for a government to encourage economic activity. Both trade and currency agreements, that is, promote international trade.

I doubt that even Barro would claim that trade agreements have led to centralized governments. In fact, rather than leading countries down the road to serfdom, trade agreements have paved the way to prosperity. That's what we can reasonably expect from currency agreements.