Advantages and Disadvantages of a Single Currency.

  1. As the title of this topic suggests, we would understand both advantages and disadvantages of a single currency. The arguments presented will use Euro as an example.
  2. The Euro, the single currency of European Union (EU) came into existence on 1 January, 1999.
    "The process of economic and monetary unification will contribute to the promotion of a harmonious and balanced development of economic activities throughout the European currency area, assist in the achievement of sustainable and non-inflationary growth and thus help bring about a high level of employment."

    The European Central Bank (ECB).

  3. Advantages.

    1. Eliminate exchange rate fluctuation.
      1. Businesses who operate within the European Currency area would no longer have to worry about exchange rate fluctuations. In the past a German firm who traded with Italy would have to worry about how much 1 Deutschmark exchange for Italian Lire. If payment were to be settled in the future, exchange rate fluctuation could either mean that the German firm pay more or less in term of Deutschmark for its Italian ordered placed in the past, say a month ago. Obviously the German firm would not like to pay more in Deutschmark a month from now for the same order. To get over this problem, the firm could "hedge" the currency, that is, it would buy from the market for the delivery of a certain amount of Italian Lire (say Lire 50 billion) for a definite price in Deutschmark. This "perfect answer" come with a "hedging costs" that the firm has to pay. A survey in Europe found that exchange rate fluctuations affected small businesses more than big multinationals. With a single currency like Euro, both our German and Italian firms can do away with exchange rate fluctuations and hedging costs. Thus, trade and investment are stimulated within this currency union.
    2. Reduced Transaction Costs.
      1. A single currency would encourage tourisms in the single currency area. A tourist to the European countries in the Euro currency area (12 of them in 2002) would not have to worry about exchanging different currencies and loss in transaction costs (commission and time) as she travel. A survey in the past found that a unit of currency say 1 French Franc would lose 40% of its value after if it is exchanged into each of the 12 national currencies then used in the European Community (before the formation of EU).
      2. This also encourage trade across borders in this single currency area. A Euro for example eliminate the extra accounting costs needed to keep tract of different and fluctuating exchange rates among trading partners within the single currency area. This reduced cost of trading within the single currency area and thus stimulate more trade.
    3. Price Transparency.
      1. Within the single currency union, all prices would be quoted in the same currency and this facilitate easy price comparison. Firms no longer could mask their high prices in local national currencies. Consumers could now compared the Euro prices of say coffee powder in Belgium and the Netherlands with ease. This supposed to encourage more cross borders businesses.
      2. This would also encourage firms to improve their efficiencies and competiveness in the single currency area.
    4. Facilitate market expansion.
      However, prices differences would still exist in a single currency area due to transportation costs, storage costs, and other operation costs. There would be price differences between a bottle of 500g ABC olive oil sold in the local Mr. Pinocchio store and that sold in the local chain shopping mall. There would also be price differences between a bottle of 500g ABC olive oil sold in the local Mr. Pinocchio store and that sold in a store in another city or even country. Such price differences and price transparency may encourage firm ABC that sells olive oil to expand its market within the currency area. Lower transaction costs, elimination of exchange rate fluctuations, and price transparency will give incentive for firms to expand their markets within the single currency area. This would also generate investment and employment.
    5. A more stable currency.
      1. The Euro would be more stable, that is, experiences less exchange rate fluctuations when compared to national currencies because the "value" of Euro reflects the average economic conditions of the whole Union and not that of a single national economy.
      2. Moreover, Euro would enjoy more credibility because it is used in a larger currency zone. At the end of 2011, 17 countries in EU used Euro as legal tender. This credibility is enhanced by the stability pact of December 1996 that commits participating nations to fiscal responsibilities like limiting budget deficit and debt ratio to levels that are acceptable by the pact.
      3. The stability of Euro is also protected by the explicit stability-oriented monetary policy of European System of Central Banks (ESCB) that controls the value of Euro.
    6. Prevent competitive devaluation by nation states.
      A single currency would prevent the need for nation states in EU to devalue their national currencies to achieve competitive edge over other nation states. When one nation devalues its currency it actually force others to devalue their respective currencies as not to lose to unfair competition from the first nation that devalues its currency. This kind of devaluation is unhealty to the economic health of all nation states in EU. In the European Monetary System (EMS), currencies of members are fixed within a band of 2.25 % of the central parity. This system is still in operation and the central parity is now the Euro. Devaluation by any member within this system would encourage speculators to attack the currency and/or other currencies within the system because the credibility of EMS depends on maintainig the band. This speculation would fulfill its own prophecy and the currency would devalue further. Click here for a brief history of attacks on the EMS in 1992/93.
    7. Lower interest rates because Euro enjoy monetary stability of the European Central Bank (ECB) and the absence of premium due to elimination of exchange rate flucutations.
      More information about the Euro at http://www.ecb.europa.eu/euro/html/index.en.html
  4. Disadvantages.

    1. Lost of autonomous monetary policy.
      1. With the formation of Euro, the ECB and not national central banks that set the interest rate for the Euro area. ECB also controls the money supply within the Euro area. Thus, nation states within the Euro area loss the ability to employ monetary policy to fine-tune their respective national economies. Example: Greece was not able to use monetary policy to address its Debt Crisis in 2011.
      2. The commitment to the stability pact of 1996 also put pressure on these nation states to pursue discretionary fiscal policy because budget deficit has to be kept within certain acceptable limit.
    2. Risk of uneven development within the single currency area.
      1. Harmonization of national regulations and the introduction of a single currency like Euro in principle create a single market from the different national economies that join this currency union. In the word of ECB, the creation of Euro enhance the mobility of capital and financial services within the Euro area. Due to external economies of scales, businesses have the tendency to concentrate in certain areas. This means, some peripheral areas within the Euro area would lose out on employment and growth.
      2. Higher unemployment rate and lack of growth increase deflationary costs in these peripheral areas. These areas may experience more social problems (eg. crimes, suicide, broken homes, etc.), loss of skills and loss of irretrievable economic potential.
      3. Although capital can move with ease within the Euro area, labour force does not enjoy the same mobility. There are still great cultural and language barriers to labour mobility within the Euro area.
    3. Some economists argue that the Euro area is by no means a single economy. National economies maintain their distinct charecteristics within the Euro area and possess their respective business cycles. Thus, the monetary policy of ECB cannot address the economic need of individual member states.
    4. Easier access to loans with lower interest rates can leads to mounting public debt as seen in Ireland, Greece and Spain. For instance, when Greece was inducted into the Euro Zone, it started to enjoy the monetary credibility of ECB and began having access to loans with lower interest rates (as compared to its previously high interest rates due to higher risk premium) and access to larger pool of loanable fund from other banks within the Euro zone. This led to a lot of public infrastructure projects in the country and some with little profit prospect. Very similar story in Spain where cheap loans funded the building of many airports. In 2011, there were 20 airports handled less than 100,000 passengers a year when a minimum 500,000 was needed to make an airport profitable (SCMP, Nov 2011). Public debt climbs and when the economy turned bad as in after the SubPrime Crisis in the US, these countries were left with public debt that they could neither service not repay back.
    5. The British Retailing Consortium estimates that British retailers would have to spend between 1.7 billion pound and 3.5 billion pound to train people to use Euro and make the appropriate transitions. But this appears feasible for the present 12 members of the Euro area (2002).