Only a short time ago, economists were predicting that the number of currencies in the global monetary system would fall from more than 150 to perhaps three or four. In 2001, Harvard’s Kenneth Rogoff wrote in the American Economic Review, “It appears likely that the number of currencies in the world, having proliferated along with the number of countries over the past fifty years, will decline sharply over the next two decades.” While a domestic currency had traditionally been conceived as part of a nation’s sovereignty and tied to its political existence, there was no reason for that to persist. Leaving politics aside, the consolidation of currencies could be seen as a logical next step in the globalization process, one that followed quite rationally from the increasingly globalized pattern of trade.

Today’s vantage point is very different. While we suffer through the aftermath of the subprime crisis, its effects on financial markets, and potentially the largest economic downturn since the Great Depression, it is difficult to imagine greater monetary integration in the form of new monetary unions as part of the solution—for reasons that I will outline below. Indeed, currency consolidation, as it was discussed a decade ago, seems remote. But there are ways in which our monetary relationships are deepening, as the response to the current crisis has required increased coordination among existing central banks and supervisory authorities, something that is unlikely to disappear any time soon. In the remainder of this article, I discuss key aspects of monetary integration: how it has evolved over time, the different forms it can take, the benefits and potential drawbacks associated with it, and what the subprime crisis bodes for global monetary relationships.

Monetary Integration Before the Subprime Crisis

Just a decade ago, the world appeared to be on the verge of currency consolidation. As a result of the financial crisis that originated in Asia in the late 1990s and spread to other countries around the globe, emerging market countries had abandoned their fixed or pegged exchange-rate systems in favor of floating exchange rates. Understanding that floating exchange rates can be very volatile and that this volatility can have important repercussions when a country is heavily exposed to international trade, it seemed likely that developing economies would eventually seek an alternative monetary anchor, one that could provide the stability and credibility that a fixed exchange-rate system had been intended to provide. This alternative monetary anchor involved the surrendering of the sovereign currency and the adoption of another currency, either through a monetary union or through outright currency replacement.

There were several notable examples of this behavior. In 1999, eleven countries in the European Union formed a full-fledged monetary union, complete with a new central bank and currency. Today, this union now comprises sixteen countries (Slovenia, the newest member, was welcomed just this year). Its central bank, the European Central Bank, is one of the world’s most influential institutions, and its currency, the euro, is one of the world’s most prominent. In 1998, Argentina proposed to replace its domestic currency, the peso, with the US dollar.

This proposal received substantial attention not only in Argentina, but also in the United States, where the Congress held hearings on the implications of so-called dollarization. Dollarization is not new; Panama, for example, has used the dollar as its currency since 1904. Although dollarization never took place in Argentina, it did in Ecuador and El Salvador (in 2000 and 2001, respectively) and, for a time, economists debated the circumstances under which this was an appropriate policy choice.

Monetary integration, it was thought, would advance along regional lines, complementing already-existing unions designed to promote intra-regional trade. Seen in this way, Europe’s monetary union is a natural outgrowth of the European Union; and there are other regional monetary unions among countries in the eastern Caribbean, southern Africa, and western Africa that have followed the establishment of a common market or customs union. It is not too big a leap, then, to imagine that a North American monetary union could supplement the trading arrangement for NAFTA (North American Free Trade Agreement) countries, a South American monetary union for MERCOSUR (Common Market of the South) countries, or an East Asian monetary arrangement for ASEAN (Association of South East Asian Nations) countries. Trade is not the only factor to consider when forming a monetary union, however, and each potential union must be evaluated with respect to the full spectrum of its benefits and costs.

What is Monetary Integration?

Monetary arrangements that supplement trading relationships have existed for centuries. During the Roman Empire, for example, the solidus coin—a money whose metallic content was stable—circulated widely. In the nineteenth century, there were several well-known arrangements among groups of European countries that set standards for the minting and exchange of specie coins whose value was fixed by their gold or silver content. This type of monetary arrangement was not a true monetary union but rather a common-currency-standard area, because each country’s monetary policy was separately rooted in a commodity—such as gold or silver—and the union did not establish a common monetary authority or currency.

In today’s world, monetary integration can take several forms and range in the degree of cooperation required from its participants. I discuss four types of monetary integration, ranging in cooperation from greatest to least.

A full-fledged monetary union between two or more countries is the most ambitious, involving the creation of a new multinational currency, its substitution for members’ national currencies, the establishment of a new multinational central bank, and the legal transfer of responsibility for monetary policy to that new supranational institution. This type of union requires not only great cooperation and coordination, but also necessitates the participating countries to surrender individual sovereignty with respect to monetary matters.

A second, looser form of monetary integration involves the unilateral adoption of another country’s currency, but is much simpler than full-fledged monetary union because it does not require the creation of a new currency or central bank. In this case, the currency typically adopted is a widely-traded one (known as a “reserve” currency, meaning that it is held in the reserves of many countries) and is usually already in widespread use in the private sector of the adopting country. Because the countries that have pursued this unilateral adoption have replaced their sovereign currencies with the US dollar or the euro, this form of monetary integration is referred to as “dollar-ization” or “euro-ization.” As already noted, Ecuador, El Salvador, and Panama are dollarized economies; Andorra, Montenegro, and Vatican City use the euro.