Tuesday, March 31, 2009

A single currency?

On Bloomberg Surveillance this morning the concept of a single world-wide currency was discussed. Personally, I am not sure how that would even be possible. How would investors or the market be able to reflect their opinions as to the relative security and stability of various governments?

Even with a single world-wide currency, governments and countries will have different levels of output, stability, production, etc. There needs to be a way for the markets to reflect this. Currently, this can be done by the relative value of one currency versus another. Now consider every country has just one currency. The governments, natural resources, and indigenous economies are still different. Unless the currency is 100% backed by some universal commodity (gold, for example) part of the value of the currency is the "full faith and credit" in the issuing body, and that the currency note is redeemable for equivalent goods and services across national borders. That discrepancy between entities still exists regardless of shape, color, size, and portraits on the bills or coins in use.

Perhaps the discrepancies will become evident in different interest rates that need to be offered by the treasuries of the respective countries; a government with a stronger economy can offer lower rates in return for the inherent stability. Well, doesn't that make government securities in and of themselves a "shadow currency"? We can have the two bonds with the same par value, the same coupon, and the same duration with different prices, due to the perceived difference in risk and stability. I'd guess that pretty soon thereafter a market for trading these identical yet different instruments will be created, and we are pretty much back where we started.

As this is just semi-knowledgeable ramblings on my part, I'm curious to know how investors bet the German economy against the French, if both use the Euro. While an optimal currency area may be larger than a country, I'm pretty sure it is smaller than the entire world.