[Artigo] Robert Alexander Mundell Currency Areas and International Monetary Reform at the Dawn of a New Century

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Currency Areas and International Monetary Reform
at the Dawn of a New Century
Robert Alexander Mundell*
Abstract
The Asian crisis and the creation of the euro have jump-started once again discussion of exchange rate
systems, currency areas, and international monetary reform. The role of power in the international mone-
tary system is discussed and its relevance to analysis of the new euro area as an instigator of change in the
power configuration of the system. The dollar, euro, and yen areas have achieved a high degree of price sta-
bility, but international efficiency is seriously undermined by exchange rate gyrations of these three cur-
rencies. The best path to international monetary reform leads through a new international currency called
the INTOR based on a G-3 monetary union platform possibly linked to gold.
1. Introduction
On 23–25 March 1997, the Claremont Graduate School in California sponsored an
International Monetary Conference on “The Euro, the Dollar, and Economic Growth.”
At that conference, which included several Nobel Laureates in Economics, a poll was
taken on two issues: that the euro would come into being, and that it would be a desir-
able event. On both counts there was a distinctly pessimistic and negative attitude. I
cannot say that this attitude surprised me because opposition to and skepticism about
the euro in the United States was well known. But it represented a polarization of
opinion that would be difficult to explain on economic grounds alone. While there are
europhiles and europhobes on both sides of the Atlantic, the latter are concentrated
on the western shore.
Two years after this event the euro has become a reality. It promises to be a lasting
fixture of the global economic landscape. The trials and tribulations associated with its
introduction provide a number of lessons for monetary policy and historians. But the
fact that a large number of important countries have voluntarily decided not just to
lock exchange rates irrevocably but to scrap their own currencies for a common “super-
currency” stands in stark contrast to the recommendations of the mainstream eco-
nomics profession and the policies recommended by our international institutions,
which have been for almost three decades angry opponents of any regime of fixed
exchange rates.
It is inevitable that the choice to adopt the euro in 11 (now 12) relatively advanced
countries will have a demonstrable effect on currency area formation in other parts of
the world. No longer will it be taken as an act of faith that each nation must assert its
nationality by having a separate currency floating against other currencies. Instead,
countries are looking at new alternatives. If a common currency is good for Europe,
why would it not be good for other continents?
Review of International Economics, 9(4), 595–607, 2001
© Blackwell Publishers Ltd 2001, 108 Cowley Road, Oxford OX4 1JF, UK and 350 Main Street, Malden, MA 02148, USA
*Mundell: Room 1031, International Affairs Building, 420 West 118th Street, Department of Economics,
Columbia University, New York, NY 10027, USA. Tel: (212) 854-3669; Fax: +1 (212) 854-8059; E-mail:
ram15@columbia.edu. This paper is an extended version of a presentation made at the conference “Is 
Globalization of Capital Flows a Boost or Hinder to Development?” sponsored by the Program in Eco-
nomic Policy Management at Columbia University in New York in April 1999.
Just as countries might decide that the optimum tariff area is not the nation state,
but rather a wider optimum free trade area, so countries might decide, as indeed a
dozen EU countries have decided, that the optimum currency area is not the nation
state but a wider area that might conceivably comprise several countries or even the
entire world!
As a result of this change in viewpoint, it is inevitable that discussion of currency
areas has come to the forefront of international monetary analysis. In this paper I will
try to touch on some of the major issues that are relevant to a choice of currency areas
and their optimum size or number.
2. The World an Oligopoly
Let me start with one of the great omissions from economic theory. I refer to the
concept of power. Of course power is properly the preserve, a pivot of analysis, of 
political science. But power is also a fundamental part of economics and especially
monetary economics. We use terms like economic power, monopoly power, monetary
power, purchasing power as standard fare. But we are not used to using concepts 
like “the power configuration of nations” that I have found inescapable in monetary
analysis.
One of the most astonishing puzzles in the history of economic analysis has been
the way in which the economics profession swallowed hook, line and sinker, the argu-
ment for flexible exchange rates before it had been the subject of serious analysis in
an international context. When this idea was first proposed by Pier Christianen of
Sweden in the 1760s, by Thomas Attwood of Britain in the 1820s, by Irving Fisher of
America in the 1910s, or by Frank and Benjamin Graham of the United States in the
1940s, or by two future Nobel Laureates in Economic Science in the postwar era,
Milton Friedman of the United States and James Meade of Britain, it was typically to
solve the problems in a very particular context of a specific economy.
When Friedman, an eloquent libertarian conservative, proposed flexible exchange
rates in 1953 he had in mind that other countries would thereby be enabled to give up
exchange controls and that the United States, by ending its commitment to gold, would
be free to follow an alternative (but completely untried) monetary rule of fixing the
rate of growth of some monetary aggregate. Thus was born the modern versions of
“monetarism” and generations of foreign students studying economics at the Univer-
sity of Chicago took the idea home and applied it to their own countries where the 
situation was completely different.
When Meade advanced the idea of flexible exchange rates in Britain, it was for com-
pletely different reasons. Meade was a liberal socialist who wanted the Labor party to
be able to pursue socialist objectives without having to worry about the balance of
payments. His recommendation for the emerging common market countries in Europe
was that they move to free trade but achieve balance of payments equilibrium by flexi-
ble exchange rates!
None of the advocates of flexible exchange rates ever developed a global model to
show that the world would be better off with national currencies connected by fluctu-
ating exchange rates than any alternative. Most well-trained economists studied and
used general equilibrium theory as the basis of their analysis, but there was nothing in
the basic general equilibrium models of Leon Walras and his successors that gave any
clue to currency theory. Walrasian general equilibrium implicitly assumed a single cur-
rency in the “world” or “closed” economy.
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When the international monetary system based on the convertible dollar—the
Bretton Woods arrangements—broke down in the early 1970s, the absence of nego-
tiable alternatives led to the breakup of the system into flexible exchange rates. Instead
of it being looked upon as an aberration or a temporary expedient, the idea of flexi-
ble exchange rates was promoted by US, French, and German officials1 as a new
“system.” In reality, it was the abandonment of the international monetary system.
The International Monetary Fund had been set up at the Bretton Woods Confer-
ence in 1944 to manage the international monetary system of fixed exchange rates
linked to a US dollar that was in turn linked to gold. The Fund involved a set of rules
and a bag of currencies. Countries were legally obliged to keep their currencies within
1% of their par values, fixed in termsof gold or the 1944 gold dollar, while the United
States was committed to buying and selling gold freely at $35 an ounce.2 Countries had
(and still have) IMF “quotas” more or less in proportion to their economic size, and
filled these quotas by subscriptions in gold, foreign exchange, and predominantly
(75%) national currencies. These quotas determined a member’s normal “drawing” (in
effect borrowing) rights, but the Executive Board of the Fund could disperse larger
amounts in needy cases. The bag of currencies was needed to provide funds to coun-
tries in balance-of-payments emergencies.3 The breakdown of the IMF system in 1971
undermined the legality of the IMF agreement and removed the primary purpose of
the Fund.4 The Second Amendment to the IMF Articles of Agreement in 1977
endorsed what was called “managed flexible exchange rates.” This was a leap into the
dark because there was no background analysis either at or outside the IMF of how a
“system” of “managed flexible exchange rates” would work.
Economic performance in the decade of the 1970s, when the dollar system broke
down, was the worst on record since the 1930s, the decade when the international gold
standard, badly reconstructed in the 1920s, broke down. Inflation reached two-digit
levels in the United States, the prices of gold and oil soared, and a new word, stagfla-
tion, had to be invented to describe the dual malaise of simultaneous inflation and
unemployment. But despite these great evils, the world was saved from the disaster of
generalized floating by the power configuration of the world economy.
The importance of the power configuration of the world economy, with one currency
per country, should be intuitively obvious. A single country in the world would imply
a single currency—complete monetary integration. By contrast, a world of say 200
countries each of equal size would imply monetary disintegration and the chaos of no
fewer than 1/2 ¥ 200 ¥ 199 = 19,900 bilateral exchange rates! The framers of the Second
Amendment to the Articles of Agreement of the IMF, like the original proponents of
flexible exchange rates, did not consider or even recognize this problem.
Had the 180-odd current members of the IMF been around equal size, no econo-
mist in his right mind would have suggested flexible exchange rates as an international
monetary system. Under such a power configuration a metallic currency like silver or
gold (or both) would have emerged to provide an underlying numèraire. Ever since
coinage was developed in the 8–7th century bc, countries could have national curren-
cies but their gold or silver contents gave the world monetary system a coherent unit
of account as well as a medium of exchange.
In a world of paper currencies, in a world composed of small countries, there is no
common denominator that can serve as a unit of account and the result would have
been chaos—a chaos that, however, would soon make necessary a reconstruction of
an international monetary system.
The world in which “managed flexible exchange rates” was adopted, however, was
neither that of a single country with one currency nor a large number of small states
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of equal sizes.The “free” world was instead an oligopoly, with one “Gulliver” economy,
the United States, a few “oligops,” like Japan, Germany, France, Britain, Italy (the G-
7 countries minus Canada), several middle-sized economies like India, Canada, Brazil,
Mexico, Argentina, Australia, etc., and a large number of “minigops” too small to have
much individual influence in the world economy.
The existence of the Gulliver economy gave the world something close to a universal
unit of account and the international monetary system a coherence it would not have
had under a symmetrical constellation of sizes in the world economy. In place of inco-
herent unstructured exchange rate relations there was a focus on dollar exchange rates.
That the coherence and workability of the international monetary system depended
on the power configuration of the world economy may have escaped the attention of
international monetary officials,but it was not unknown to the best economists of earlier
generations. Before he died in 1873, John Stuart Mill had already recognized the future
emergence of two superpowers, the United States and Russia. By the 1880s the US
economy was already the largest in the world and in 1914 it is three times the size of its
rivals Britain and Germany. Keynes, in his 1923 Tract on Monetary Reform, acknowl-
edged in a much misquoted phrase that “the gold standard is already a barbarous relic”
and that the stability of the international monetary system came to rest on the policies
of a “few” central banks.The two world wars only reinforced the relative strength of the
United States. The international monetary system ratified at Bretton Woods was an
asymmetrical monetary system that could work only with US leadership.
When President Richard M. Nixon unilaterally took the dollar off gold in August
1971, the legal basis for the system broke down and the other major countries took
their currencies off the dollar. Thus ended the Bretton Woods era. After four months
of floating, the major powers, at an agreement reached at the Smithsonian Institution
in December 1971, put their currencies back on the dollar but it was to a dollar no
longer convertible into gold. The new system was a pure dollar standard.
Like any single-currency standard, the dollar standard would last only if either of
two conditions were met: either the United States takes into account the interests of
the rest of the world in determining its own monetary policy to avoid pushing infla-
tion or deflation to other countries; or that the other countries acquiesce in a US mon-
etary diktat. Neither of these conditions held in 1973. US monetary policy was too
expansionary for the other major countries, and that is why, despite another devalua-
tion of the dollar, the Smithsonian arrangements broke up by mutual agreement.
3. Advent of the Euro
Already during the Bretton Woods era, 1945–71, European countries had undertaken
steps to reduce dependence on the dollar and to establish their own monetary iden-
tity. Interest in monetary union in Europe was complementary to the other motives
for European integration, which included fear of invasion from the Soviet Union, emu-
lation of the United States, and the need to bury Franco-German enmity. It also rep-
resented a concern with the domination of the dollar in the international monetary
system, inflationary policies in the United States during the Viet-Nam war, and the
exaction of the “inflation tax” from the growing use of dollars in international reserves.
The Hague Summit in December 1969 established the goal of monetary union
among the members of the Economic Community. In that same month I presented the
first explicit plan for a European currency, dubbed the “europa.” 5 At that time Euro-
pean exchange rates were fixed to the dollar and so fixed to each other, with the result
that inflation rates as well as interest rates had already achieved a high degree of con-
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vergence. From a technical standpoint, therefore, monetary union would have been
comparatively easy before the breakdown of the system in the early 1970s, much easier
than the tortuous process two decades later!
Politically, however, the European countries were not yet prepared to move quickly
to monetary union. The final plan had not been settled on, and there was no agree-
ment on which, if any, country’s currency should replace the dollar as the pivot for
fixing exchange rates in the transition to the monetary union. It was not then realized
that the failure to capitalize on the pre-1971 convergence achieved through the dollar
would delay the end resultby more than two decades.
The movement to generalized floating was harmful to Europe but it was hardly less
harmful to the United States and the rest of the world. For better or worse the dollar
system anchored to gold had provided an anchor of monetary stability. No longer faced
with balance of payments constraints or, in the case of the United States, the constraint
of gold convertibility, monetary and fiscal policies became more lax, giving rise to
soaring gold prices and an explosion of liquidity in the euro–dollar market, the upshot
of which was a quadrupling of oil prices in 1974 following by another doubling of oil
prices in 1980. The price of gold hit $875 an ounce in early 1980, 25 times its pre-1971
official price. Three years of back-to-back two-digit inflation rates in 1979–81 closed
out a decade of the worst economic performance since the 1930s.
As already noted, the process toward monetary integration in Europe became more
difficult when European monetary convergence around the dollar was broken up with
the advent of flexible exchange rates. Throughout the decades-long process, “euro-
fever” followed the dollar cycle. When the dollar was weak euro-fever increased, and
when the dollar recovered it abated. Thus, in the dollar and euro–dollar crisis of the
late 1960s, the Hague Summit marked the first wave of euro-fever, but it subsided after
generalized floating began in 1973. With rapid US inflation and the flopping dollar of
the late 1970s, there resulted the EMS and its offspring, the exchange rate mechanism
(ERM); but with Reaganomics and the strong dollar of the early 1980s, enthusiasm
abated. With dollar weakness after the Plaza and Louvre Accords in the middle to late
1980s there resulted the Delors Report (1989); and, spurred by the unification of
Germany (which seemed to make a further move toward integration a political neces-
sity), the Treaty of Maastricht (1991). The strong dollar after 1995 aggravated euro-
skepticism, leading to the strong doubts about the euro I noted at the beginning of this
lecture; but the institutional momentum built up at Maastricht, with its three-stage
process, its convergence conditions, and its hard deadlines was strong enough to pull
off something approaching a miracle.
After the event it is easy to overlook the difficulties. But skepticism about the euro
ran high in the late 1990s, and it was by no means assured that a quorum of countries
would be both ready and willing to proceed to EMU, let alone a resounding majority.
If I were to choose a critical turning point, I would put it in August 1996, at the meeting
of President Jose Aznar of Spain and Premier Romano Prodi of Italy in Valencia. At
that meeting, as it was reported in the Financial Times, Prodi solicited Aznar’s agree-
ment to form a kind of “Club Med”(that would include Portugal) bloc that would push
for postponement of the 1999 deadline for the introduction of the euro. Aznar said no,
any attempt at delay would put at risk the whole Treaty, and Spain would make every
effort to meet the required conditions. To his great credit, Prodi accepted this verdict
and redoubled Italy’s efforts to meet the conditions. By 1 May 1998 all fifteen EU
members except Greece qualified to proceed to EMU, and eleven of those members
(now twelve with Greece) adopting the euro. Three countries, the UK, Sweden and
Denmark, qualified but have opted out for the time being, with a referendum on the
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subject expected in Britain. By the middle of 2002, the transition to monetary union
will be complete.
4. Three Islands of Stability
The advent of the euro is an unprecedented event in the history of the international
monetary system.Never before had sovereign countries of great importance in the world
economy voluntarily chosen to scrap their national currencies in favor of a supranational
currency. The step could not have occurred in the absence of strong political motives
linked to recognized economic gains. The political motives were not basically different
from the other motives for European integration: already noted. Similar motives will
keep pressure for deeper political integration simmering.
How does the euro affect international currency arrangements? It has been likened
to a shock comparable to the breakup of the international monetary system in the
1970s. But I think it has a different and in some sense deeper significance. The breakup
of the system in the 1970s did not change the power configuration of the international
currency system. Before and after the breakups in 1971 and 1973, the dollar was the
dominant international currency. But the euro has the prospect of becoming an alter-
native to the dollar in the international currency system. Upon its creation it suddenly
became the second most important currency in the world, and taking into account the
probable entry of remaining EU members, Britain, Sweden, and Denmark, in addition
to 10 or more accession countries, the euro area will in a decade comprise a larger
GDP area than the United States. For this reason, the advent of the euro promises to
be an event as important in the history of the international monetary system as the
replacement of the pound sterling by the dollar during World War I.
The importance of currency areas is measured by monetary mass, more or less pro-
portionate to GDP. The three largest currency areas in the world are the dollar, euro,
and yen areas, encompassing GDP areas that are respectively about $10, $7 and $5 tril-
lion.6 Much further down the list come the pound with $1.5 trillion and China’s RMB
or yuan with $1.2 trillion. Together the three largest areas comprise more than half of
world GDP. Reform of the international monetary system therefore has to deal with
dollar, euro, and yen exchange rates.
A fact of great significance is that the dollar, euro, and yen areas are zones of essential
price stability.After the abominable decade of the 1970s,governments and central banks
learned something about monetary policy.A flexible exchange rate is no panacea.Giving
up the anchor of fixed exchange rates and gold requires, not just flexible exchange rates,
but the replacement of the old discipline with a new anchor. Gradually, most of the
OECD countries and at least a few developing countries have learned to bring inflation
under control even in the absence of an effective international monetary system. In the
industrial countries, inflation in the 1970s averaged 8.4%; in the 1990s, it had been
reduced to 2.7%. The dollar, euro, and yen areas have been caught up in this pursuit of
stability and for this reason represent three large anchors of stability.
In my Nobel Lecture (Mundell,2000a), I noted that in one important sense the decade
of the 1990s was similar to the first decade of the twentieth century. There was a high
degree of price stability in the major countries. But the first decade of the century had
two advantages over the last decade.There was then also exchange rate stability, and in
addition a universal unit of account, represented by gold. One of the great puzzles of the
modern world is why we have such enormous fluctuations in exchange rates among the
major currency areas within which there is comparable price stability!
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In his important little treatise, A Tract on Monetary Reform, Keynes argued that when
external and internal stability were in conflict, it was most important to opt for internal
stability—inotherwords,price stability was more important than exchange rate stability.
I do not disagree with Keynes’ position on this issue. But what has been missed is that
Keynes also stressed the importance of exchange rate stability when it was not in conflict
withpricestability.TheimportanceofKeynes’viewson this subject cannot be understood
outsidethe context of the international monetary system about which he was writing.
Keynes was writing in 1921 and 1922, in the aftermath of the war inflation.The dollar
was the only currency tied to gold and so any attachment of the pound to the dollar
meant attachment to gold. The US price level had doubled between 1914 and 1921 and
then the new Federal Reserve severely tightened the money supply bringing the price
level down from an index of 200 (1914 = 100) to 140 in 1921. This was an unprece-
dented deflation. Had the pound been fixed to the dollar (or gold) in 1921, Britain
would have suffered, like the United States, a 30% deflation in one year! No wonder
Keynes would want to opt out of external stability (tying the pound to the dollar or
gold) in favor of internal stability (stabilizing the price level). Who wouldn’t?
But one exceptional postwar episode cannot be extrapolated forever. In a situation
where prices are stable and can be expected to remain stable there is no reason for
huge changes in exchange rates. But that is exactly the situation we have today: price
stability within the G-3 coupled with gyrating exchange rates that destabilize capital
movements, financial systems, debt relations, foreign investment, and the burden of tax
systems. That is why we have to think of the dollar, euro, and yen areas, not just as
potential anchors of stability, but also as independent islands of stability.
5. Unstable Exchange Rates
Unexpectedly large changes in nominal exchange rates typically induce large changes
in real exchange rates completely unjustified by real conditions. In other words, large
nominal exchange rate changes typically represent a movement away from the condi-
tions required for optimal trade; they create distortions. Yet the instability of both
nominal and real exchange rate over the past two decades has been astonishingly large.
Let us take mark/dollar and yen/dollar exchange rates as benchmarks for the past two
or three decades to underline the high degree of exchange rate instability since gen-
eralized floating began.
For most of the Bretton Woods era, from the Dodge currency reform in Germany 1948
until the Paris riots of 1968, the dollar was fixed at DM4.2 or 4.0, but by the mid-1970s it
had fallen to about DM3.5. Five years later, in 1980, the dollar had fallen in half to about
DM1.7, but over the next five years, by 1985, it had doubled to DM3.4. Over the next
seven years, in the pit of the ERM crisis in September 1992,the dollar had dropped below
DM1.35. Today the dollar is back up around DM2.2! If the dollar–euro rate duplicated
the instability of the DM/dollar rate, it would crack Euroland apart!
The situation has been no better with the yen–dollar rate. From the Dodge currency
reform in Japan in 1948 until 1970, the dollar was fixed at 360 yen. By 1978 the dollar had
fallen below 195 yen but then, by 1985, it had risen to 250 yen. From 1985 to April 1995
the dollar fell to a low of 78 yen, only to rise over the next three years to 148 yen in June
1998, after which it dropped back to 105, followed by a likely rise to about 125 yen in
2002.These great gyrations in the yen–dollar rate have not only undermined the Japan-
ese economy and its banking system but done untold damage to Japan’s neighbors in
East Asia.
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Given the fact that price stability has been achieved in Japan and the United States
and the EMU countries, would it not be a great benefit to the entire world for exchange
rates among these major blocs to be fixed?
6. Fixed versus Flexible an Oxymoron
Much idle time has been wasted on the debate over whether fixed or flexible exchange
rates are better for any country. Can the two be compared? The answer is no, not within
a structure of comparable monetary stability. A fixed exchange rate is a precise mon-
etary rule that delivers to a country the inflation rate of the anchor currency country.
By contrast, flexible exchange rates are consistent with any inflation rate at all!
Germany had a flexible exchange rate during its great hyperinflation of the 1920s,
which ended only after a currency conversion of 1 trillion marks for 1 new gold mark!
I hasten to emphasize that when I speak about a fixed exchange rate system I am
not speaking about “pegged” or pseudo-fixed exchange rates. When a country “pegs”
its exchange rate by intervening in the foreign exchange market, but at the same time
sterilizes the monetary effects of the transaction by open market operations, it kills the
adjustment mechanism. A pegged exchange rate will ultimately break down because
there is no adjustment mechanism and the exchange rate will not stay fixed.
The relevant choice is not between fixed and flexible exchange rates but between
alternative targets to achieve given price level or inflation targets. Among principal
targets that have come under discussion—gold price, wage rate, price level, money
supply, money income, exchange rate—most attention has been focused on inflation,
monetary, or exchange rate targets. Monetary (sometimes money-base) targeting
makes sense for countries experiencing hyperinflation, but it is too clumsy an instru-
ment at low inflation rates owing to the variability of the money-multipliers and
income velocity. Inflation targeting is the favorite of some large central banks like the
Federal Reserve, the European Central Bank, and some smaller independently minded
central banks like those of the UK, Canada, Australia, and Chile. Exchange rate tar-
geting is the approach of those favoring currency board systems, like Hong Kong,
Argentina, Estonia, Bulgaria, etc., and monetary unions, like the euro area.
There is room for debate—in the absence of an international monetary system—
about which of these alternatives is better for any particular country at a particular
time. But there is no room for intellectual debate about the oxymoron of fixed versus
flexible exchange rates.
7. The So-Called Asian Crisis
The 1997/98 crisis among some currencies in East Asia has been dubbed the “Asian
Crisis” or—in Korea—the “IMF–Asian” crisis. Yet of the fifty-odd countries in Asia, it
affected in a major way only four countries, although repercussions were felt also in
their neighbors. These countries were Thailand, Malaysia, Indonesia, and South Korea.
I will refer to these as “B” countries. The official consensus seems to be that “crony
capitalism” was at the root of the crisis in these countries, but that is unconvincing.
Most economies—capitalist and communist—have elements of “cronyism”—“old-
boy” networks and the like—and they are not restricted to developing or emerging
market countries. Moreover, there is no real evidence that cronyism suddenly appeared
on the scene in the late 1990s or that it disappeared when the crisis was resolved.
Rather, the crony theory seems to be an alibi for market forecasters and international
institutions that failed to predict the crisis.
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What did the countries experiencing the crisis have in common, by contrast with
those that escaped it? Let us look at Singapore, Hong Kong, China, Taiwan, and Japan,
five countries or regions that were not directly affected, that I will refer to as the “A”
countries. The A countries/regions had three characteristics in common: explicit hard
targets for monetary policies, and low international debts and large reserves. By con-
trast, the four ailing countries mentioned above had soft targets for their monetary
policies and high debts and low reserves.
Notice that, while the five unaffected countries had firm targets for monetary policies,
they were not the same targets. Singapore’s monetary authority fixed to a currency
basket;7 Hong Kong, a currency board system; China, a fixed exchange rate with capital
controls; and Taiwan and Japan, a commodity-baskettarget (inflation targeting).
The fact that the A countries and a host of others survived 1997/98 without a major
crisis shows that it was not an “Asian” crisis. It was a crisis of four countries. For that
reason I have referred to the crisis as a “so-called” Asian crisis.
If crony capitalism was not the cause of the crisis, what was its cause? The answer
stares one in the face: the sudden appreciation of the dollar and depreciation of the
yen. Countries that had their currencies merely pegged to the dollar suffered specula-
tive attacks. Prior to the crisis, capital had flowed inward and supported strong growth
at the same time financing and creating substantial current account deficits. When the
dollar appreciated and the yen fell, East Asian exports became less competitive in
world markets and were shut out of Japanese markets; and, in addition, direct invest-
ment from Japan, which had done much to drive East Asia growth, dried up. Current
account deficits had to shrink and speculative capital outflows aggravated the pressure
on exchange rates. The IMF was called in and made flexible exchange rates a condi-
tion of financial aid. That, instead of solving the problem, exacerbated it, leaving no
anchor around which foreign investment could make plans.
Not surprisingly, the one country that rejected IMF policies and did without orga-
nized international aid, Malaysia, was one of the first to recover. Before the crisis, the
dollar was 2.5 ringgits. Initially, under IMF policies, the ringgit was driven down to
levels that created inflationary pressures as the dollar rose close to 5 ringgits. Policy
reform independent of the IMF then fixed the dollar at an intermediate level at 3.8
ringgits, where it has since remained. At the same time some exchange controls were
imposed, ostensibly to defend the currency against speculation, but also to screen the
direction of foreign investment.The Malaysian policy led to a strong international posi-
tion, an unprecedented buildup of international reserves, and low interest rates. At
least by comparison with the other B countries, Malaysian policy has to be judged a
success, although it has been a success tempered somewhat by a slowing down of
foreign direct investment.
8. Monetary Policy and the Current Slowdown
Let us, then, blame at least part of the “Asian” crisis on the gyrations of the yen–dollar
exchange rate. But that does not dispose of the issue: what caused and who is to blame
for the exchange rate gyrations? Why did the dollar appreciate? Was US monetary
policy too tight?
A case can be made that US monetary policy was too tight. First, inflation rates in
the period 1994–98 at less than 3% were lower than in either the preceding or suc-
ceeding period. Second, money (using its narrow definition) growth rates in the same
period were lower than before or after the crisis. Third, the price of gold fell by 25%
between 1994/95 and 1998/99. Fourth, metal prices in general fell by 25% between 1995
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and 1998, as did food, beverages, and raw materials. Fifth, all the countries that had
hard fixed exchange rates with the dollar suffered at least some mild deflation in the
period 1995–99. These measures individually merely suggest that Federal Reserve
monetary policy was too tight but collectively they make quite a convincing case. The
emergence of a serious global slowdown originating in the United States goes far to
confirm the case against Federal Reserve policy.
Federal Reserve errors in the late 1990s stemmed from its failure to take into account
factors other than the current CPI inflation rate.The Fed ignored the evidence of exces-
sively tight monetary policies provided by the strong appreciation of the dollar against
major foreign currencies that showed no evidence of inflationary pressure, the fall in the
price of gold, the decline of metals, food and raw materials prices, and the deflation suf-
fered by those countries with currency board arrangements or hard fixed exchange rates
against the dollar. It provides ample evidence that a lexicographic attachment to a single
inflation-rate-forecast variable is an insufficient guide for monetary policy.
The fault lies not just with the monetary authorities. It lies also with the interna-
tional system and the international institutions, including especially the International
Monetary Fund. The prevailing general consensus of monetarist economists and the
international monetary authorities has been that a central bank should conduct mon-
etary policy to achieve a low and stable inflation target. Because of the widely accepted
view that there is a long and variable lag (usually said to be 9–18 months) in the effect
of monetary policy—a view with surprisingly little evidence to back it up!—this means
that the monetary policy committees have to forecast inflation rates from 9 to 18
months ahead and change interest rates (or conduct open market purchases or sales)
in such a way as to move the forecast inflation rate closer to the target rate. This is an
almost superhuman task that few central banks can be successful in achieving. At the
same time, central bank forecasters are supposed to neglect changes in exchange rates,
gold prices, or real variables except insofar as they bear directly on the forecasts!
Yet there is a schizophrenia in thinking about money today. Despite the insistence
that inflation targeting is the policy for the two largest central banks, and that these
central banks should completely ignore exchange rates, there is general recognition
that the international monetary system is seriously flawed. The same officials who dog-
matically defend current policy and the neglect of exchange rates and gold prices
sponsor conferences on “Reforming the Architecture of the International Monetary
System” from which no serious proposals for reform ever emerge. The best they come
up with are pleas for “more transparency” of the IMF, or “better surveillance,” or “more
diligence in detecting crises before they cause harm,” followed by self-congratulatory
remarks about how quickly they were able to act when the unpredicted Asian crisis
arrived. The fault is not far to seek: the major problems of the system—gyrating
exchange rates of major currencies, the lack of an international monetary unit and
anchor for the world price level—have not even been addressed. It is still taboo to 
criticize flexible exchange rates or talk about gold or an alternative international
anchor. It is the common syndrome of Hamlet without the Prince of Denmark!
9. G-3 Monetary Union
Elsewhere (Mundell, 2000b) I discussed the possibility of a G-3 Monetary Union, not
on the pattern of EMU, which is a single-currency monetary union, but with dollars,
euros, and yen remaining in existence. The formation of such a union would follow the
procedures adopted for creating the 11-currency monetary union of the EMU, but
before the introduction of the single paper currency notes.As with any monetary union
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it involves procedures for (1) locking exchange rates; (2) defining the price index for
calculating a common inflation rate; (3) agreeing on a common inflation target; (4)
forming a joint Monetary Policy Committee (MPC); and (5) establishing a formula for
division and rebate of the seigniorage.The locking of exchange rates needs some atten-
tion. Taking into account the current size configuration of the three areas, the dollar
would, at least initially, be the pivot, passive or anchor currency. The BoJ would fix the
yen and the ECB the euro to the dollar, leaving the monetary effects of their inter-
vention unsterilized by offsetting open market operations. The MPC would meet reg-
ularly and make all decisions to change the money supply or alter interest rates with
the object of achievingthe agreed inflation target objectives.
The superiority of a G-3 monetary union over the three interest rate islands that
now exist can hardly be gainsaid. A common inflation objective would give each of the
areas the agreed inflation rate, subject to an error factor, and the area as a whole would
no longer have to cope with the instability imported from exchange rate gyrations.
Political issues represent another question. Any kind of monetary union has an
intensely political component. Monetary unions work best among friendly nations.
They would lack credibility among areas that were following antagonistic trade prac-
tices or were building up war chests of reserves in case of war within the union. At the
same time the increased interaction and cooperation needed to make a union work
would be a catalyst for better political relations.
In the post-Cold War era, the three major currency areas could provide the leader-
ship not only in mitigating harmful exchange rate instability among themselves, but 
in asserting a leadership position with respect to the international monetary system—
culminating, perhaps, in a movement to create a new truly international currency.
10. The Intor
In ancient times something approaching a global currency did exist. The precious
metals provided the common denominator. Currencies were names for different quan-
tities of gold or silver. The great empires of the past provided the ancient equivalents
of the gold sovereigns and dollars of recent centuries.
In the age of Caesar Augustus, the universal unit of account was the aureus, later
called the solidus, nomisma, or bezant. That unit provided a unit of account that lasted
over ten centuries. In the Middle Ages, the “dollars” were the sequins, florins and ducats
of the Italian city states. In the Renaissance the Spanish dollar served the same
purpose, and in the nineteenth and twentieth centuries it was the pound sterling and
the American dollar. The decades since 1971 have been unique over the entire period
of recorded history in the absence of a universal unit of account. If national curren-
cies were merely names for different quantities of the precious metals, the metallic
content provided a common basis for a global unit of account.
The case for a world currency is an extension of the same logic that makes a national
currency preferable to decentralized provincial currencies. The advantages of a
national currency over multiple provincial or municipal currencies are so obvious that
older generations of economists took them for granted. Soon after the United States
of America came into being, the 13 former colonies scrapped their own currencies—
based on pounds, shillings, and pence—for a common national currency based on the
Spanish dollar.
Historically, monetary integration has been an inevitable consequence of political
integration. It has typically been a sufficient condition for monetary integration; there
have been few if any integrated national states that lack monetary integration. That
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political integration is a sufficient condition for monetary integration is abundantly
clear. Is it also a necessary condition?
It is easy to understand how a world economy united under an imperial government
could produce a world currency—even a world paper currency. The same conditions
would apply in the world as a whole as apply within any centralized nation state. If the
United States ruled the world, it would be natural for that American empire to use the
dollar everywhere. Provided US monetary policy were acceptably stable, it would prob-
ably be a better international monetary system than has ever existed in the past. But
the fact that the United States is only a semi-dominant superpower rules out that
option.
At the other extreme, if the world consisted of a large number of small or medium-
sized states none of which had any transcendent hegemony, an arrangement where
each country produced its own national paper currency would result in chaos unless if
were possible to organize an international monetary system. Sooner or later, one of
three options would emerge: an agreement on an international paper money; the indi-
vidual and haphazard adoption of a common commodity—such as gold or silver—as
international money; or a concerted agreement on the use of an international com-
modity unit—such as an ounce or, say, 100 grams of gold—as a common international
unit of account.
The first type of agreement would be hard to negotiate or police outside a “security
area”, i.e., a zone in which international strife is ruled out. The second and third
approaches, however, conform fairly closely to the historical specie standards that dom-
inated the monetary system in the centuries before 1971.
The great merit of the international specie standards was that they enabled the world
to achieve a high degree of monetary unity without overt explicit political integration.8
Specie standards greatly reduced jealousy over seigniorage.The world economy before
World War I could be looked upon, as Cassel observed, a gigantic sterling area, just as
after that cataclysmic event it became a dollar area. An underlying theme of interna-
tional monetary history is that the superpower rejects any international monetary
reform likely to undermine the monopoly role of its own currency in international
transactions. Thus Britain in the nineteenth century and the United States in the twen-
tieth were the principal obstacles to the adoption of a global unit of account.
The situation at the beginning of the new century is now different. The introduction
of the euro has changed the financial power configuration, and the time can be fore-
seen when the dollar will have to vie with the euro. Under these circumstances, it is
possible if not likely that the United States will see a global currency in its own inter-
est as well as that of the rest of the world.
What form could that new currency take? My own approach would be for the G-3
areas to take steps in the direction of a G-3 monetary union as outlined above, and to
build a global currency on the platform of the G-3 unit as its anchor, with of course a
unique name such as the intor. The intor would be interconvertible into the G-3 cur-
rencies and into any other national currency that chose to enter the new system. The
Board of Governors of the International Monetary Fund could then formally desig-
nate the G-3 as the agent of the Fund with the responsibility of maintaining price sta-
bility and reporting periodically on its policies for the benefit of all members.
Should the new intor be linked to gold? There would be much opposition to over-
come. But a link to gold would have several advantages. First, gold is still the second
most important reserve in the international monetary system, second only to the dollar.
Second, a link to gold would contribute credibility to an intor not backed by a politi-
cal union. Third, gold, as an exhaustible resource, would be an ever-present environ-
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mental reminder that global resources are finite. And fourth, gold could serve as a tan-
gible embodiment of intors in the form of an overvalued legal tender coin. It remains
to be seen whether or not these merits are sufficient to overcome the inertia of chryso-
phobia inherited from the last century.
In the meantime, however, we should be prepared to contemplate new/old ideas
about the future of the international monetary system and consider the possibility of
a world currency. As Paul Volcker has aptly put it, “A global economy needs a global
currency.” Why not?
References
Keynes, John Maynard, A Tract on Monetary Reform, London: Macmillan (1924).
Mundell, Robert A.,“A Plan for a European Currency,” in H. G. Johnson and A. Swoboda (eds.),The Economics of Common Currencies, London: George Allen & Unwin (1973):143–73.
———, “A Reconsideration of the Twentieth Century,” American Economic Review, 90
(2000a):327–40.
———, “Currency Areas, Volatility and Intervention,” The Wall Street Journal, March 30
(2000b):16A.
Notes
1. George Schultz, US Secretary of the Treasury, Valery Giscard d’Estaing, President of France,
and Helmut Schmidt, Chancellor of West Germany.
2. Not counting small handling charges of 0.25% above and below $35, resulting in actual US
Treasury buying and selling prices of $34.925 and $35.0875, respectively.
3. The basic idea of the IMF system was that countries in surplus could provide reserves to
deficit countries and would be repaid when adjustment was achieved. Two major problems
undermined the system. One was the deficit of chronic surpluses in some creditor countries and
chronic deficits in debtor countries. The other related problem was that the currencies of well
over half of the IMF members were inconvertible and thus of no use as currencies to be drawn.
4. The secondary functions of the IMF—collecting statistics, as a forum for annual meetings,
and for national consultations—now became more important than keeping the system intact.
The IMF ceased to be merely an agent of the countries designated to maintain a specific 
international monetary system, but became instead a bureaucracy dedicated to its own self-
preservation and expansion. The debt crisis that emerged in the 1980s saved it in that decade
and the collapse of communism saved it in the following decade, each occasion providing jus-
tifications for new programs and larger staffs.
5. Speech entitled “The Case for a European Currency,” delivered to the American Manage-
ment Association in New York, December 1969, reported in Chase Manhattan Bank Newsletter
(December 1969). A revised version, entitled “A Plan for a European Currency,” was presented
at the Conference on Optimum Currency Areas in Madrid, March 1970, and published in the
book of the proceedings of that conference (see Mundell, 1973). As a consequence of this paper,
I was invited to review and discuss alternative plans for monetary union with the European
Commission on Monetary Affairs in Brussels, which I was able to do in June/July 1970.
6. The relative sizes of the GDPs of these countries expressed in a single currency are of course
highly sensitive to the exchange rates at which the currencies are converted. The relative impor-
tance of the dollar area is probably somewhat exaggerated to the extent that the dollar is cur-
rently (2001) somewhat overvalued.
7. Without, however, announcing what the basket was or when it changed.
8. The “balance-of-power” system nevertheless was sufficient to make the nineteenth century a
century of comparative peace. The breakdowns of the specie standards during the Napoleonic
Wars and World War I suffice to show that no international monetary system is completely
warproof.
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