There are only four basic currency systems in the world

[<k>]

Disagree with me if you wish, and correct me where I am wrong, but I believe there are only four basic currency systems in the world.

Since I am talking about the modern world, I will begin by excluding barter, or "payment in kind".

These four systems are:

1] The state or national currency.

2] Dollarisation.

3] The currency union.

4] The currency board.

[<k>]

The State or National Currency.

The national currency is the one we are probably most familiar with. I should perhaps refer to it as the state currency, since many states contain more than one nation, and some nations, e.g. the Kurds, are lacking a state.

A state currency is officially issued by and within a single state: one country, one currency. The US dollar and the UK pound sterling are two good examples of this. The state currency is issued by a central bank: in the case of the UK, by the Bank of England; and in the USA, by the Federal Reserve (popularly known as "The Fed").

As a coin collector, the state or national currency is my favoured system. States or nations using this system produce coins whose specifications are either unique or close to being so. This gives rise to a greater variety of coinage.

However, within that system, there may be features that are not unique, for instance the effigy of the British monarch that many coins of the British Empire or Commonwealth were required to carry. Additionally, the names and denominations of those coins are not always unique. More than one country, for instance, uses coins called cents, or dirhams, or roubles; the denominations they use may or may not be unique – to my knowledge, only one country, the Bahamas, issues a fifteen cents coin.

[<k>]

Dollarisation.

Issuing your own currency comes with its own costs and complications. Some countries prefer to use the currency of other countries, either officially or unofficially. This system is called "dollarisation", a generic term used whether the currency used is dollar, the euro, or whatever. Timor Leste is, to my knowledge, the latest dollarised country.

Some countries, e.g. Palau, have continued to use the US dollar, despite becoming independent from the US. This makes sense for a small country, as issuing your own currency costs money. Two British dependencies also use the U.S. dollar: the British Virgin Islands since 1959, and the Turks and Caicos Islands since 1973. This likewise makes sense, given their location.

In Europe, we find that Montenegro has opted to use the euro as its sole official currency, despite not being a member of the European Union. Some dollarised countries use a variety of foreign currencies. Zimbabwe reportedly uses the UK pound sterling, the US dollar, the South African rand, the euro, and the Botswana pula.

The disadvantage of dollarisation is that a dollarised country does not earn seignorage: this goes to the country that issues the currency.

As a coin collector, I disapprove of dollarisation, as it reduces the variety of world coinage available for me to collect. However, that is not always the case: there are hybrid situations, where a dollarised country uses the US dollar but still issues its own coins for circulation. An example of this is Timor Leste, where one US dollar equals 100 Timorese centavos; Timor issues its own nationally themed centavo coins for circulation but uses only US bank notes.

According to Wikipedia, dollarised Ecuador uses US coins in addition to its own centavo coins:

"Ecuadorian centavo coins were introduced in 2000 when Ecuador converted its currency from the sucre to the U.S. dollar. The coins are in denominations of 1, 5, 10, 25 and 50 centavos and are identical in size and value to their US cent counterparts (although the US 50-cent piece is rarely used.) They circulate within Ecuador alongside coins and banknotes from the U.S.A. Unlike in the United States, the $1 coin is commonly found in circulation. Ecuador does not issue any banknotes, relying on US issues."

[<k>]

The Currency Union.

This is where two or more countries share a currency. Probably the best known current example is the euro. Formerly the members of the euro currency union issued their own currencies. The citizens of those countries incurred costs when they had to exchange, say, French francs into Italian lire. Now, citizens enjoy the convenience of travelling throughout the euro zone without having to exchange currencies.

The disadvantage is that there is only one central bank setting a single interest rate for the whole of the euro zone. The optimum interest rate for the euro zone as a whole may not be the optimum rate for, say, Spain or Germany. It may also take a long time for the economies within the euro zone to converge – and that convergence may turn out to be painful, as we have seen in the case of Greece.

Proponents of the currency union talk about the "optimal currency area". A currency that crosses national boundaries may in some sense be more efficient and less costly to maintain than a national one. Nevertheless, an optimal currency area, however it is defined, may vary over time. What was once an optimal area may no longer be so in 10 years' time. Some observers of the euro zone think it may currently contain two optimal currency areas: a northern European one (France, Germany, etc.) and a southern European one (Greece, Spain, etc.) - one of which may eventually leave the euro.

The euro coinage enjoys the benefit of uniformity. Each member of the euro zone is allowed its own national designs on the reverse of the coins - with certain restrictions - but otherwise the euro coinage is uniform from country to country in its obverse design, its range of denominations, and its size, shape, metal content and general specifications.

As a coin collector, I mourn the loss of the variety of the old national European currencies. The euro enjoys  variety in its national designs only – otherwise all its denominations are obviously restricted to the same specifications. Some euro countries use the same single design on the reverse of all its euro coins: Ireland, for instance, uses only its harp, replacing the diversity of its old barnyard set designs. I am told that the inhabitants of the euro zone actually prefer a single design per country, as it makes the coins less confusing and easier to recognise. If the euro zone grows, I fear that "one design per country" will eventually become a requirement.


Unlike the euro, the coins of some currency unions, for instance those of the East Caribbean states, do not include any national identifiers on their coins; although the coins of the East Caribbean states circulate throughout all the member states, the legend on the coins reads only "East Caribbean States" and does not identify any individual state or nation. So, the euro allows more design variation than the East Caribbean States, which has only one standard set of designs for all its member states.

[<k>]

The Hybrid Currency Union.

Just as there are hybrid dollarisation systems, where US dollar bills are used side by side with a national coinage, there are also hybrid currency unions. Everybody knows that any euro coin, whether its national design is Slovenian, German or whatever, is legal tender in any and every country of the euro zone.

However, what would you think if I told you that there are currency unions where that is not the case? It may surprise you to know that Jersey, Guernsey, and the Isle of Man are considered to be in currency union with the UK. This is because the Crown Dependencies, as the three dependencies are known, are semi-autonomous, are not part of the UK, and are therefore not under any requirement to use the UK pound sterling. All three do use it, however, as their only official currency. In addition, though, they are allowed to produce coins and banknotes bearing their own local designs. Apart from the designs, their banknotes and coins conform in all other respects to those of the United Kingdom: denomination, size, shape, metal content or material. All bear a portrait of Queen Elizabeth on the obverse.

Although the Crown Dependencies have their own local coins and notes, UK coins and notes are legal tender and circulate alongside the local issues. Despite all this, and despite the fact that these three dependencies are in official currency union with the UK, and despite the fact that their coins and notes are equal in value to their UK counterparts, the coins of the Crown Dependencies are not legal tender in the United Kingdom itself.

This seems to me to be an illogical and anomalous situation. Just imagine if you could spend your French euros in Germany, but not vice versa? What would be the point of that? In practice, the coins (but not the notes) of the Crown Dependencies do circulate in the UK in small numbers. In part, this is because they are almost identical in specification to the UK coins, and they also carry a portrait of the Queen. They therefore easily slip into circulation unnoticed. In part, it is because the average person cannot tell the difference between UK coins and those of the dependencies. That also goes for many shop assistants and shopkeepers.

As a coin collector, I welcome variety in coinage. I do not, however, think one-sided currency unions are logical. The UK should make the coins and banknotes of the Crown Dependencies legal tender within the UK. Then we would enjoy a true currency union.

[<k>]

The Currency Board.

Countries, dependencies or territories that use currency boards do not have a central bank that issues its own independent currency. Instead, they issue their own coins and banknotes that are backed by someone else's currency. The backing currency is technically known as the "anchor currency". The currency board then maintains it national or local currency at a fixed rate to the anchor currency.

In the case of, say, Gibraltar, the currency board takes in UK banknotes, banks them to earn interest, then issues its own banknotes with its own distinctive local designs. It calls it own currency the "Gibraltar pound sterling" and backs it with the anchor currency, the UK pound sterling, at a rate of one Gibraltar pound to one UK pound. UK banknotes and coins are accepted and circulate alongside the Gibraltarian versions. Any Briton visiting Gibraltar will therefore find a situation that is superficially the same as the one he encounters in Jersey, where local coins and notes circulate alongside UK ones of the same denominations and value. However, technically they are two very different situations, since Jersey is in currency union with the UK, and its currency IS the UK pound sterling, despite its locally different designs. The Gibraltar pound and the UK pound are technically two different currencies, despite the fact that the former is dependent on the latter, whilst the UK pound is a totally independent currency.

A currency board must typically back its currency with 105% to 115% of the anchor currency. It will find that over time its inflation rate comes into line with that of the country providing the anchor currency. However, unlike dollarised countries, a country using a currency board is able to earn interest on its anchor currency reserves. If its currency is not fully backed, this will cause problems once it becomes generally known. By 1994, the Cook Islands' dollar was backed to a rate of only around 95% by its anchor currency, the New Zealand dollar. The New Zealand banks thereafter refused to accept Cook Islands dollars, and as a result the Cook Islands were forced to abandon their currency board and revert to dollarisation, by using the New Zealand dollar as their official currency.

As a coin collector, I find that a currency board is a welcome alternative to dollarisation, in that it leads to greater variety of coinage than would otherwise be the case. However, the coinage will often enough follow the same format and denominational system as those of the anchor currency, and only its designs will be unique.

[<k>]

Serbian dinar.

There is only one remaining situation.

That is where different currencies are used in different parts of a country.

Logic dictates that such a country is then no longer a country.


We saw that in the confederation known as Serbia-Montenegro.

Serbia used the dinar and Montenegro used the euro.


That country duly fell apart.

Its former constituent parts are now independent states.

[Figleaf]

It depends on how you define currency. In most countries, tokens still play a role, e.g. the national transport tokens in the UK, car wash tokens, parking tokens, coffee machine tokens, beer tokens, prison tokens, to name a few. Some are just another form of the national currency (transport tokens), others can be bought (e.g. beer tokens), some are emphatically not the national currency (prison tokens) and some have no monetary value (parking tokens).

The IMF distinguishes other forms of currency and calls what you call dollarization fixed rate currencies (e.g. DKK) or currencies floating against a basket (e.g. the Chinese Yuan) or in a band as it considers convertibility and the reach of central banks important, but it doesn't distinguish between what you call currency unions and national currencies. I think this is correct, as it is an implicit value judgement on the form of government of its members.

The differences between unitary states, federal states and the unique EU are just not very important for the efficiency of the currency. The "one-size-fits-all" argument can just as well be applied to the US, Germany, Australia or, for that matter, the UK, where e.g. economic growth in England is different from economic growth in Scotland. In fact, you can stretch the argument ad absurdum to city (London grows faster than Newcastle), or even quarter level or on a pan-regional level, making the argument that fixed rates can never work in theory because of this argument, which reminds me of the archeologists who "proved" that archeopterix couldn't fly, until it was shown that by the same argument, bees couldn't fly either.

Speaking of the IMF, there are also constructed currencies, such as the ECU and the SDR. Go back a few decades only in time, and you find that the gold-franc (a currency that no longer existed) was used as a unit of account, e.g. by the International Postal Union and for telecommunication payments. Similar mechanisms exist for payments between countries with inconvertible or partially convertible currencies.

Peter

[<k>]

The differences between unitary states, federal states and the unique EU are just not very important for the efficiency of the currency. The "one-size-fits-all" argument can just as well be applied to the US, Germany, Australia or, for that matter, the UK, where e.g. economic growth in England is different from economic growth in Scotland. In fact, you can stretch the argument ad absurdum to city (London grows faster than Newcastle), or even quarter level or on a pan-regional level, making the argument that fixed rates can never work in theory because of this argument, which reminds me of the archeologists who "proved" that archeopterix couldn't fly, until it was shown that by the same argument, bees couldn't fly either.

Peter

Which is why I made my point about Serbia-Montenegro (as a let-out clause!) and what constitutes a country: it doesn't use different currencies in different regions.

[Figleaf]

The Republic used many different currencies and produced even more, the Holy Roman Empire used tens of different currencies, the double-monarchy used two currencies, even France used at least three different currencies simultaneously. Several Spanish colonies used the heavy real and the light real. All were single countries.

Peter

[Figleaf]

I was recently in the Turkish part of Nicosia. OK, I was in a touristy area only, but the only prices I saw were in euros, not in Turkish lira ...

Peter

[Austrokiwi]

Good Thread but it runs the danger of conflicting discussion. 

I recently read Keynes Treatise on Money ( both Volumes). I Initially found Keynes description of money types( not Currency) overly anally retentive ( apologies to Feud), but then as I read on I realised the analysis was important if only to highlight the fluid nature of the "substance" we call money.  Given that money is so hard to define a fear a clear and accepted definition of currency and its types will always be subject to discussion ( worthwhile discussion that is).

[<k>]

> Good Thread but it runs the danger of conflicting discussion. 

Agreed, but the point of the forum is to discuss, disagree, and hopefully enlighten along the way.

> Given that money is so hard to define a fear a clear and accepted definition of currency and its types will always be subject to discussion ( worthwhile discussion that is).

Also agreed. I recognise my categories are largely subjective, but I find them to be a good starting point, from my collector point of view, to understanding the relationship between modern currency systems and the types of coinage they throw up.

[Figleaf]

I never managed to read Keynes or Freud. Compliments for tenacity.

As a former financial economist, I feel that Keynes was way too system-oriented, neglecting the individual, while Freud was too individual oriented. There's a truth somewhere in the middle, but it is so complicated. Even behavioral investing doesn't capture it, as the BI funds don't produce an excess return (alpha) in practice. Markets fersure don't capture it, as they tend to be either regulated or wildly unstable.

Keynes and his "mathematical" approach are to be commended for bringing some rigor to economics, but model elasticities are just tools. They vary by the second on outside impulses (or advertising would be useless) and one cannot build a model with the elasticities as variables. Same for observed correlations (probabilities). During the banking crisis they all tended towards 1, destroying diversification.

Freud explains fear pretty well, though IMHO he describes too much to childhood and not enough to experience. Traders who never went through a down cycle are a danger to stability or an easy prey, depending on where you are in the market. Freud doesn't explain greed, the other major market driver, unless you see it as part of the sex drive. However, I think the sex drive is part of the power drive, which at its most basic is an attempt to control the world (or at least the environment of the individual) and the thing that comes closest to explaining greed.

Haven't tried sociology for an answer, but there may be something there. The herd mentality is a good example.

Sorry for the shop talk. It's all Austrokiwi's fault Akona, can you comment?

Peter

[akona20]

The function of various currencies these days is merely something to speculate on.