Factors which make a national currency an international one
In a global economy, international currencies are needed. Internationally important goods have to be priced in a common currency. More important, cross boarder credits must be denominated in the currency of the creditor or debtor or a third currency. As soon as an international currency exists there is the need and motivation to use this currency as a store of international monetary wealth. There is no world currency in the sense that this currency only takes over international functions. Keynes’ (1969) proposed Bancor and later the Special Drawing Rights (SDRs) created by the IMF have elements of an international currency but can only be used by central banks. International functions are taken over by national currencies. Which currencies take over international functions is selected by private wealth owners and other economic agents. The selected currencies own a relatively high level of liquidity premium; they offer for their users a lot of convenience and asset safeguarding quality.
We group the factors which make a national currency an international one in macroeconomic, institutional and geopolitical factors.' Until now monetary Keynesians have not contributed much to this debate. But this debate is very fruitful for monetary Keynesians.
The macroeconomic preconditions include factors of size. Important are the relative GDP size, relative trade shares, diversification of trade structure, role in global supply chains, and centrality' in global trade networks. Essential is also the domestic financial market development, meaning a deep, broad, liquid, resilient financial system. Size factors lead, comparable with the use of a language, to economies of scale and scope in terms of decreasing transaction costs or increasing liquidity of keeping monetary wealth in a currency, the more economic agents use it. Size factors support inertia, meaning the tendency of using a currency which everyone else is using in spite of the erosion of factors which make a currency an international currency. The erosion and rise of an international currency are most likely cumulative and disruptive.
Importance for the asset safeguarding quality of a currency is a low level of inflation and low variability of the inflation as well as the exchange rate. Overall macroeconomic stability in the currency-issuing country is a precondition for an international role of a currency.
Looking at institutional preconditions a liberalized domestic financial system and free cross-border capital flows are quintessential for currency internationalization. Other relevant institutional factors are the existence of the rule of law and its enforcement. About all these factors there is a broad consensus in the literature.
Geopolitical factors are of key importance as well. To play a leading international role the currency issuing country must provide a safe haven which implies economic, political and military power. US military power and widespread military bases across the world are considered to be a significant factor sustaining the US dollars international status.
The mirror image of the disadvantages of countries with low levels of their marginal liquidity' premium functions of monetary wealth denominated in their domestic currencies is the privilege of the countries issuing high-quality currencies (Cohen 2012). Countries with international currencies, first of all, can afford a much higher credit expansion in domestic currency and lower interest rates and in this way increase their development chances.They can earn high seigniorage because banknotes and coins held outside the country allow the import of goods and services without exporting something or take a credit. Internationally important goods are traded in the international currency. More important is that domestic units from firms to public household can accumulate foreign debt denominated in domestic currency and avoid currency mismatch. Last but not least, countries issuing an international currency have high room of manoeuvre to afford capital export for all kind of economic, political and military purposes. In fact, a bidirectional relation exists, such that military and political power supports a currency’s international role and an international currency allows a large monetary policy space, which facilitates military and political power.