Why Do Most Countries Have Their Own Currency? Governments Wanted It That Way.
Among the many facts of modern life that are accepted without question by most ordinary people is that it is somehow perfectly natural, expected, and unremarkable that every sovereign state should have its own currency. We see this everywhere in names such as "the US dollar" or "the Chinese yuan" or "the Japanese yen." Indeed, among the 203 sovereign states of the world, there are nearly as many separate national currencies. The euro, of course, is a notable—and recent—exception to this, but even after more than 20 years of the euro, only 26 of the world's states use it. Many of those are very small states such as Andorra, Vatican City, Malta, and Latvia. Moreover, the British refuse to give up the pound sterling. The Swedes are sticking with the krona. The Swiss still have the franc.
Similarly, a handful of states choose to use the US dollar in place of local national currencies. Yet, nearly all of these are tiny island nations. The largest country—by far—in the dollar zone is Ecuador.
In other words, in the overwhelming majority of modern states, currency zones correspond to that state's borders. This is not a coincidence. Since the eighteenth century, states increasingly and deliberately sought to create and promote national currencies that were treated as the preferred currency within local national borders. This was true even in the days of the gold standard. Although gold at this time was theoretically the only true money, national governments sought to define gold in terms of national currencies.
This was a key event in the growth of state power because once national currencies became popular and widely used in their own rights, this enabled states to shed the metallic backing altogether.
[Read More: "How Governments Seized Control of Money" by Ryan McMaken]
None of this, however, is necessary for a well-functioning economy or useful money. There is no natural law or sound economic theory that tells us that the world needs territorial currencies created by states. National currencies are not the natural result of market forces or consumer demand. National currencies were created by princes and legislators primarily to address political concerns, not economic ones.
Before National Currencies
In an unhampered marketplace, what is widely used as a currency would be determined by the subjective values of consumers and investors. Nor is there any reason why those currencies need to be associated with any particular country or government. Historically, a wide variety of currencies have been used as payment. Privately minted gold coins can be currency, as can silver coins. However, the cumbersome nature of gold and silver has often led to the use of pieces of paper—which were backed by precious metals, and which we would generally call bank notes today. The "currency zones" of these early paper currencies were anywhere that the currency was in demand. The currency was neither government-issued nor "national" in nature.
Before European states began to seize control of money in the late Middle Ages, Europe contained countless private mints employed by local nobles and elites. These private mints produced a wide variety of coins that functioned as currencies throughout Europe. Paper currency was private as well. In this, Martin van Creveld notes:
Beginning already in the fourteenth century . . . banking and commerce revived; Italian banks in particular made great fortunes and were soon opening branch offices throughout the Continent. Bills of exchange were developed to facilitate financial transactions between those branches, and to the extent that they were made out to the bearer rather than any individual they may be regarded as the first non-metallic money in Europe. During the next two centuries the system spread to France, Spain, the Low Countries, and finally England. Note, however, that the money in question was produced not by the slowly emerging state but by private institutions.1
During this time, however, Europe's monarchs were working to wrest control of the coinage away from local elites and private institutions: "While private institutions were thus beginning to develop paper money, rulers, on their part, were slowly imposing a monopoly on coinage."2
Turning Private Currencies into Government Currencies
Progress was slow. It was not until the seventeenth century that "the idea that the right to mint was one of the prerogatives of sovereignty had gained wide recognition."3 Only in 1696 did the English create the first truly "public" mint that was controlled by government employees as a function of the state. This was accompanied by the creation of the Bank of England (in 1694) which would eventually gain far more control over coinage and bank notes. England's national bank was followed by similar institutions in France and elsewhere.
[Read More: "Why Did the World Choose a Gold Standard Instead of a Silver Standard?" by Ryan McMaken]
Gold and silver coins continued to be widely used, but this did not prevent states from defining these metals in terms of national currencies. For example, if one were to ask a shopkeeper how much a loaf of bread cost in England in 1840, one was likely to hear the price in terms of pounds (or pence) rather than in terms of some specific weight of gold. It would have been known that the price of an ounce of gold was around 4.3 British pounds, but money was increasingly a matter of legally-defined territorial currency.
This became increasingly important as the money economy grew and became more complex. The difficulty of moving physical gold in large amounts increased the use of gold- and silver-backed paper money. This paper currency, of course, was increasingly denominated in the local national currency of each country.
This progression toward specific national currencies required both changes in thinking and in legal realities. One important policy change was the effort to issue more government-produced token coins. These coins often contained some precious metals, but the legal face value of these coins exceeded the value of their metallic content. These coins taught people to separate the concept of coinage from full-weight gold and silver coins. Another legal change within each state was to eliminate subnational monetary standards and coinage where they existed. States also gradually moved toward making bank notes uniform nationwide while securing a monopoly over money. In the US and Switzerland, for example, the central government first began merely regulating the issuance of private bank notes. Later, this evolved into a full-blown government monopoly over notes. In 1844 in England, the Bank Act began the process of bringing all bank-note authority under the central bank. Similar trends continued throughout Europe and Latin America.
By the nineteenth century, the process of centralization of power into vast territorial states neared completion. As described by Eric Helleiner:
the emergence of the nation-state in the nineteenth century acted as a key precondition for the creation of territorial currencies. Many of the activities associated with the construction of territorial currencies relied on the nation-state's unprecedented capability to influence and directly regulate the money in use within the territory it governed. This capability stemmed from such features as its policing powers, its more pervasive role in the domestic economy, its centralized authority, and its stronger ability to cultivate the "trust" of the domestic population.4
In practical terms, changes in technology—combined with vast tax revenues—allowed states to employ new technologies that made state-controlled currencies more manageable:
Territorial currencies could not be created, furthermore, without a technological transformation that has received less scholarly attention: the application of new industrial technologies to the production of coins and notes in the nineteenth century. This development dramatically and rapidly improved the uniformity of the money in circulation. . . . Equally important, the high quality of the new industrially produced money made counterfeiting a much more difficult proposition, a development that in turn strengthened the ability of state authorities to maintain stable national "fiduciary" forms of money on a mass scale. This latter development was of enormous significance in enabling states to create and maintain territorial currencies.5
Why Governments Want a National Currency—Even When There's a Gold Standard
Why have states been so enthusiastic about creating national currencies? On this, politics generally trumps economics. As the free-market liberals of the eighteenth and nineteenth centuries often understood, territorial currencies did not offer an economic advantage. Rather, an ideal currency is that which enjoys widespread usage both inside and outside one's own national territory. Splitting the world into currency zones is an economic drag. This was one reason why liberals insisted that all national currencies continue to be tied to gold. A common connection to gold (or silver, and some other commodity) provided a continued bridge between currencies even as states increasingly passed legislation that favored the local national currency and required its use. Indeed, many liberals hoped that international trade would again move away from gold-backed national currencies and move toward a single global gold currency.
Unfortunately, events moved in the opposite direction instead. States continued to assert more and more control over national currencies until the public began to accept them as commodities in their own right. This would eventually enable governments to separate national currencies from precious metals altogether. Nonetheless, even for policymakers who had no plans to abolish metal-backed money, states and their agents still had many reasons to press for national currencies subject to state control.
First, states sought to create closer economic bonds among communities and industries within the domestic economy. By mandating or legally favoring the use of a certain currency in all domestic markets, governments built cohesion among domestic markets while putting foreign merchants, banks, and producers at a disadvantage. These currency zones were essentially a form of protectionism. Naturally, foreign buyers and sellers could convert their own currencies to gold, and then into whatever currencies were needed. Yet, this imposed transaction costs that were absent in trade within a single currency zone.
[Read More: "How the Classical Gold Standard Fueled the Rise of the State" by Ryan McMaken]
Another political motivation was the perception that state control over the national currency allowed governments to insulate themselves from the monetary discipline imposed by the gold standard. This can be most often seen in the fact that governments could temporarily unlink the national currency from gold so as to allow for more spending—enabled my monetary inflation—for the duration of the perceived emergency. During the Napoleonic wars, for instance, The British state abandoned the gold standard so the regime could more freely spend on war needs.
Since the abolition of the gold standard, states with their own currencies have gained even more autonomy in manipulating money. Those states that lack their own currency—such as Italy under the euro—do not enjoy as much autonomy. Yes, Italy under the euro enjoys the benefits of lower exchange risk and lower transaction costs. Yet, the Italian state also has less of an ability to augment domestic spending via monetary inflation or to tailor monetary policy to Italy's specific economic circumstances.
Finally, there are cultural and social elements as well. National currencies have long been central to strongly held nationalist beliefs. Eric Hobsbawm has noted that in recent centuries, a country's money is its "most universal form of public imagery," and Richard Farmer writes that "[m]oney, in its physical form, functions as a national symbol and is frequently associated with sovereignty and identity." As nationalism gained popularity in the nineteenth century, many domestic populations associated national currency with national prestige, autonomy, and security. Even today, we can find many who believe in the idea that "great powers have great currencies." This is also undoubtedly a factor in continued opposition to adoption of the euro among many Europeans.
The Final Triumph of National Currencies
By the twentieth century, it was clear that national currencies were something much more than mere local measures of gold or silver. Wartime measures had proven that these currencies could be taken off these gold standard for years without their values collapsing. Moreover, large banks throughout the nineteenth century had increasingly turned to holding large amounts of paper money in the form of national bank notes as reserves. Paper reserves even began to outnumber gold reserves toward the end of the nineteenth century.
World War One brought a new Europe-wide experiment in de-coupling national currencies from gold. National currencies moved even further away from precious metals when the world's regimes introduced the "gold exchange standard" in the interwar years. With this new system, gold was only money at the international level. Large banks and governments could still settle exchanges in gold, but domestic economies were to be conducted almost exclusively in terms of the government's currency. Virtually no one thought about making purchases in terms of some amount of gold or silver anymore. Increasingly, the only questions that mattered in daily life were questions like "How many French francs does it cost . . . how many US dollars?"
The role of gold was reduced sill further with the introduction of the Bretton Woods system in 1945. The final link to gold was abolished in 1971, when Bretton Woods failed and the world embraced floating national fiat currencies. But it didn't have to be this way. There is no economic disadvantage to currencies issued by private banks, subnational units, or private mints. Yet, from the state's perspective there are indeed many political advantages to national currencies. Wherever we find strong states, we usually find that government-issued territorial currencies have sprung up as a means of giving the state ever more control of money.