Why do different countries have different currency?

Question

Why do different countries have different currency?

I have this question because I want to know why to divide it? If it's not divided then we can easily use the money anywhere and we won't need to use currency exchange.

Answer 1

I will focus on some economics reasons not mentioned explicitly so far. There are economic benefits to having your own currency. Your question essentially raises the question of so-called "Optimum Currency Areas" (OCAs). There was a lot of interest in the question of what areas should have the same currency. It is in general not immediately obvious that different countries should have the same currency, or even that the same country should have the same currency everywhere.

Your question boils down to asking whether the whole world is an OCA - and the short answer is no.

The pros of having different currencies are that you can use monetary policy to offset shocks. Especially for trade shocks, because monetary policy can change the exchange rate of a currency to affect trade. For example if Germany and France are hit by different shocks, then they will want to conduct different monetary policies, which they can't if they share the same currency. The main cost of different currencies are transaction costs of exchange, which can hamper things like trade and tourism.

Therefore an area should have the same currency (is an OCA) if it is subject to the same shocks or other factors are present, such that those shocks are absorbed without monetary policy. This thinking leads us to the four most important criteria for an area to be an OCA. You can use these criteria to evaluate whether countries should have the same currency and to answer your question.

It is worth noting, that the pioneer in this literature was Robert Mundell with his 1961 paper. The other two most important works are Kenen (1969) and Mckinnon (1963). The criteria are:

1. The regions should have similar business cycles. As mentioned, if the countries tend to experiene similar shocks, then they will require the same monetary policy. In that case there is no reason for them to have different currencies!

2. Openness of the economy (Mckinnon). This can be divided in two parts:

2.1. High labor mobility across regions. If there is a recession in one region and people can move to another one as a response, then monetary policy is less important in adjusting to the shock, as labor itself adjusts. This is a reason why countries can usually have the same currency within their whole territory. For example, people who lose their job in one U.S. state often move to another. If that wouldn't be possible, then adjusting to the recession with monetary policy would be more important. That is why the freedom of movement agreement is so important for the Euro to be sustainable. Note that wage flexibility would be required here as well.

2.2. Capital mobility. The reasons are similar as for labor mobility. If a region becomes less developed, then returns to capital there will increase. If markets are free, then capital can travel from the more prosperous region to the one hit by the shock, thereby mitigating the negative effects of the shock. Note that price flexibility must be given here for these effects to occur.

3. A risk sharing system, such as fiscal transfers. Since monetary policy can't be used, we would need fiscal policy. Fiscal transfers from unaffected areas can help with negative shocks in another region. The Eurozone has a no-bailout clause, so this condition wasn't given during the Greek crisis. However, this was de facto abandoned. This is unsurprising to those familiar with the theory of OCAs.

4. Product Diversity (Kenen). Trade shocks, which monetary policy can help with, usually occur to certain industries and not the whole economy. If countries produce a variety of products, they will be less likely to suffer from large demand shocks. Hence, more diverse economies will face fewer trade fluctuations and see smaller increases of unemployment if shocks occur to one industry. This also reduces the need for monetary policy stabilization, since any given shock has a small impact on the overall economy.

Sometimes further criteria are also given, but they are less important. These include "solidarity" as well as homogenous preferences across regions, for similar reasons as the condition of similar business cycles.

So you can use these criteria to evaluate whether certain countries or areas should have the same currrency or not. All these criteria are definitely not fulfilled for the whole world, so there is a role for different currencies. An issue with the theory of OCAs is that it is unclear how much weight we should give to each criterium. So it could be unclear how to evaluate whether two countries who partially fulfill some of the criteria should have the same currency or not.

Answer 2

Two reasons: history and ability to control the money supply.

History: paper-money started by being issued by trustworthy agents from kings/governments, as a way to be able to transfer the ownership of gold without moving the gold physically. This looked something like "This paper is exchangeable for 10 gold coins at this location". This meant you had to go to that specific kingdom to get the paper (bill) converted into gold. These papers evolved into what we now call banknotes, and kept tied to a specific country.

Money supply control: having your own currency allows governments to fund themselves by producing more money, or stimulate exports by devaluing their currency. Look at the euro-zone difficulties with the government debt of Greece: this could be solved (with consequences, of course) if they had their own currency.

Answer 3

There are also many countries without their own currency. For example, Ecuador and Panama both use the US dollar as their official currency. See this list for more examples.

There are several reasons why you might like to adopt another country's currency, but common factors are

• high inflation: the domestic currency loses value against foreign ones. Therefore, people start more and more to use foreign currency for transactions (e.g. dollars in Venezuela today). Therefore, one solution is simply to get rid of your own currency and adopt a foreign one. This immediately stabilises prices, as the central bank can no longer print money.

• high levels of trade with one country: for example, if you trade very much with the US (as many small Caribbean islands do), you would rather adopt the US dollar. This will give much more certainty to exporters and business in general.

Answer 4

You might also want to think about

If it's not divided then we can easily use the money anywhere.

Is that positive and desirable for everyone in all situations? If you want to control the flow of money and people, different currencies are helpful.

JoaoBotelho also pointed to control of the supply and historical reasons, I would also add that everyone would have to agree, what the currency of the world is supposed to be. Different countries have (and have had) very different ideas as to how a currency should behave. Like:

• gold- or silver-backing, or fiat money?
• how independent should the central bank be?
• general monetary policy - this will never fit all of the world at the same time
• what is the right amount of inflation?

Answer 5

Ultimately, a complete answer has to deal with the history of money. Here I just provide a very brief attempt to answer the question. There are dedicated books on the topic, of which the most authoritative source might be Glyn Davies' book. The analysis here is based on that book and Wikipedia.

What is money?

Davies defines money as:

Money is anything that is widely used for making payments and accounting for debts and credits.

As Davies states, money have a variety of economic functions:

• Unit of account
• Common measure of value
• Medium of exchange
• Means of payment
• Standard for deferred payments
• Store of value

These functions are important because they tell us why later on official authorities would like to "produce their own money".

Origin of money

Given the above functions, it would seem simple to believe that money came to exist because its economic benefits, for example, to replace barter as a method of commerce. However, as Davis state:

Money originated very largely from non-economic causes: from tribute as well as from trade, from blood-money and bride-money as well as from barter, from ceremonial and religious rites as well as from commerce, from ostentatious ornamentation as well as from acting as the common drudge between economic men.

In other words, money originated from social customs. Davies does acknowledges that "the clumsiness of barter" gave an economic impulse to the spread of money, but it was not the cause of it.

Coins

Yet, as civilisations became more complex and trade among nations grew, the economic functions of money became more relevant. Davies notes that many physical items have been used as money:

Amber, beads, cowries, drums, eggs, feathers, gongs, hoes, ivory, jade, kettles, leather, mats, nails, oxen, pigs, quartz, rice, salt, thimbles, umiacs, vodka, wampum, yarns, and zappozats (decorated axes).

But with the advance of ancient civilisations, coins became the most common item to function as money. Pretty much every major civilisation or group had its own coins (e.g. Roman Empire denarius, Etruscan empire Shekel, Persian daric, Chinese myriad of round-with-middle-hole coins, just to name a few; notice that the Incas had no money). Coins normally represented a form of commodity money, in that the coin itself had value because it was made of a valued metal like gold or silver.

As such, Roman emperors, Etruscan Kings, and other civilisations, pretty much until the end of the middle ages produced their own coins in order to foster commerce, facilitate taxes payment, and so on. Money usually had the stamp of a royalty or emperors, and minting was usually a monopoly of the state.

In fact, one of the first schools of economic thought was mercantilism, which considered the accumulation of species (gold, silver, etc), primarily via trade surplus and mining as the chief economic objective of a government. As such, each country producing its own money via minting became a core state objective. Why would you then use another country's money? Why would the English Kings give up their capacity to control their currency and instead adopt that of e.g. the Kingdom of France? The most sensible option was the sovereign control of the monopoly of money.

Paper Money

The above already explains why different countries had different money systems. The "natural" transition from commodity money to fiat money simply reproduced national differences into banknotes and eventually, to modern currencies.

Simply put, different bank notes emerged in the late middle ages (although its used has been recorded earlier in China), often as a simple mechanism to store and transfer money. Instead of you giving a load of heavy coins to someone, you simply used a bank to keep that physical money in exchange of a note that credited that ownership. You can then simply transfer the note and thereby the ownership of the load of coins. Many times there were many competing bank notes, but eventually the state and kings, not the least because of some economists recommendation pursued the monopoly of banknote issuance, leading to what now are central banks.

Currency replacement

Yet, in more recent times, some countries have gave up their own currencies. Notably is the case of the Euro, which replaced many national currencies like the Deutsche Mark, the Lira, the Peseta, etc. This was already commented by BB King in another answer. Myself also commented on why some countries have adopted the US Dollar (or other major currency). Most of the factors are economical, but political factors cannot be discounted too (e.g. Euro as part of a wider political integration process, not the least to avoid further war in the continent).

---

In summary, different countries have had different currencies because of historical reasons, ranging from non-economic to economic ones. In the beginning, the production of competing forms of money by different civilisations and kingdoms was mainly a cultural issue, but with the growth of commerce and the growing complexity of societies, money became a powerful tool to foster economic activity and why not, military capacity. The state soon realised that controlling the monopoly of money production was beneficial for their interests. In this context, having no money and using other countries money was a totally irrational option. In modern times, economic motives has been the primary factor defining whether countries have or not their own currency.

Answer 6

So they can set their own monetary policy for good reasons such as to improve macroeconomic stability.

So they can set their own monetary policy for bad reasons such as to print increasingly devalued money instead of engaging in better macro management.

So corrupt people can print and/or otherwise control monetary within their country.

So other countries will not control the value of the monetary instruments used in the country.

Because they don't like Uncle Sam or the Fed.

Because they don't trust EU bankers.

Answer 7

If I go down to the border with Mexico and step over the line that separates the two countries, what has changed? The air is the same. The sunshine is the same. There is only one thing that is not the same. The laws. I am now under a different legal system. If I commit a crime, I am arrested by Mexican police and face a Mexican judge who applies Mexican law to my case.

Money is legal tender. It's what the law recognizes as the unit that holds value for all economic activity occurring under the jurisdiction of the body that prints it. It's what the law itself uses to impose fines, enforce contracts, levy taxes, and so on. The entity that makes the laws also issues the currency and declares it the legal tender and guards its integrity.