Regional Monetary System

INTRODUCTION It is not possible for a modern economy develop without a currency. This is also a requirement at the international level: using monetary instruments as a means of payment and counting unit in international transactions is a prerequisite for the development of global trade. The advantages of money in conducting both national and international transactions are well understood. Yet, despite the apparent advantages of using money, it is extraordinarily difficult to introduce a currency in the international economy which gains domestic as well as global acceptance. What are the obstacles of introducing a universal means of payment and counting unit at the international level that also make its issue difficult at the national level? How might a regional currency such as the ICU (Islamic Currency Unit) proposed here avoid the problems encountered by a global currency? CHARACTERISTICS OF CURRENCY To begin our discussion, we must recognize some basic properties of currency. The first characteristic is that money is similar to a that is, the utility of money to any one person stems from the fact that others use it too. But because it is difficult to deprive an individual from using a collective commodity, there is no incentive for individuals to to use the commodity, giving rise to the so-called free rider problem. The second characteristic of money which makes it a very particular collective commodity is that it is easy to make those who use money to do so, thus obviating the free-rider problem. Money balances such as current deposits or cash carry low interest or even zero interest; thus, a person must forego greater interest on their assets in order to maintain those money balances. This foregone interest represents a kind of payment, or fee, for using currency. Since everyone using money must pay this fee, the free-rider problem is avoided. Now we come to the third characteristic of money. The inclination to maintain money balances is based on one's confidence in the maintenance of value of these assets. Thus accepting a particular currency is based on the belief that the supplier of this currency will not act in such a way as to devalue it. If economic agents expect depreciation of the currency, they will not maintain money balances voluntarily. This creates a fundamental issue for the currency supplier--how best to create faith in the currency. One method is to guarantee a fixed exchange of the currency with other assets whose value is not controlled by the currency supplier, as was accomplished by the gold-standard when economic agents could exchange their money for gold in central banks. Thus, the supplier of currency must bear the expense of establishing stability of the value of money otherwise economic agents will not voluntarily maintain money balances (i.e., for the use of money). This implies that although money has some characteristics of a collective commodity, its supply can be viewed as a profitable business for private institutions or government-run banks. The fourth characteristic of money relates to economies of scale. If a country uses two different currencies, A and B, but some transactions must be carried out with currency A and others made with currency B, the utility of both currencies decreases for the inhabitants of that country. But if currency A is accepted for any transaction, it's usefulness is clearly increased. Subsequently, the residents of that country are prepared to a higher price for currency A, given its public acceptance for all transactions. Thus, the supplier of currency A increases his profitability through developing his operations and substitution for currency B. The supplier has both assets (which are the establishment and expansion of credits) and liabilities (the currency in circulation). The profit to the money supplier is the difference between the interest rate associated with assets and the interest rate paid for liabilities. …