The U.S. government has a legal monopoly on the printing of U.S. currency. For t

Question

The U.S. government has a legal monopoly on the printing of U.S. currency. For the sake of this question, suppose the government decides to relinquish its monopoly—the Department of Justice will “break up” the federal government’s monopoly on U.S. currency and replace this market structure with one where each state now will issue its own unique currency. Answer the following questions using this setup.

1. With 50 different currency suppliers, that number is large enough such that we may assume this new money market has the potential to be perfectly competitive. Would this money market be, in fact, perfectly competitive or would it take a different form? Does the elasticity of demand for money play a role? If so, what? Briefly argue which type of market structure you believe would emerge: remaining perfectly competitive or becoming some type of oligopoly or monopoly and any role that the elasticity of demand might play.   

2. How would the new money market structure you described in part a) affect the value of the U.S. dollar on foreign exchange markets, ceteris paribus? To give your answer structure, begin with the initial change to the money market described in the setup and end with the market structure you argued in part a) of the question.

Explanation / Answer

(1)

With given information, I do not believe that the emerging market structure will be a perfectly competitive one. Instead, it is more likely to be a monopolistic competition.

In perfect competition, each firm produces identical products (homegeneous). But here, each of the 50 states will produce their own "unique" currency. So, while the basic good is the same (currency), each state will produce a differentiated version of it suited to its own state. Monopolistic competition is the market structure where many firms exists, each producing a slightly differentiated good - therefore, this market structure is the most suited.

Elasticity of demand will not play an important role in such a market form as per my opinion. Reason is, demand for a state's currency will not depend on its value relative to the currency of another state. Instead, quantity demanded of a state's currency will be the function of income of residents of that state, condition of business in that state and perfect mobility across states (such that, higher values currency in state X can enable residents and corporations to costlessly shift from state X to state Y).

(2)

Demand for dollar will rapidly decline.

This is because, now we no longer know how exactly we define a "Dollar!" 50 states are now printing their own unique variations of dollar, and other countries will face extreme uncertainty in financial transactions in a currency that has 50 variations! Point to note here is that we are not dealing with a consumer product like a phone or TV which can have multiple models, each slightly differentiated. A national currency varying across states is a deterrant of trade and its demand will decline.

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