The Euro feels like a novelty – but it is not. It was preceded by quite a few Monetary Unions in European countries and outside it.
To start with, countries such as the USA and the USSR are (or were in the latter’s case) monetary unions.
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A single currency has been or is used over enormous land masses incorporating previously distinct politics, social and economic entities. The American constitution, for instance, did not give the existence of a central bank. Founding fathers, the likes of Madison and Jefferson, objected to its existence. A central monetary institution was established just in 1791 (modelled after the Bank of England). But Madison (as President) let its concession expire in 1811. It was revived in 1816 – only to die again. It took a civil war to lead to a budding financial union. Bank regulation and guidance were instituted only in 1863 and a distinction was made among national and state-level banks.
Simply by that time, 1562 private banks were printing and issuing notes, some of them not a legal tender. In toll free there were only 25. The same thing occurred in the principalities which were later to constitute Germany: 25 private banks were established only between 1847 and 1857 with the express purpose of printing banknotes to move as legal tender. In 1816 – 70 different types of currency (mostly foreign) were being used in the Rhineland alone.
A tidal wave associated with banking crises in 1908 led to the formation of the Federal Reserve System and 52 years were to elapse until the full monopoly pounds issuance was retained by it.
Exactly what monetary union? Is it sufficient to possess a single currency with free plus guaranteed convertibility?
Two additional circumstances apply: that the exchange rate be effective (realistic and, thus, not vunerable to speculative attacks) and that the members of the union adhere to one financial policy.
Actually, history shows that the condition of a single currency, though preferable, is not really a sine qua non. A union could incorporate “several currencies, fully and permanently convertible into one another at irrevocably fixed trade rates” which is really like having a solitary currency with various denominations, every printed by another member of the particular Union. What seems to be more important could be the relationship (as expressed through the exchange rate) between the Union and other economic players. The currency of the Partnership must be convertible to other currencies in a given (could be fluctuating : but always one) exchange price determined by an uniform exchange price policy. This must apply all around the territory of the single currency : otherwise, arbitrageurs will buy it in one place and sell it within another and exchange controls would have to be imposed, eliminating free convertibility and inducing panic.
This is not the theoretical – and thus unnecessary — debate. ALL monetary unions in past times failed because they allowed their foreign currency or currencies to be exchanged (against outside currencies) at varying rates, depending on where it was converted (in which part of the monetary union).
“Before long, all Europe, save England, will have one money”. This was written by William Bagehot, the Editor of The Economist, the renowned British magazine. Yet, it was written 120 years ago when Britain, even then, was debating whether to adopt just one European Currency.
Joining a monetary union means giving up independent monetary policy and, with it, a sizeable slice of national sovereignty. The particular member country can no longer control its the money supply, its inflation or even interest rates, or its foreign exchange prices. Monetary policy is transferred to a central monetary authority (European Central Bank). A common currency is a transmission mechanism of economic signals (information) and expectations, often through the financial policy. In a monetary union, financial profligacy of a few members, for instance , often leads to the need to raise rates of interest in order to pre-empt inflationary pressures. This need arises precisely because these countries share a common currency. In other words, the consequences of one member’s fiscal decisions are communicated to other members (through the particular monetary policy) because they share one particular currency. The currency is the moderate of exchange of information regarding the present and future health of the economies included.
Monetary unions which did not follow this course are no longer with us.
Monetary unions, as we said, are no novelty. People felt the need to create a standard medium of exchange as early as the days of Ancient Greece and Middle ages Europe. However , those early monetary unions did not bear the hallmarks of modern day unions: they failed to have a central monetary authority or monetary policy, for instance.
The first really modern example would be the monetary partnership of Colonial New England.
The New England colonies (Connecticut, Massachusetts Bay, New Hampshire and Rhode Island) accepted each other’s paper money as legal tender until 1750. These notes were even approved as tax payments by the government authorities of the colonies. Massachusetts was a major economy and sustained this arrangement for almost a century. It was envy that will ended this very successful set up: the other colonies began to print their own notes outside the realm of the partnership. Massachusetts bought back (redeemed) most its paper money in 1751, spending money for it in silver. It instituted the mono-metallic (silver) standard and ceased to accept the paper money of the other three colonies.
The second, more important, test was the Latin Monetary Union. It was a purely French contraption, intended to further, cement, and augment its political prowess and monetary clout. Belgium adopted the French Franc when it attained independence in 1830. It was only natural that France and Belgium (together with Switzerland) should encourage others to join them within 1848. Italy followed in 1861 and the last ones were Greece and Bulgaria (! ) in 1867. Together they formed the particular bimetallic currency union known as the Latin Monetary Union (LMU).
The LMU seriously flirted with Austria plus Spain. The Foundation Treaty was officially signed only on 23/12/1865 within Paris.
The rules of this Union were somewhat peculiar and, in some respects, seemed to defy conventional economic wisdom.
Unofficially, the French influence extended to eighteen countries which adopted the Precious metal Franc as their monetary basis. 4 of them agreed on a gold to silver conversion rate and struck gold coins which were legal tender in all of them. They voluntarily accepted a money supply limitation which forbade them to print more than 6 Franc coins per capita (the four were: France, Belgium, Italy plus Switzerland).
Officially (and really) a gold standard developed throughout Europe and included coin issuers such as Germany and the United Kingdom). Still, in the Latin Monetary Union, the particular quantities of gold and silver Union coins that member countries could great was unlimited. Regardless of the quantities minted, the coins were legal sensitive across the Union. Smaller denomination (token) silver coins, minted in limited quantity, were legal tender just in the issuing country.
There was not one currency like the Euro. Countries maintained their national currencies (coins), but these were at parity with each other. An exchange commission of 1. 25 % was charged to convert them. The tokens had a lower silver content than the Union coins.
Governmental and municipal offices were required to acknowledge up to 100 Francs of bridal party (even though they were not convertible and had a lower intrinsic value) in one transaction. This loophole led to mass arbitrage: converting low metal content coins to buy high metal content material ones.
The Union had necessary supply policy or management. It had been left to the market to determine how much cash will be in circulation. The main banks pledged the free conversion of gold and silver to coins. But , this pledge meant that the Central Banks of the participating countries were forced to maintain a fixed ratio of exchange between the two metals (15 to 1, at the time) ignoring the values fixed daily in the world markets.
The LMU was too negligible in order to influence the world prices of these 2 metals. The result was overvalued silver, export of silver from one associate to another using ingenious and more devious ways of circumventing the rules of the Union. There was no choice yet to suspend silver convertibility and therefore acknowledge a de facto precious metal standard. Silver coins and tokens remained legal tender.
This grew to become a major problem for the Union and the hen house de grace was delivered by unprecedented financing needs brought on by the First World War. The LMU has been officially dismantled in 1926 – but died long before that. The particular lesson: a common currency is not sufficient – a common monetary policy monitored and enforced by a common Central Bank is required in order to sustain the monetary union.
As the LMU had been formed, in 1867, an International Monetary Conference was convened. Twenty nations participated and discussed the introduction of a global currency. They decided to adopt the gold (British, USA) standard and also to allow for a transition period. These people agreed to use three major “hard” currencies but to equate their particular gold content so as to render them completely interchangeable. Nothing came out of it – but this plan was a lot more sensible than the LMU.
One incorrect path seemed to have been the Scandinavian Monetary Union.
Sweden (1873), Denmark (1873) and Norway (1875) shaped the Scandinavian Monetary Union (SMU). The pattern was familiar: they accepted each others’ gold coins because legal tender in their territories. Expression coins were also cross-boundary lawful tender as were banknotes (1900) recognized by the banks of the associate countries. It worked so flawlessly that no one wanted to convert the particular currencies and exchange rates were not available from 1905 to 1924, when Sweden dismantled the Union following Norway’s independence. Actually, the particular countries involved created (though not officially) what amounted to an unified central bank with unified reserves – which extended monetary credit lines to each of the member countries.
The particular Scandinavian Kronor held well as long as gold supply was limited. Globe War I changed this situation since governments dumped gold and inflated their currencies, engaging in competitive devaluations. Central Banks used the depreciated currencies to buy gold at official (cheap) rates. Sweden saw through this ploy and refused to sell the gold in the officially fixed cost. The other members began to sell huge quantities of the token coins in order to Sweden and use the proceeds to buy the much Stronger Swedish “economy” (=currency) at an ever cheaper price (as the price of gold collapsed). Sweden responded by prohibiting the import of other members’ tokens. Without a set price of gold and without coin convertibility, there was no Union to talk associated with.
The last big (and recent) test in monetary union was the Eastern African Currency Area. An comparative experiment is still going on in the Francophile part of Africa involving the CFA currency.
The parts of East Africa ruled by the British (Kenya, Uganda and Tanganyika and, in 1936, Zanzibar) adopted in 1922 a single common currency, the East African shilling. Independence in East Africa acquired no monetary aspect because it continued to be part of the Sterling Area. This assured the convertibility of the local currencies into British Pounds. Regarding this particular a matter of national pride (and tactical importance) the British poured inordinate amounts of money into these rising economies. This monetary union was not disturbed by the introduction (1966) associated with local currencies in Kenya, Uganda and Tanzania. The three currencies had been legal tender in each of these nations and were all convertible to Pounds.
It was the Pound which gave way by strongly downgrading in the late 60s and earlier 70s. The Sterling Area had been dismantled in 1972 and with it the strict monetary discipline which it imposed – explicitly and through the free convertibility – upon its members. A divergence within the value of the currencies (due to different inflation targets and resulting interest rates) was inevitable. In 1977 the East African Currency Region ended.
Not all monetary unions met the same gloomy end, however. Perhaps, the most famous of the successful ones is the Zollverein (German Customs Union).
At the beginning of the 19th century, there have been 39 independent political units which usually made up the German Federation in what is today’s Germany. They all struck coins (gold, silver) and had their very own standards for weights and actions. Labour mobility in Europe had been greatly enhanced by the decisions from the Congress of Vienna in 1815 but trade was still ineffective because of the number of different currencies.
The German statelets formed a traditions union as early as 1818. This was accompanied by the formation of three local groupings (the Northern, Central plus Southern) which were united in 1833. In 1828, Prussia harmonized plus unified its tariffs with the additional members of the Federation. Debts related to customs could be paid in gold or silver. Several currencies had been developed and linked to each other through fixed exchange rates. There was an over-riding single currency: the Vereinsmunze. The Zollverein (Customs Union) has been established in 1834 to help trade and reduce its costs. Most of the political units agreed to choose between one of two monetary standards (the Thaler and the Gulden) in 1838 and 9 years later, the central financial institution of Prussia (which comprised 70% of the population and land bulk of the future Germany) became the efficient Central Bank of the Federation. The North German Thaler was fixed at 1 . 75 to the South The german language Gulden and, in 1856 (when Austria became associated with the Union), on 1 . 5 Austrian Florins (this was to be a short lived affair, because Prussia and Austria declared war on each other in 1866).
Philippines was united by Bismarck within 1871 and a Reichsbank was founded 4 years later. It issued the Reichsmark which became the legal and only tender of the whole German born Reich. The currency Union made it two world wars, a disastrous bout of inflation in 1923 and a collapse of the currency following the Second World War. The Reichsmark became the solid and dependable Bundesbank. The Union still survives in the Deutschmark.
This is the only situation of a monetary union which been successful without being preceded by a political set up. It survived because Prussia was sizeable and had enough real strength and perceived clout to enforce compliance on the other members from the Federation. Prussia wanted to have a stable currency and introduced consistent material standards. The other states could not deny their currencies of their intrinsic ideals. For the first time in history, coinage became a professional economic decision, totally depoliticized.