| The Euro feels like a novelty - but it is not. It was | | | | seemed to have been the Scandinavian Monetary |
| preceded by quite a few Monetary Unions in Europe | | | | Union.Sweden (1873), Denmark (1873) and Norway |
| and outside it.To start with, countries such as the USA | | | | (1875) formed the Scandinavian Monetary Union (SMU). |
| and the USSR are (or were in the latter's case) | | | | The pattern was familiar: they accepted each others' |
| monetary unions. A single currency was or is used | | | | gold coins as legal tender in their territories. Token |
| over enormous land masses incorporating previously | | | | coins were also cross-boundary legal tender as were |
| distinct political, social and economic entities. The | | | | banknotes (1900) recognized by the banks of the |
| American constitution, for instance, did not provide for | | | | member countries. It worked so perfectly that no one |
| the existence of a central bank. Founding fathers, the | | | | wanted to convert the currencies and exchange rates |
| likes of Madison and Jefferson, objected to its | | | | were not available from 1905 to 1924, when Sweden |
| existence. A central monetary institution was | | | | dismantled the Union following Norway's independence. |
| established only in 1791 (modelled after the Bank of | | | | Actually, the countries involved created (though not |
| England). But Madison (as President) let its concession | | | | officially) what amounted to a unified central bank with |
| expire in 1811. It was revived in 1816 - only to die again. It | | | | unified reserves - which extended monetary credit |
| took a civil war to lead to a budding monetary union. | | | | lines to each of the member countries.The |
| Bank regulation and supervision were instituted only in | | | | Scandinavian Kronor held well as long as gold supply |
| 1863 and a distinction was made between national and | | | | was limited. World War I changed this situation as |
| state-level banks.By that time, 1562 private banks | | | | governments dumped gold and inflated their currencies, |
| were printing and issuing notes, some of them not a | | | | engaging in competitive devaluations. Central Banks |
| legal tender. In 1800 there were only 25. The same | | | | used the depreciated currencies to buy gold at official |
| thing happened in the principalities which were later to | | | | (cheap) rates. Sweden saw through this ploy and |
| constitute Germany: 25 private banks were | | | | refused to sell its gold in the officially fixed price. The |
| established only between 1847 and 1857 with the | | | | other members began to sell large quantities of the |
| express intention of printing banknotes to circulate as | | | | token coins to Sweden and use the proceeds to buy |
| legal tender. In 1816 - 70 different types of currency | | | | the much Stronger Swedish "economy" (=currency) at |
| (mostly foreign) were being used in the Rhineland | | | | an ever cheaper price (as the price of gold collapsed). |
| alone.A tidal wave of banking crises in 1908 led to the | | | | Sweden reacted by prohibiting the import of other |
| formation of the Federal Reserve System and 52 | | | | members' tokens. Without a fixed price of gold and |
| years were to elapse until the full monopoly of money | | | | without coin convertibility, there was no Union to talk |
| issuance was retained by it.What is a monetary union? | | | | of.The last big (and recent) experiment in monetary |
| Is it sufficient to have a single currency with free and | | | | union was the East African Currency Area. An |
| guaranteed convertibility?Two additional conditions | | | | equivalent experiment is still going on in the Francophile |
| apply: that the exchange rate be effective (realistic | | | | part of Africa involving the CFA currency.The parts of |
| and, thus, not susceptible to speculative attacks) and | | | | East Africa ruled by the British (Kenya, Uganda and |
| that the members of the union adhere to one | | | | Tanganyika and, in 1936, Zanzibar) adopted in 1922 a |
| monetary policy.Actually, history shows that the | | | | single common currency, the East African shilling. |
| condition of a single currency, though preferable, is not | | | | Independence in East Africa had no monetary aspect |
| a sine qua non. A union could incorporate "several | | | | because it remained part of the Sterling Area. This |
| currencies, fully and permanently convertible into one | | | | guaranteed the convertibility of the local currencies into |
| another at irrevocably fixed exchange rates" which is | | | | British Pounds. Regarding this a matter of national pride |
| really like having a single currency with various | | | | (and strategic importance) the British poured inordinate |
| denominations, each printed by another member of the | | | | amounts of money into these emerging economies. |
| Union. What seems to be more important is the | | | | This monetary union was not disturbed by the |
| relationship (as expressed through the exchange rate) | | | | introduction (1966) of local currencies in Kenya, Uganda |
| between the Union and other economic players. The | | | | and Tanzania. The three currencies were legal tender |
| currency of the Union must be convertible to other | | | | in each of these countries and were all convertible to |
| currencies at a given (could be fluctuating - but always | | | | Pounds.It was the Pound which gave way by strongly |
| one) exchange rate determined by a uniform | | | | depreciating in the late 60s and early 70s. The Sterling |
| exchange rate policy. This must apply all over the | | | | Area was dismantled in 1972 and with it the strict |
| territory of the single currency - otherwise, arbitrageurs | | | | monetary discipline which it imposed - explicitly and |
| will buy it in one place and sell it in another and | | | | through the free convertibility - on its members. A |
| exchange controls would have to be imposed, | | | | divergence in the value of the currencies (due to |
| eliminating free convertibility and inducing panic.This is | | | | different inflation targets and resulting interest rates) |
| not a theoretical - and thus unnecessary - debate. ALL | | | | was inevitable. In 1977 the East African Currency Area |
| monetary unions in the past failed because they | | | | ended.Not all monetary unions met the same gloomy |
| allowed their currency or currencies to to be | | | | end, however. Arguably, the most famous of the |
| exchanged (against outside currencies) at varying | | | | successful ones is the Zollverein (German Customs |
| rates, depending on where it was converted (in which | | | | Union).At the beginning of the 19th century, there were |
| part of the monetary union)."Before long, all Europe, | | | | 39 independent political units which made up the |
| save England, will have one money". This was written | | | | German Federation in what is today's Germany. They |
| by William Bagehot, the Editor of The Economist, the | | | | all minted coins (gold, silver) and had their own |
| renowned British magazine. Yet, it was written 120 | | | | standards for weights and measures. Labour mobility in |
| years ago when Britain, even then, was debating | | | | Europe was greatly enhanced by the decisions of the |
| whether to adopt a single European Currency.Joining a | | | | Congress of Vienna in 1815 but trade was still |
| monetary union means giving up independent | | | | ineffective because of the number of different |
| monetary policy and, with it, a sizeable slice of national | | | | currencies.The German statelets formed a customs |
| sovereignty. The member country can no longer | | | | union as early as 1818. This was followed by the |
| control its the money supply, its inflation or interest | | | | formation of three regional groupings (the Northern, |
| rates, or its foreign exchange rates. Monetary policy is | | | | Central and Southern) which were united in 1833. In |
| transferred to a central monetary authority (European | | | | 1828, Prussia harmonized and unified its tariffs with the |
| Central Bank). A common currency is a transmission | | | | other members of the Federation. Debts related to |
| mechanism of economic signals (information) and | | | | customs could be paid in gold or silver. Several |
| expectations, often through the monetary policy. In a | | | | currencies were developed and linked to each other |
| monetary union, fiscal profligacy of a few members, | | | | through fixed exchange rates. There was an |
| for example, often leads to the need to raise interest | | | | over-riding single currency: the Vereinsmunze. The |
| rates in order to pre-empt inflationary pressures. This | | | | Zollverein (Customs Union) was established in 1834 to |
| need arises precisely because these countries share a | | | | facilitate trade and reduce its costs. Most of the |
| common currency. In other words, the effects of one | | | | political units agreed to choose between one of two |
| member's fiscal decisions are communicated to other | | | | monetary standards (the Thaler and the Gulden) in |
| members (through the monetary policy) because they | | | | 1838 and nine years later, the central bank of Prussia |
| share one currency. The currency is the medium of | | | | (which comprised 70% of the population and land |
| exchange of information regarding the present and | | | | mass of the future Germany) became the effective |
| future health of the economies involved.Monetary | | | | Central Bank of the Federation. The North German |
| unions which did not follow this course are no longer | | | | Thaler was fixed at 1.75 to the South German Gulden |
| with us.Monetary unions, as we said, are no novelty. | | | | and, in 1856 (when Austria became associated with |
| People felt the need to create a uniform medium of | | | | the Union), at 1.5 Austrian Florins (this was to be a |
| exchange as early as the times of Ancient Greece | | | | short lived affair, because Prussia and Austria declared |
| and Medieval Europe. However, those early monetary | | | | war on each other in 1866).Germany was united by |
| unions did not bear the hallmarks of modern day | | | | Bismarck in 1871 and a Reichsbank was founded 4 |
| unions: they did not have a central monetary authority | | | | years later. It issued the Reichsmark which became |
| or monetary policy, for instance.The first truly modern | | | | the legal and only tender of the whole German Reich. |
| example would be the monetary union of Colonial New | | | | The currency Union survived two world wars, a |
| England.The New England colonies (Connecticut, | | | | devastating bout of inflation in 1923 and a collapse of |
| Massachusetts Bay, New Hampshire and Rhode | | | | the currency after the Second World War. The |
| Island) accepted each other's paper money as legal | | | | Reichsmark became the solid and reliable Bundesbank. |
| tender until 1750. These notes were even accepted as | | | | The Union still survives in the Deutschmark.This is the |
| tax payments by the governments of the colonies. | | | | only case of a monetary union which succeeded |
| Massachusetts was a dominant economy and | | | | without being preceded by a political arrangement. It |
| sustained this arrangement for almost a century. It | | | | survived because Prussia was sizeable and had |
| was envy that ended this very successful | | | | enough real power and perceived clout to enforce |
| arrangement: the other colonies began to print their | | | | compliance on the other members of the Federation. |
| own notes outside the realm of the union. | | | | Prussia wanted to have a stable currency and |
| Massachusetts bought back (redeemed) all its paper | | | | introduced consistent metallic standards. The other |
| money in 1751, paying for it in silver. It instituted a | | | | states could not deprive their currencies of their |
| mono-metalic (silver) standard and ceased to accept | | | | intrinsic values. For the first time in history, coinage |
| the paper money of the other three colonies.The | | | | became a professional economic decision, totally |
| second, more important, experiment was the Latin | | | | depoliticized.In this context, we must mention another |
| Monetary Union. It was a purely French contraption, | | | | successful (on-going) union - the CFA Franc Zone.The |
| intended to further, cement, and augment its political | | | | CFA (French African Community) is a currency used |
| prowess and monetary clout. Belgium adopted the | | | | in the former French colonies of West and Central |
| French Franc when it attained independence in 1830. It | | | | Africa (and, curiously, in one formerly Spanish colony). |
| was only natural that France and Belgium (together | | | | The currency zone has been in existence for well |
| with Switzerland) should encourage others to join them | | | | over three decades and comprises diverse ethnic, |
| in 1848. Italy followed in 1861 and the last ones were | | | | lingual, cultural, political and economic units. The |
| Greece and Bulgaria (!) in 1867. Together they formed | | | | currency withstood devaluations (the latest one of |
| the bimetallic currency union known as the Latin | | | | 100% vis a vis the French Franc), changes of regimes |
| Monetary Union (LMU).The LMU seriously flirted with | | | | (from colonial to independent), the existence of two |
| Austria and Spain. The Foundation Treaty was | | | | groups of members, each with its own central bank, |
| officially signed only on 23/12/1865 in Paris.The rules of | | | | controls of trade and capital flows - not to mention a |
| this Union were somewhat peculiar and, in some | | | | host of natural and man made catastrophes. What |
| respects, seemed to defy conventional economic | | | | makes it so successful is maybe the fact that the |
| wisdom.Unofficially, the French influence extended to | | | | reserves of the member states are hoarded in the |
| 18 countries which adopted the Gold Franc as their | | | | safes of the French Central Bank and that the |
| monetary basis. Four of them agreed on a gold to | | | | currency is almost absolutely convertible to the French |
| silver conversion rate and minted gold coins which | | | | Franc. Convertibility is guaranteed by the French |
| were legal tender in all of them. They voluntarily | | | | Treasury itself.France imposes monetary discipline |
| accepted a money supply limitation which forbade | | | | (that it sometimes lacks at home!) directly and through |
| them to print more than 6 Franc coins per capita (the | | | | its generous financial assistance.Europe has had more |
| four were: France, Belgium, Italy and | | | | than its share of botched (the Snake, the EMS, the |
| Switzerland).Officially (and really) a gold standard | | | | ERM) and of successful (ECU, the United Kingdom and |
| developed throughout Europe and included coin issuers | | | | Ireland) currency unifications.A neglected one is |
| such as Germany and the United Kingdom). Still, in the | | | | between Belgium and Luxembourg (BENELUX is the |
| Latin Monetary Union, the quantities of gold and silver | | | | political alignment which includes the Netherlands).There |
| Union coins that member countries could mint was | | | | is no real currency union here. Both maintain separate |
| unlimited. Regardless of the quantities minted, the coins | | | | currencies. But their currencies are at parity and serve |
| were legal tender across the Union. Smaller | | | | as legal tender in both countries since 1921. The Belgian |
| denomination (token) silver coins, minted in limited | | | | Central Bank controls the monetary policies of both |
| quantity, were legal tender only in the issuing | | | | countries, with the exception of exchange regulations |
| country.There was no single currency like the Euro. | | | | which are overseen by a joint agency. In both 1982 |
| Countries maintained their national currencies (coins), | | | | and 1993 the two countries considered dismantling the |
| but these were at parity with each other. An | | | | union - but this was not serious talk, the advantages |
| exchange commission of 1.25 % was charged to | | | | being so numerous (especially to the smaller |
| convert them. The tokens had a lower silver content | | | | partner).These three currency unions have all survived |
| than the Union coins.Governmental and municipal | | | | due mainly to the fact that one monetary authority has |
| offices were required to accept up to 100 Francs of | | | | been responsible, at least de facto, for managing the |
| tokens (even though they were not convertible and | | | | currency.What can we learn from all this (not |
| had a lower intrinsic value) in a single transaction. This | | | | insubstantial) cumulative experience?(A) A dominant |
| loophole led to mass arbitrage: converting low metal | | | | country is required for a Union to succeed. It must |
| content coins to buy high metal content ones.The | | | | have a strong geopolitical drive and maintain political |
| Union had no money supply policy or management. It | | | | solidarity with some of the other members. It must be |
| was left to the market to determine how much money | | | | big, influential, and its economy must be intermeshed |
| will be in circulation. The central banks pledged the free | | | | with the economies of the others.(B) Central institutions |
| conversion of gold and silver to coins. But, this pledge | | | | must be set up to monitor and enforce fiscal and other |
| meant that the Central Banks of the participating | | | | policies, to coordinate activities of the member states, |
| countries were forced to maintain a fixed ratio of | | | | to implement political and technical decisions, to control |
| exchange between the two metals (15 to 1, at the | | | | the money aggregates and seniorage (=money |
| time) ignoring the prices fixed daily in the world | | | | printing), to determine the legal tender and the rules |
| markets.The LMU was too negligible to influence the | | | | governing the issuance of money.(C) It is better if a |
| world prices of these two metals. The result was | | | | monetary union is preceded by a political one. Even so, |
| overvalued silver, export of silver from one member to | | | | it might prove tricky (consider the examples of the |
| another using ingenious and ever more devious ways | | | | USA and of Germany).(D) Wage and price flexibility |
| of circumventing the rules of the Union. There was no | | | | are sine qua non. Their absence is a threat to the |
| choice but to suspend silver convertibility and thus | | | | continued existence of any union. Fiscal policy (money |
| acknowledge a de facto gold standard. Silver coins | | | | transfers from rich areas to poor) are a partial |
| and tokens remained legal tender.This became a | | | | remedy. They can mitigate and ameliorate problems - |
| major problem for the Union and the coup de grace | | | | but not solve them. Transfers also call for a clear and |
| was delivered by the unprecedented financing needs | | | | consistent fiscal policy regarding taxation and |
| brought on by the First World War. The LMU was | | | | expenditures. Problems like unemployment plague a |
| officially dismantled in 1926 - but died long before that. | | | | rigid, sedimented union. The works of Mundell and |
| The lesson: a common currency is not enough - a | | | | McKinnon (optimal currency areas) prove it decisively |
| common monetary policy monitored and enforced by | | | | (and separately).(E) The last prerequisite is clear |
| a common Central Bank is required in order to sustain | | | | convergence criteria and monetary convergence |
| a monetary union.As the LMU was being formed, in | | | | targets.Judging by these requirements, the current |
| 1867, an International Monetary Conference was | | | | European monetary union did not sufficiently assimilate |
| convened. Twenty countries participated and | | | | the lessons of its ill begotten predecessors. It is set in a |
| discussed the introduction of a global currency. They | | | | Europe more rigid in its labour and pricing practices |
| decided to adopt the gold (British, USA) standard and | | | | than 150 years ago, it was not preceded by serious |
| to allow for a transition period. They agreed to use | | | | political amalgamation, it relies too heavily on transfers |
| three major "hard" currencies but to equate their gold | | | | without having in place either a coherent monetary or |
| content so as to render them completely | | | | a consistent fiscal policy.This monetary union is, |
| interchangeable. Nothing came out of it - but this plan | | | | therefore, likely to join its forefathers and remain a |
| was a lot more sensible than the LMU.One wrong path | | | | footnote in the annals of economic history. |