CURRENCY UNION : “Before long, all Europe, save England, may have one money “.This was written by William Bagehot, the Editor of “The Economist”, the renowned British magazine, 120 years ago when Britain, even then, was heatedly debating whether to adopt a single European Currency or not. A century later, the euro is finally here (though without British participation). Having braved numerous doomsayers and Cassandras, the currency – though much depreciated against the dollar and reviled using quarters (especially in Britain) – is now in used in both the eurozone and in eastern and southeastern Europe (the Balkan). Generally in most countries in transition, it has recently replaced its much sought-after predecessor, the Deutschmark. The euro still feels as though a novelty – but it’s not. It was preceded by many monetary unions in both Europe and outside it.
Currency Union Definition
People felt the necessity to create a standard medium of exchange as early as in Ancient Greece and Medieval Europe. Those proto–unions did not need a main monetary authority or monetary policy, yet they functioned surprisingly well in the uncomplicated economies of the time. The initial truly modern example is the monetary union of Colonial New England. The four types of paper money printed by the New England colonies (Connecticut, Massachusetts Bay, New Hampshire and Rhode Island) were legal tender in all until 1750. The governments of the colonies even accepted them for tax payments. Massachusetts – undoubtedly the dominant economy of the quartet – sustained this arrangement for almost a century.
One other colonies became so envious they begun to print additional notes outside the union. Massachusetts – facing a risk of devaluation and inflation – redeemed for silver its share of the paper money in 1751. It then retired from the union, instituted a unique, silver-standard (mono-metallic), currency and never looked back. An even more important attempt was the Latin Monetary Union (LMU). It was dreamt up by the French, obsessed, as usual, by their declining geopolitical fortunes and monetary prowess. Belgium already adopted the French franc when it became independent in 1830. The LMU was an all natural extension of the franc zone and, as the two teamed up with Switzerland in 1848, they encouraged others to participate them.
Italy followed suit in 1861. When Greece and Bulgaria acceded in 1867, the members established a currency union centered on a bimetallic (silver and gold) standard. The LMU was considered sufficiently serious to manage to flirt with Austria and Spain when its Foundation Treaty was officially signed in 1865 in Paris. This despite the fact that its French-inspired rules seemed often to sacrifice the economic to the politically expedient, or even to the grandiose. The LMU was the state subset of an unofficial “franc area” (monetary union based on the French franc). This is similar to the utilization of the US dollar or the euro in many countries today. At its peak, eighteen countries adopted the Gold franc as his or her legal tender (or peg).
Four advisors (the founding individuals the LMU: France, Belgium, Italy and Switzerland) agreed upon a gold to silver conversion rate and minted gold and silver coins that have been legal tender in all of them. They voluntarily limited their own supply by adopting a rule which forbade those to print in excess of 6 franc coins per capita. Europe (especially Germany and also the United Kingdom) was gradually switching at the time to your gold standard. However the individuals the Latin Monetary Union paid no focus to its emergence. They printed expanding quantities of gold and silver coins, which constituted legal tender over the Union.
History of Currency Unions
Smaller denomination (token) silver coins, minted in limited quantity, were legal tender only inside the issuing country (because they a lower silver content compared to the Union coins). The LMU had no single currency (akin to your euro). The nation’s currencies of its member countries were at parity with each other. The price of conversion was restricted to an exchange commission of 1.25%. Government offices and municipalities were obliged to simply accept nearly 100 Francs of non-convertible and low intrinsic value tokens per transaction. People lined to convert low metal content silver coins (100 Francs per transaction each time) to acquire higher metal content ones.
Apart from the above-mentioned per capita coinage restriction, the LMU had no uniform money supply policies or management. How much money is in circulation was determined from the markets. The central banks from the member countries pledged to freely convert precious metals to coins and, thus, were instructed to maintain a limited exchange rate between the 2 main metals (15 to 1) ignoring fluctuating market prices. Even at its apex, the LMU was unable to move the earth prices of these metals. When silver became overvalued, that it was exported (at times smuggled) from the Union, in violation of its rules. The Union had to suspend silver convertibility and thus pay a humiliating de facto gold standard.
Silver coins and tokens remained legal tender, though. The unprecedented financing needs from the Union members – due to the First World War – delivered the coup de grace. The LMU was officially dismantled in 1926 – but expired well before that. The LMU had one common currency but this failed to guarantee its survival. It lacked one common monetary policy monitored and enforced by one common Central Bank – these deficiencies proved fatal. In 1867, twenty countries debated the roll-out of a global currency inside the International Monetary Conference. They decided to embrace the defacto standard (already made use of by Britain and also the USA) following a time of transition. They created a nifty scheme.
They selected three “hard” currencies, with equal gold content in order to render them interchangeable, as his or her legal tender. Regrettably for students from the dismal science, the blueprint reached naught. Another failed experiment was the Scandinavian Monetary Union (SMU), formed by Sweden (1873), Denmark (1873) and Norway (1875). It was a by-now familiar scheme. Seventy one recognized each others’gold coinage in addition to token coins as legal tender. The daring innovation was to simply accept the members’banknotes (1900) as well. As Scandinavian schemes go, ours worked too perfectly. Use of would definitely convert one currency to another. Between 1905 and 1924, no forex rates among method currencies were available.
Monetary Union Pros and Cons
When Norway became independent, the irate Swedes dismantled the moribund Union during an act of monetary tit-for-tat. The SMU had an unofficial central bank with pooled reserves. It extended credit lines to every one of the three member countries. Provided that gold supply was limited, the Scandinavian Kronor held its ground. Then governments started to finance their deficits by dumping gold during World War I (and thus erode their debts by fostering inflation with a string of inane devaluations). In a unparalleled act of arbitrage, central banks then turned around and used the depreciated currencies to scoop up gold at official (cheap) rates.
When Sweden refused to to promote its gold from the officially fixed price – the people declared effective economic war. They forced Sweden purchasing enormous quantities with their token coins. The proceeds had been to pick the much stronger Swedish currency at a persistantly cheaper price (as the money necessary for gold collapsed). Sweden found itself subsidizing an arbitrage against some economy. It inevitably reacted by ending the import of people’tokens. The Union thus ended. The expense of gold was no longer fixed and token coins were you can forget convertible. The East African Currency Area is a pretty recent debacle. An equivalent experiment, between CFA franc, continues occurring inside the Francophile an important part of Africa.
The parts of East Africa ruled by its British (Kenya, Uganda and Tanganyika and, in 1936, Zanzibar) adopted in 1922 one common currency, the East African shilling. The newly independent countries of East Africa remained a part of the Sterling Area (i.e., the area currencies were fully and freely convertible into British Pounds). Misplaced imperial pride coordinated with outmoded strategic thinking led the British to infuse these emerging economies with inordinate amounts of money. Despite all this, the resulting monetary union was surprisingly resilient. It easily absorbed the brand new currencies of Kenya, Uganda and Tanzania in 1966, forcing them to tender in the 3 and convertible to Pounds.
Ironically, it’s the Pound which gave way. Its relentless depreciation inside the late 60s and early 70s, generated the disintegration on the Sterling Area in 1972. The strict monetary discipline which characterized the union – evaporated. The currencies diverged – because of a divergence of inflation targets and interest rates. The East African Currency Area was formally led to 1977. Its not all monetary unions ended so tragically. Arguably, essentially the most famous on the successful ones is definitely the Zollverein (German Customs Union). The nascent German Federation was composed, at the start of the 19th century, of 39 independent political units. Most women busily minted coins (gold, silver) together ones own – distinct – standard weights and measures.
Economic and Monetary Union
The decisions on the much lauded Congress of Vienna (1815) did wonders for labour mobility in Europe though not so for trade. The baffling variety of (mostly non-convertible) different currencies wouldn’t help. The German principalities formed a customs union as early as 1818. The three regional groupings (the Northern, Central and Southern) were united in 1833. In 1828, Prussia harmonized its customs tariffs with the other members of the Federation, which makes it possible to cover duties in gold or silver. Some members hesitantly tried new fixed exchange rate convertible currencies. But, in practice, the union already had just one currency: the Vereinsmunze.
The Zollverein (Customs Union) was established in 1834 to facilitate trade by reducing its costs. This is done by compelling the majority of the members to select between two monetary standards (the Thaler and the Gulden) in 1838. Much while the Bundesbank was to Europe in the next half the twentieth century, the Prussian central bank became the effective Central Bank of the Federation from 1847 on. Prussia was undoubtedly the dominant member of the union, as it comprised 70% of the populace and land mass into the future Germany. The North German Thaler was fixed at 1.75 to the South German Gulden and, in 1856 (when Austria became informally associated with the Union), at 1.5 Austrian Florins.
This last collaboration was to be always a short lived affair, Prussia and Austria having declared war on each other in 1866. Bismarck (Prussia) united Germany (Bavarian objections notwithstanding) in 1871. He founded the Reichsbank in 1875 and charged it with issuing the crisp new Reichsmark. Bismarck forced the Germans to just accept the newest currency as the only real legal tender through the entire first German Reich. Germany’s new single currency was in effect a monetary union. It survived two World Wars, a devastating episode of inflation in 1923, and a monetary meltdown after the Second World War. The stolid and trustworthy Bundesbank succeeded the Reichsmark and the Union was finally vanquished only by the bureaucracy in Brussels and its euro.
This is the only case ever sold of a successful monetary union not preceded by way of a political one. But it’s hardly representative. Prussia was the regional bully and never shied from enforcing strict compliance on the other members of the Federation. It understood the paramount significance of a reliable currency and sought to preserve it by introducing various consistent metallic standards. Politically motivated inflation and devaluation were eliminated, for the very first time. Modern monetary management was born. Another, perhaps equally successful, and still on-going union – may be the CFA franc Zone. The CFA (stands for French African Community in French) franc has been in use within the French colonies of West and Central Africa (and, curiously, in one formerly Spanish colony) since 1945.
It is pegged to the French franc. The French Treasury explicitly guarantees its conversion to the French franc (65% of the reserves of the member states are kept in the safes of the French Central Bank). France often openly imposes monetary discipline (that it often lacks at home!) directly and through its generous financial assistance. Foreign reserves must always equal 20% of short term deposits in commercial banks. All this made the CFA a nice-looking option in the colonies even after they attained independence. The CFA franc zone is remarkably diverse ethnically, lingually, culturally, politically, and economically.
Monetary Union Economics
The currency survived devaluations (as large as 100% vis a vis the French Franc), changes of regimes (from colonial to independent), the existence of two sets of members, each with its own central bank (the West African Economic and Monetary Union and the Central African Economic and Monetary Community), controls of trade and capital flows – not to mention quite a few natural and fabricated catastrophes. The euro has indirectly affected the CFA as well. “The Economist” reported recently lack of small denomination CFA franc notes. “Recently the printer (of CFA francs) is too busy producing euros for this market home” – complained the West African central bank in Dakar. But this can be a minor problem.
The CFA franc is in danger because of internal imbalances one of the economies with the zone. Their growth rates differ markedly. There are mounting pressures by some members to devalue the everyday currency. Others sternly resist it. “The Economist” reports the fact that Economic Community of West African States (ECOWAS) – eight CFA countries plus Nigeria, Ghana, Guinea, the Gambia, Cape Verde, Sierra Leone, and Liberia – is considering a unique monetary union. The majority of the prospective people in this union fancy the CFA franc less as opposed to EU fancies their capricious and graft-ridden economies. But an ECOWAS monetary union could constitute a significant – and a lot more economically coherent – alternative on the CFA franc zone.
A neglected monetary union is the main one between Belgium and Luxembourg. Both maintain their idiosyncratic currencies – however, these have parity and work as legal tender both in countries since 1921. The monetary policy of both countries is dictated with the Belgian Central Bank and exchange regulations are overseen using a joint agency. Both the were all-around dismantling the union at least 2 times (in 1982 and 1993) – but relented.
Europe has received a lot more than its share of botched and of successful currency unions. The Snake, the EMS, the ERM, on the one hand – along with the British Pound, the Deutschmark, along with the ECU, about the other. The currency unions making it necessary survived as they relied on a single monetary authority for handling the currency. Counter-intuitively, single currencies are sometimes regarding complex political entities which occupy vast swathes of land and incorporate previously distinct -and often politically, socially, and economically disparate – units. The USA is a fiscal union, as was the late USSR. All single currencies encountered opposition on both ideological and pragmatic grounds when these were first introduced.
The American constitution, for example, failed to offer a central bank. The majority of the Founding Fathers (e.g., Madison and Jefferson) refused to countenance one. It took the nascent USA twenty years to develop a semblance of any central monetary institution in 1791. It had become modeled once the successful Bank of England. When Madison became President, he purposefully let its concession expire in 1811. Within the forthcoming half century, it revived (for instance, in 1816) and expired some times. The United States became a monetary union only following its traumatic Civil War. Similarly, Europe’s monetary union is definitely a belated outcome of two European civil wars (the two World Wars).
America instituted bank regulation and supervision only in 1863 and, first, banks were classified as either national or state-level. This classification was necessary because by the completed on the Civil War, notes – legal and illegal tender – were being issued by at the least 1562 private banks – up from only 25 in 1800. A similar process occurred in the principalities which were later to constitute Germany. In your decade between 1847 and 1857, 30 private banks were established there for any express intent behind printing banknotes circulation as legal tender. Seventy (!) different types of currency (mostly foreign) were being used while in the Rhineland alone in 1816. The Federal Reserve System was founded only through a tidal wave of banking crises in 1908.
Not until 1960 did it put on a full monopoly of nation-wide money printing. The monetary union while in the USA – the US dollar like a single legal tender printed exclusively by using a central monetary authority – is, therefore, a fairly recent thing, not older versus euro. Very to confuse the logistics of one’s monetary union using its underpinnings. European bigwigs gloated covering the smooth introduction on the physical notes and coins of their new currency. But having a single currency with free and guaranteed convertibility is only the manifestation of one’s monetary union – not merely one of the company’s economic pillars.
History teaches us that for that monetary union achievement, the exchange rate of the single currency must be sensible (for instance, reflect the purchasing power parity) and, thus, not susceptible to speculative attacks. Additionally, the members on the union must adhere to 1 monetary policy. Surprisingly, history demonstrates that the monetary union is simply not necessarily predicated on arsenic intoxication one single currency. A monetary union could incorporate “several currencies, fully and permanently convertible into one at irrevocably fixed forex rates “.This could be like having a single currency with some other denominations, each printed by another member on the Union.
What really matters are the cost-effective inter-relationships and power plays among union members and concerning the union along with currency zones and currencies (as expressed on the exchange rate). Usually the single currency on the Union is convertible at given (though floating) forex rates subject for a uniform exchange rate policy. This is applicable to each of the territory of the single currency. It is intended to prevent arbitrage (buying the single currency within a place and selling it in another). Rampant arbitrage – ask anyone in Asia – often creates the requirement to impose exchange controls, thus eliminating convertibility and inducing panic. Monetary unions in the last failed because they allowed variable forex rates, (often subject to where – where an area of the monetary union – the conversion took place).
A uniform exchange rate policy is merely amongst the concessions members of one’s monetary union must make. Joining always means quitting independent monetary policy and, along with it, a sizeable slice of national sovereignty. Members relegate the unsafe effects of their cash supply, inflation, interest levels, and foreign fx rates to the central monetary authority (e.g., the European Central Bank around the eurozone). The requirement for central monetary management arises because, in economic theory, a currency is not only a currency. It is considered a transmission mechanism of economic signals (information) and expectations (often through monetary policy will be outcomes).
It’s been argued that any single fiscal policy isn’t only unnecessary, but potentially harmful. A monetary union means the surrender of sovereign monetary policy instruments. It could be advisable to allow the members in the union apply fiscal policy instruments autonomously so as to counter the corporation cycle, or manage asymmetric shocks, goes the argument. As long as there is not any implicit or explicit guarantee in the whole union for the indebtedness of its members – profligate individual states might be punished by the forex market, discriminately. But, inside a monetary union with mutual guarantees on the list of members (even if at all only implicit as is the situation around the eurozone), fiscal profligacy, even of a handful of large players, may force the central monetary authority to boost interest levels so as to pre-empt inflationary pressures.
Monetary Union Advantages
Interest levels needs to be raised because the effects of just one member’s fiscal decisions are communicated to fellow members via the common currency. The currency will be the medium of exchange of knowledge about the present and future health in the economies involved. Hence the notorious “EU Stability Pact”, recently so flagrantly abandoned industry by storm German budget deficits. Monetary unions which couldn’t follow the way of fiscal rectitude will with us. Within an article I published in 1997 (“The Good reputation for Previous European Currency Unions“), I identified five paramount lessons on the short and brutish lifetime of previous – now invariably defunct – monetary unions:
- To prevail, a monetary union must remain founded by a handful of economically dominant countries (“economic locomotives”). Such driving forces must remain geopolitically important, maintain political solidarity with fellow members, be happy to exercise their clout, and turn economically involved with (or even dependent on) the economies of the other one members.
- Central institutions must remain set up to monitor and enforce monetary, fiscal, or other economic policies, to coordinate activities in the member states, to implement political and technical decisions, to stop the bucks aggregates and seigniorage (i.e., rents accruing as a result of money printing), to discover the stamp and also rules governing the issuance of money.
- Marketing promotions campaigns where a monetary union is preceded because of a political one (consider the furnished the USA, the USSR, the UK, and Germany).
- Wage and price flexibility are sine qua non. Their absence is a threat to the continuing information on any union. Unilateral transfers from rich areas to poor certainly are a partial and short-lived remedy. Transfers also call for a clear and consistent fiscal policy regarding taxation and expenditures. Problems like unemployment and collapses needed often plague rigid monetary unions. The works of Mundell and McKinnon (optimal currency areas) prove it decisively (and separately).
Clear convergence criteria and monetary convergence targets. Our present-day European Monetary Union is not heeding the teachings of its ill fated predecessors. Europe’s labour and capital markets, though recently marginally liberalized, continue to be more rigid than 150 years ago. The euro hasn’t been preceded by an “ever closer (political or constitutional) union “.It relies too heavily on fiscal redistribution without the main advantage of a coherent monetary or simply a consistent fiscal area-wide policy. The euro is just not developed to cope either with asymmetrical economic shocks (affecting only some members, however is not others), or while using vicissitudes in the business cycle. This does not bode well. This union may become just one more footnote around the annals of economic history.