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