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Options for Europe – Part 2

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014. The book will be about 180 pages long. Given the time constraints I plan to devote most of my blog time over the next 3 months to the production of the book. I will of-course break that pattern when there is a major data release and/or some influential person says something stupid or something sensible. I hope the daily additions will be of interest to you all. A lot has to be done! Because the drafting has to be tighter than the normal stream of consciousness that forms my usual blogs, the daily quotient is likely to be shorter.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).



The idea of a common currency in Europe or parts of Europe has long been entertained. In the C19th, when Europe was undergoing the unification of states, the introduction of a common currency was seen as an essential element of nationhood. Germany in 1834 united its states and formed the German Customs Union (or Zollverein) with a common currency the Vereinsmunze. In 1876, the Reichsmark became the national currency, once the German Reichsbank took control of all currency issuance (see Holtferich, 1995). Simmilarly, the Italian unification of 1861 was also accompanied by the creation of a unified lira monetary unification.

Other common currency arrangements formed in Europe in the C19th collapsed. Upon attaining independence in 1830, Belgium adopted the French franc and formed the franc zone. In 1848, they formed the Latin Monetary Union (LMU) with Switzerland. Italy joined in 1861 and in 1867 Greece and Bulgaria also joined the union. The LMU was a bi-metallic (gold and silver) currency arrangement with each nation retaining its own currency (gold and silver coins), which were exchange at parity across the union (apart from a small transaction charge). Importantly (for understanding modern developments), the motivation for the formation of the LMU came from France who were concerned that their colonial power was in decline and this would undermine their economic power (see Flandreau 1995, 2000; Einaudi 2000; Flandreau and Maurel, 2005).

The member-states of the LMU did not share common monetary policies although under the agreement, their respective central banks had to guarantee convertibility of gold and silver into minted coins at a fixed parity. Problems arose when silver lost value which forced the central banks to suspend convertibility. The onset of World War I and the requirements on warring governments to fund the war effort finally brought the system to an end after years of dysfunction. It was was formally abandoned until 1926.

A similar, multinational currency experiment was formed in 1873 when the Scandinavian Currency Union (SCU) was established between Sweden and Denmark with Norway joining two years later. It was a monetary union based on gold. Each nation “introduced the decimal system and adopted a common unit of currency”, a Scandinavian krona (Bergman, 1999: 365). The currencies of the member nations (gold coins and other silver and bronze tokens) were fixed against the price of gold and remained freely exchangeable at parity for a period of eight years, whereupon the common currency unit would prevail (see Bergman, 1999; Bergman et al., 1993; Henrikson and Kaergard, 1995). As in the LMU the union did not survive World War I. Prior political developments (Norway breaking with Sweden in 1905) led to Sweden limiting convertibility. But the monetary instability associated with the onset of World War I, which led to the abandonment of the gold standard (as respective governments funded their war spending by selling off gold and driving down its price) was the last straw. The formal arrangement was terminated in 1921. There were other unsuccessful attempts at establishing monetary unions in Europe in the C19th (see Bordo and Jonung, 2003).

What lessons do we learn which help us understand the options for Europe in 2014? First, the adoption of a common currency by previously separate states as part of a national unification were successful. It is important to note that the formerly independent states that agreed to unify had quite diverse economic structures (types of industry, sources of employment) and considerable income disparities. The formerly independent states also had distinct cultural differences. So we cannot conclude that cultural homogeneity or major economic disparities undermine the possible success of a currency union. The common element is that these previously independent states agreed, politically, to forego their differences and create a single national state, which then established, among other things, the economic policy machinery that would work to improve the prosperity of all citizens in the new nation.

Second, the multilateral arrangements such as the LMU and the SCU failed because there was no political agreement to merge the independent governmental structures into a national entity. Throughout the life of the union, each government acted in the best interests of its own nation and only agreed to participate in the currency union inasmuch as it advanced its own national goals rather than the goals of all three member-nations. These conflicting aims were exposed at times of extreme monetary instability (World War I) when the abandonment of the gold standard was clearly a reflection of independent national interests being exercised even though such action undermined the currency union.

Moving into the C20th, the idea of a European currency was revived in 1929 when the German Foreign Minister, Gustav Stresemann, who had worked assiduously in the inter-war period to reconcile Germany and France, petitioned the League of Nations on September 9, 1929 with the following question, “Where are the European currency and the European stamp that we need?” (European Commission, 2012). Stresemann wasn’t to know that the New York Stock Exchange would collapse on Black Friday just six weeks later which put paid to any idea of international currency cooperation in Europe for the indefinite future.

Of significance though for understanding the current state of play, you will note that Stresemann saw the need to bring France and Germany into a closer economic working relationship, a theme that dominated and motivated discussions about the introduction of the euro.

After World War II, the 44 Allied nations agreed to return to a type of gold standard because they believed this would bring economic stability. The so-called Bretton Woods system was established in July 1944 and required the central banks of participating nations to maintain their currencies at agreed fixed rates against the US dollar with the newly created International Monetary Fund (IMF) empowered (with contributions from the member states) to offer short-term funding to any nations that could not earn sufficient foreign currency reserves via trade. The US government, in turn, agreed to convert US dollars into gold at a fixed price. The system collapsed in August 1971, after President Nixon suspended the convertibility of the US dollar into gold. This meant that national currencies were no longer associated with any gold backing. This shift established the era of fiat currencies, where there is no guaranteed convertibility into any other commodity (such as gold) and the currency is given legal status by dint of legislative fiat at the imprimatur of the national government.

Various currency arrangements followed the formal abandonment of Bretton Woods system in March 1973. Most nations freely floated their currencies against other currencies, which means their values became determined by the forces of supply and demand in foreign exchange markets. That situation persists today. Other nations opted to peg their currency to another currency or perhaps to a basket of other currencies while others adopted a foreign currency outright (for example, nations that “dollarised” by accepting the US dollar as their domestic currency).

After the Treaty of Rome 1957, which established the European Economic Community (EEC), there was regular discussion about the need for closer economic cooperation between the member states. In February 1969, the so-called Barre Report which reaffirmed the European preference for fixed exchange rates and a move to a common monetary policy.

The Report stated (Barre, 1969: 3):

In the 1962 Memorandum, the Commission of the European Economic Community affirmed that the co-ordination of the Member States’ policies “would be incomplete, and therefore possibly ineffective, if no comparable action were taken in the field of monetary policy”. It recommended, among other things, the creation of a number of procedures for prior information and consultation, the establishment of a common position with regard to external monetary relations, and the negotiation of an agreement laying down “the extent of the obligations … with regard to mutual aid under the Treaty”.

The Europeans were concerned about developments in world currency markets and the depletion of US gold reserves, in the context of the commitment by the US government under Bretton Woods to guarantee US dollar convertibility into gold. During the 1960s a large quantity of gold reserves shifted from the US to Europe as a result of persistent US balance of payments deficits.

The use of the US dollar as a reserve currency exposed the instability of the Bretton Woods system. The economist Robert Triffin had warned in the early 1960s that the system required the US to run balance of payments deficits so that other nations, who used the US dollar as the dominant currency in international transactions, were able to convert their gold stocks into US dollars. However, the Triffin paradox was that this continued expansion of US dollars into world markets undermined confidence in its value and led to increased demands for convertibility back into gold (Triffin, 1960). The loss of gold reserves further reinforced the view that the US dollar was overvalued and the system would come unstuck.

In his evidence before the US Congress Joint Economic Committee in December 1960 (US Congress, 1960: 230), Triffin said:

A fundamental reform of the international monetary system has long been overdue. Its necessity and urgency are further highlighted today by the imminent threat to the once mighty U.S. dollar.

The way out of the dilemma was for the US to raise its interest rates and attract the dollars back into investments in US-denominated financial assets or productive capital. But this would push the US economy into recession, which was politically unpalatable and increasingly inconsistent with other domestic developments (the War on Poverty) and the US foreign policy obsession with fighting communism exemplified by the build up of NATO installations in Western Europe and the prosecution of the Vietnam War.

The ongoing US balance of payments deficits meant that US dollars were flooding world markets and convertibility meant that US gold reserves went to the surplus nations in Europe.

The US spending associated with the Vietnam War overheated the domestic economy and expanded US dollar liquidity in the world markets further. The resulting inflation was then transmitted through the fixed exchange system to Europe and beyond. Fixed exchange rates spread inflation in this way.


The balance of payments deficits were not just a matter of US actions. In the growth period after World War II, other nations demonstrated a strong desire to accumulate US dollar reserves and the only way they could do that was to run external surpluses against the US. In other words, they were exchanging real goods and services in favour of America in exchange for US dollar-denominated financial claims.



Additional references

This list will be progressively compiled.

Barre Report (1969) Commission Memorandum to the Council on the co-ordination of economic policies and monetary co-operation within the Community, Secretariate of the Commission of the European Communities, February 12,

Bergman, U.M. (1999) ‘Do Monetary UnionsM ake Economic Sense? Evidence from the Scandinavian Currency Union, 1873-1913’, Scandinavian Journal of Economics, 101(3), 363-77.

Triffin, R. (1960) Gold and the Dollar Crisis. The Future of Convertibility, London, Oxford. University Press.

US Congress (1960) Current Economic Situation and Short-Run Outlook, US Congress Joint Economic Committee, December,

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    This Post Has 10 Comments
    1. Rather than write an entire book, I’ve decided to sum up the Euro problem in 150 words, for what that’s worth (at least one Euro, I’d say). Here goes.

      If each Euro country is equally competitive, no Euro country will have a significant balance of payments surplus or deficit (assuming the EZ as a whole doesn’t have an external surplus or deficit). In that scenario, the ECB can bring full employment throughout the EZ by simply buying the right amount of each national government’s debts.

      In contrast, given competitiveness disparities, that’s a problem. It can be solved by migration, but that isn’t taking place fast enough at present. It can be solved by internal devaluation, but that’s taking place far too slowly as well.

      A third possibility some sort of ENFORCED internal devaluation. I.e. force through a 20% or so pay cut and price cut in uncompetitive countries. That would work given enough goodwill by citizens and firms in the uncompetitive country. But perhaps that’s too much to hope for.

      Fourth solution: leave the Euro and go back to national currencies.

    2. Ralph, internal devaluation (through unemployment and labor reforms than undermine workers rights) is already happening, but that’s a race to the bottom that eventually will benefit no one (apart from the usual suspects, though they too are feeling the heat now).
      Billy, I’m not sure that the passage First, the adoption of a common currency by previously separate states as part of a national unification were successful is correct: we’ve had a political (and a monetary) union in Italy for 150 years and in that period not only it hasn’t managed to level the imbalances between the south and the north but it led to the appearance of the green shirts in the north. Transpose that to the European level and it will lead to black shirts in Germany, where people have been told that their problems (derived from the Hartz reforms) are due to the subsidies to the lazy southerners (of course they omit the fact that those subsidies are to repay debts to the German banks, that, thanks to the monetary union and the disappearance of the exchange risk and the financial liberalization imposed by the north, have lent without checking the solvency of the debtor, knowing very well that in the end the states would intervene to repay those private debts, private debts that have been necessary to compensate for the fact that wages from the eighties have been stagnant while productivity rose, and debts that have been used to buy German goods, made competitive by their internal labor devaluation, in clear violation of the european rules they imposed to the other nations).
      The only alternative is a dismantlement of the eurozone, possibly in a controlled manner as explained in the European Solidarity Manifesto.

    3. great history here, Bill;

      That history drives home the point that we should never let theoretical economists anywhere near national policy?

      And we should also not let any single lobby, in this case banking, dominate policy.

      Policy agility requires consensus? Otherwise, you end up with a constrained policy space. If populations could keep that simple idea in mind when approaching policy, theoretical economists would be kept in check.

      Coordinate narrow factions through appropriate checks and balances> James Madison’s anthropomorphic summary of system science still awaits application of appropriate methods

    4. Andy,

      Good point. At least if surplus countries spent their surpluses in a way that permanently reduced their surplus (e.g. Germans took more holidays in periphery countries) that would be a solution. Or if they spent in such a way as to raise inflation in Germany (while inflation in the periphery countries stayed the same) that would work.


      Internal devaluation doesn’t have a huge effect on living standards in the relevant country because wages and prices fall by roughly the same amount. Reason is that the price of goods is made up of the cost of labour needed to make and market those goods. E.g. the majority of the cost of goods and services in Greece is accounted for by the cost of Greek labour.

      Internal devaluation is (at least in theory) exactly the same as a country with its own currency devaluing. The UK devalued the £ by 25% in 2008, but there wasn’t a sudden drop in living standards. Plus I don’t remember a huge number of complaints about the rise in the cost of foreign holidays (though doubtless the cost of those holidays did rise).

      Labour reforms are a separate issue. If the labour market can be made more efficient in socially acceptable ways, then nothing wrong with that. That would cut costs in periphery countries. But if those reforms are not acceptable, then the relevant country can just devalue.

      Obviously I’m not thrilled by the unemployment needed to bring about internal devaluation. That’s why I suggested a quick ENFORCED devaluation above. If that were feasible, it would be far better than years of excess unemployment, which is the method currently being adopted to achieve internal devaluation.

    5. Dear Luca Olivetti (at 2014/01/02 at 0:55)

      Thanks for your observation.

      I wasn’t implying the Italy was a success after unification in 1861 just that the currency persisted. I noted the disparity across regions had also persisted. But the fact is that Italy has remained one nation with one currency whereas all the other attempts at currency arrangements between separate nations failed.

      There was no implication in my use of the term “success” that the single currency would resolve all the problems the nation faces. That depends on how the government uses its currency and the way the people behave. The rise of right-wing fanaticism is not due to the single currency but a lack of education and poor socio-economic policies.

      best wishes

    6. Dear Ralph Musgrave (at 2014/01/01 at 20:51)

      This is not the first time you have suggested you can encapsulate a complex story in a few words. It is also not the first time you have failed to do that. There is a difference between dot-point assertions amounting to 150 words and education and understanding.

      Your 150 words requires a person to have a vast amount of prior knowledge – even just at the level of jargon. For example, what is an internal devaluation? How many people would really know what that meant without prior learning.

      Your 150 words also provides no historical context for understanding the evolution of the structures nor any insights into the “cultural” and “social” issues that might make one option superior (and possible) relative to another.

      best wishes

    7. Ralph:Internal devaluation is (at least in theory) exactly the same as a country with its own currency devaluing. No, it isn\’t. Not in the current European context, not in Eurozone vs the UK comparisons. Internal devaluation of a Eurozone country, remaining in the Euro is theoretically the same as the UK devaluing – if the UK had massive Euro (that is foreign) denominated debt – which it does not.

      And even so, internal devaluation is theoretically fine and dandy – but as Lerner, who amply treated these topics long ago, noted, it is only theoretically so. In practice it is impossible and amounts to forcing depressions and does have a huge and negative effect on living standards – relevant recent examples being Greece & Latvia.

    8. Dear Ralph Musgrave (at 2014/01/02 at 4:19)

      You asserted:

      Internal devaluation is (at least in theory) exactly the same as a country with its own currency devaluing.

      This is exactly the sort of logic that Keynes railed against the Classical (Treasury) view in the 1930s and is why neoclassical theory (falsely) accused him (and later Keynesians) of falling into the trap of money illusion.

      There is all the world of difference between an internal devaluation where nominal wages and benefits are cut and the real wage cuts implied by currency depreciation.

      Our contracts are always specified in nominal terms – the principle one being our mortgages and credit card bills. So much dollars per month have to be paid irrespective of the real value.

      When our real wages are being squeezed, by nominal exchange rate depreciation, within limits we have room to re-arrange our monthly spending to maintain integrity of our nominal commitments. But if we take the same cuts in money wages there is a danger that we will quickly become insolvent and be forced to default on our contractual obligations.

      That is why Keynes argued that workers would accept a real wage cut if it was via a rise in the general price level but would resist the same implied real wage cut if it was engineered via a money wage cut.

      The same logic applies here. We can reduce our exposure to the real wage impacts of currency depreciation by altering our purchases (for example, by avoiding buying imports) but we have no discretion if our nominal wages are being attacked by austerity merchants.

      You should be careful in expounding “theory” that you clearly do not fully grasp.

      best wishes

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