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).[PRIOR MATERIAL HERE FOR CHAPTER 1]
CONTINUING … [STARTING WITH A REWRITE OF PART OF YESTERDAY’S TEXT] …
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.[EXPLANATION TO COME]
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.
THIS DISCUSSION IS LEADING US TO THE WAY IN WHICH EUROPE REACTED TO THE COLLAPSE OF THE BRETTON WOODS SYSTEM AND PARTICULARLY THE WAY IN WHICH GERMANY AND FRANCE REACTED IN THE EARLY 1970s WHERE GERMANY WANTED A JOINT FLOAT BUT FRANCE (AND THE EC) WANTED TO MAINTAIN FIXED PARITIES WITH CAPITAL CONTROLS.[MORE HERE ON THE 1970s DEBATES, DELORS REPORT etc NEXT TIME]
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, http://ec.europa.eu/economy_finance/emu_history/documentation/chapter2/19690212en015coordineconpoli.pdf
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, http://hdl.handle.net/2027/mdp.39015081224407