Bulletin of the Transilvania University of Braşov • Vol. 6 (55) •No. 2 - 2013 Series V: Economic Sciences

HISTORICAL RECORD OF MONETARY UNIONS: LESSONS FOR THE EUROPEAN ECONOMIC AND MONETARY UNION

Ileana TACHE1

Abstract: The aim of this paper is to make a record of previous monetary unions and derive some useful lessons for the European Economic and Monetary Union. Evaluating the political economy of the euro through the lens of history, with the help of comparative analysis, can contribute to better understanding the present stage of the EMU and its challenges. Even if the EU is a unique, sui generis, phenomenon, the analytical lessons learned from the historical cases could be applied to the contemporary situation of the euro.

Key words: European Economic and Monetary Union, Gold Standard, USA monetary union, monetary unification of Italy, German Zollverein, Latin Monetary Union, Scandinavian Monetary Union.

1. Introduction The study is built on the main contributions Even if euro still appears like a novelty in of the literature in this field, such as Bordo the process of European construction and as and Jonung (1999), Bergman (1999), international currency, it was preceded by a Foreman-Peck (2005), McNamara (2011) few monetary unions on the continent and or de Vanssay (1999). outside of it. While much of the European The paper is organized as follows. The monetary project has indeed been of an next section is dedicated to the Gold ambition never seen in Europe before, the Standard, then the other monetary unions idea of bringing currencies together is far are discussed: USA monetary union after from new. The earlier examples offer the Civil War, monetary unification of Italy, fascinating echoes of today’s experience in the German Zollverein, the Latin Monetary the euro area. Union and the Scandinavian Monetary This paper tries to investigate the context Union. Each section contains comparisons of these previous arrangements, which did and parallels with the present European not have a central monetary authority, yet Economic and Monetary Union. The last they functioned surprisingly well in the section provides the final concluding economies of that time. The aim is to extract remarks. the lessons that history teaches us and to reveal some pitfalls that should be avoided.

1 Dept. of Marketing, Tourism and International Relations, Transilvania University of Braşov. 162 Bulletin of the Transilvania University of Braşov • Vol. 6 (55) • No. 2 - 2013 • Series V

2. The Gold Standard reduction in money supply, a decline in the The classical gold standard, in which domestic price level, a rise in participating countries committed to fix the competitiveness and, therefore, a correction prices of their national currencies in terms in the balance of payments deficit. The of a specified amount of gold, lasted from reverse would be true for countries with a 1880 till the World War I, when countries balance of payments surplus. This is the so- resorted to inflationary finance. The system called “price-specie flow mechanism” set was re-introduced for a short period of time, out by Scottish philosopher and economist between 1925 and 1931 as the Gold David Hume (1752). Exchange Standard, when countries could The great virtues of the gold standard hold gold or or pounds as reserves, were: excepting the UK and USA, which held a) It assured long-term price stability, only gold reserves. In the face of huge gold which results from comparing the and capital outflows, UK departed from average annual inflation rate of 0.1 gold in 1931; in USA the gold owned by percent between 1880 and 1914 with the private citizens was nationalized in 1933. average of 4.1 percent between 1946 and There was a further modification of the gold 2003 (Bordo, 2008). standard under the Bretton Woods system b) It corresponds to a period of spectacular (1946-1971), in which most countries real economic growth and relatively free maintained the exchange rate by tying it to trade in goods, labor and capital. the American . The dollar took over Experts debate to what extent the gold the role that gold had played under the gold standard enabled the above mentioned standard in the international financial success and to what extent it flourished system. However, a negative balance of because of some favorable conditions. Most payments in USA and growing public debt probably causality flowed in both directions incurred by Vietnam War led president but it could not be denied that the gold Nixon to announce in 1971 the standard at least helped to facilitate the abandonment of the dollar’s gold positive tendencies. convertibility, marking the final step of the There were, of course, some gold standard. disadvantages of the gold standard, the most In the gold standard era, countries’ money important being that it did not allow policy supplies were linked to gold. The necessity makers to help the economy through a of being able to convert fiat money into gold monetary stimulus. In addition, as national on demand strictly limited the quantity of currencies were tied to gold, the money fiat money in circulation to a multiple of the supply critically depends on the global central banks’ gold reserves. Most countries stock of monetary gold, which is influenced had legal minimum ratios of gold to notes by gold discoveries. or currency issued or other similar limits. An interesting parallel between the gold As explained by World Gold Council standard and the functioning of the (2013), international arrangement implied a European Monetary Union is offered by self correcting mechanism: a country Baldwin and Wyplosz (2009). They provide running a balance of payments deficit rigorous exposition of David Hume’s would experience an outflow of gold, a “price-specie flow mechanism”, which Tache, I.: Historical record of monetary unions … 163 implies an automatic change in the money Greece and other peripheral European stock to achieve balance of payments countries have suffered much greater equilibrium. Under metallic money, Europe economic harm than did Argentina in the was actually a de facto monetary union. Baring Crisis of 1890. This is the reason why understanding how it worked helps understand how the present 3. USA monetary union after the Civil union operates. War The euro shares indeed the characteristic American monetary history is commonly of permanently fixed exchange rates with used as a benchmark by economists when the gold standard but there are also examining various issues of the process of significant differences between the two European monetary unification (Bordo and regimes. The euro is a monetary union with Jonung, 1999, p. 27). the European Central Bank (ECB) at its Multiple versions of the dollar circulated apex which sets policy for the entire euro widely throughout the US before the Civil zone, whilst the gold standard had no such War of 1861-1865 and state-based banks institution. It only linked sovereign states issued banknotes functioning as paper and was ultimately undermined by conflicts money. There was no permanent national between them. central bank and no federal mechanisms for Some perturbing parallels between the controlling the monetary aspects. US of the gold standard and the euro are set out by nineteenth century can be viewed as a loose The Economist (6 July, 2013), which averts federal structure with central coordination that the gold standard holds worrying limited to a few key areas. lessons for the single currency and Currency consolidation was motivated by emphasizes Bordo and James’ new study two main factors. The first one was war (2013) about euro’s fragility. These authors itself, determining public officials’ need to acknowledge some striking similarities rationalize the monetary system and collect between the pre-1914 gold standard and bigger federal revenues in order to finance EMU at present. Both arrangements are the American Civil War. The second factor based of fixed exchange rates, monetary setting the stage for a single currency was and fiscal orthodoxy. Each regime gave the achievement of a single American easy access by financially underdeveloped market, spurred on by the federal courts, peripheral countries to capital from the core which created increasing societal pressures countries. But the gold standard was a for regulation of the monetary regime. contingent rule – in the case of an As McNamara (2011) explains, single emergency like a major war or a serious currencies have most commonly been financial crisis – a country could created in times of war, as a way to temporarily devalue its currency. The EMU consolidate the fiscal power of the state has no such safety valve. Capital flows in rather than as a purely monetary exercise. both regimes fueled asset price booms via Currencies have generally been introduced the banking system ending in major crises by political actors who need to federalize in the peripheral countries. Bordo and the raising of revenues and payments James arrive at the conclusion that, not necessary for war-fighting. having the escape clause, present day 164 Bulletin of the Transilvania University of Braşov • Vol. 6 (55) • No. 2 - 2013 • Series V

In antebellum USA, while the dollar was silver and gold certificates (McNamara, the standard unit of account, state dollars 2011). floated at different rates and the American In general lines, the major difference states had independent fiscal policies with between the single European currency and few interstate fiscal mechanisms to the American monetary unification is that, encourage political solidarity. It was even while Europe wanted to integrate possible for the different states to borrow (inclusively in monetary terms) in order to directly from foreign capital markets in avoid new wars on the continent, in USA pursuit of their own goals. the Civil War provided the immediate The Civil War split the political union and reason and means for federalizing monetary the monetary union in two parts. In the control and building fiscal capacity. Some North, paper money circulated at a pessimistic authors, like Feldstein (1997) significant discount relative to gold coins. considered instead that the euro might make In the South, Confederate notes circulated Europe to fall again into conflict, creating until the end of the war in 1865. The even confrontations with the USA. national banking system, established in 1863, finally created a uniform national 4. Monetary unification of Italy banknote system. The way for Italy’s political unification According to some estimates (such as was paved by the defeat of Austria by the Hepburn, 1924 and Timberlake, 1978), French and Piedmontese armies in 1859. In before the Civil War, about 7000 different the early 1860s, the Italian Peninsula banknotes were used in the USA and a good became one of Europe’s biggest sovereign portion of them were counterfeit. For states. This urged the creation of a monetary merchants there was a chaos to cope with, union and promoted market unification by and they were forced to consult monthly investing in networking technology of that banknote detectors informing them of the time: telegraph and railways. relative value of each note. Only with the In Italy there was little market onset of the Civil War a standardized convergence prior to the political American currency became a reality by a unification. This is the reason why, in the series of reforms which centralized the first months of its existence, the new monetary system at the federal level and Parliament made a huge effort to create a outlawed the local currencies. Large customs and monetary union. quantities of “Greenbacks’ (US notes) were At the time of Italian political unification, issued in 1861-1862 by the federal authority approximately 270 types of legal-tender as fiat money, full “legal tender for all coins circulated in the Peninsula, all of debts, public and private” (as written on the different weight and metal content. The present US dollars). Between 1862-1864 decimal system did not prevail; paper note the Congress authorized the issue of $450 circulation was limited. The tremendous million Greenbacks. The Greenback was array of exchange rates blurred the meaning the only currency with legal tender status, of prices: high information costs although it continued to coexist with several discouraged arbitrage outside local other forms of currency, namely newly commodity and financial markets (Toniolo, standardized national banknotes, as well as Conte and Vecchi, 2003). Tache, I.: Historical record of monetary unions … 165

In July 1861 the Piedmontese Lira, 5. The German Zollverein renamed Lira Italiana, was proclaimed the Zollverein, the German customs union legal tender of the whole country, but this established in 1834 under Prussian was only a temporary solution. In 1862 a leadership, is seen as an important step in Monetary Act made the gold Italian lira the German reunification, creating a free trade kingdom’s unique legal tender. This Act area in Germany. It was advocated by great also established a parity of 1 to 1 of the new economists such as Friedrich List and was currency with the and set the gradually built in order to increasing trade official rates at which the old Italian coins and political unity between the fragmented would be converted into Lira at the mint. states of the . This However, the Southern regions were was followed by a series of acts allowed to go on using their pre-unification standardizing the separate systems of notes for local payments. This is obviously coinage, weights and measures used in the a sign of both the popular resistance to German states. Before the unification, a monetary unification and the obstacles met variety of coins were minted and used and by the new state in exerting its authority. only some were commonly recognized. At Actually, monetary unification took a long the same time, banknotes were not period of time, in contrast with the legal considered legal tender. unification. Italy’s de facto monetary union The North German was fixed at was accomplished only by the mid-1870s. 1.75 to the South German Gulden and, in This process was not very successful 1856 (when Austria became informally mainly because of the economic associated with the Union), at 1.5 Austrian development differences between Northern Florins. This last collaboration was a short and Southern parts of the country. Interest lived affair because in 1866 and rate shocks indicate close relations between Austria declared war on each other. states in northern Italy but negative In 1876 the Prussian Bank became the correlations between the North and the Reichsbank, with the role of controlling all South before unification, emphasizing some coinage and banknotes. The Chancellor advantages of continued Southern monetary Bismark charged the Reichsbank with independence. As a result, the monetary issuing the crisp new Reichsmark. He policies appropriate for the North were less imposed the acceptance of the new money so for the South. Confronted with the as the only legal tender throughout the first agricultural shocks originating in the USA German Reich. Reichsmark – the now- and in France, the South would have been unified German currency – was sufficiently advantaged from depreciating its exchange stable to go on with the gold standard. From rate against the North or against the external the 1870s till the outbreak of World War I trading partners. This aspect is important Germany was indeed part of the when thinking about the present European international gold standard. monetary union and the findings of Frankel Germany’s new single currency was in and Rose (1998), who demonstrate that a effect a monetary union, taking into account monetary union create the conditions for its that it survived two world wars, a own success. It seems this was not the case devastating hyperinflation in 1923 and the with Italy in the nineteenth century. monetary meltdown after World War II. 166 Bulletin of the Transilvania University of Braşov • Vol. 6 (55) • No. 2 - 2013 • Series V

Zollverein was also a highly efficient unification has followed political fiscal tool, but its structure became unification, not the other way around increasingly less suitable for developing a (Bordo and Jonung, 1999). trade policy commensurate with the growing industrialization in Germany. The 6. The Latin Monetary Union collapse of the German Monetary Union In 1865 France, Belgium, Italy and came with the World War I. Switzerland, joined by Greece in 1867, As expressed by Financial Times (July agreed to regulate their national currencies 1998): “There are not many historic on a uniform basis, thus making it freely parallels that measure up in significance to interchangeable. Several other countries European economic and monetary union informally aligned to the new monetary (EMU). The most obvious is the German union. In 1867 the members established a Zollverein in 1834, the customs union of bimetallic standard (silver and gold). The German states that gave rise first to a fixed precious metal standard reflected a exchange rate system between the gulden, commitment to fiscal conservatism and the Southern German currency, and the small balanced budgets. thaler, the Northern German currency, The Latin Monetary Union, which ran which merged into the mark in 1873. alongside Germany’s monetary union, was Historians still disagree over whether actually dreamt up by France, obsessed by customs union and monetary union gave its declining geopolitical fortunes and rise to political union, but the parallels to monetary prowess. After Napoleon, the current day Europe are evident”. French needed a strategy to support their There is however a major difference influence in Europe and they tried it through between the German monetary union and monetary alliances. This monetary the EMU. If in Germany monetary experiment was a natural extension of the unification followed political unification franc zone. It can be considered an official (epitomized by the creation of the German subset of an unofficial franc area, similar to Reich), the EMU presents a peculiar case. the use of the USA dollar or the euro in As Bordo and Jonung (1999) comment, many countries at present. Eighteen there is not any clear and unambiguous countries adopted the Gold franc as their historical precedent to EMU, where a group legal tender. The founding members of politically independent countries (France, Belgium, Italy and Switzerland) surrendered their national currencies to agreed on a gold to silver conversion rate form a common monetary union based on a (15 to 1) and they limited their money new unit of account under the leadership of supply by forbidding the printing of more a common monetary authority – while still than 6 franc coins per capita. retaining political independence. Or, as Comparing the situation with the present Goodhart (1995, p. 92) states just before the European monetary union, it must be euro introduction, what is virtually unique noticed that the Latin Monetary Union had about EMU and the euro is that it will be no single currency akin to the euro. The done without an accompanying national currencies of the member states federalization of government and fiscal were at parity with each other, the cost of functions. Usually, in the past, monetary conversions being limited to an exchange Tache, I.: Historical record of monetary unions … 167 commission of 1.25%. Also, except the per There were provided fixed exchange rates capita coinage restriction, the Latin and stability in monetary terms, but the Monetary Union had no uniform money member countries continued to issue their supply policies (the amount of money in separate currencies. Although not initially circulation being determined by the anticipated, the perceived security led to a markets) and it lacked a common central situation in which the formally separate bank. All these deficiencies, along with the currencies were accepted on a basis of “as fact that member states were cheating on the good as” the legal tender virtually gold and silver content of their coins, throughout the whole monetary zone. By contributed to the official dismantling of the the end of the nineteenth century, the union in 1926 (but it expired long before Scandinavian Monetary Union was very that). The coup de grace was given by the successful – gold coins, banknotes and World War I, with its huge financing subsidiary coins circulated in the member pressures. states and were accepted at par. The lesson offered by the temporary Latin The dissolution of political union between Monetary Union is that monetary unions of Sweden and Norway in 1905 did not affect large sovereign states which do not have the basis for cooperation in the political union eventually disintegrate. Scandinavian Monetary Union. The end This is of great importance for the was brought instead by the outbreak of European monetary unification, even if World War I in 1914. The Scandinavian politics has been the driving force behind Monetary Union is a perfect example of a EMU. More than a century ago, Europe was monetary union with multiple national also dominated by the goal of currency central banks. It collapsed when these stability and the experience of those times independent central banks tried to follow suggests that the success of the EMU is not their own monetary policy. guaranteed. The Scandinavian Monetary Union can provide useful lessons for the European 7. The Scandinavian Monetary Union economic and monetary union. The most The Scandinavian Monetary Union important is that cooperation between (1873-1921) was formed by the Northern central banks and the economic similarity states of Denmark, Norway and Sweden between countries may be necessary (that share a geographic proximity and conditions for a successful and lasting some linguistic similarity), just the moment monetary union. But they not seem to be when these countries adopted the gold sufficient conditions. When the World War standard. The union was thus contemporary I appeared, the lack of a supra-national with the Latin and German monetary regulatory institution for monetary policy unions. Actually, it was inspired by the led each country to try its own non- Latin Monetary Union established in 1866. cooperative path. As Vanssay (1999) But in contrast to the German monetary remarks, this is a classic case of the union, the Scandinavian one was neither Prisoner’s Dilemma, where cooperation is part of a great political project to unite these the optimal solution only if every player three countries, nor was it a part of a great perceives that there will be more games of plan for an economic union. the same nature over time. In any other 168 Bulletin of the Transilvania University of Braşov • Vol. 6 (55) • No. 2 - 2013 • Series V circumstance, non-cooperative behavior is stays in the major distances of economic the dominant strategy. However, the development between Northern and creation of a supra-national central bank in Southern parts of the country. order to solve this problem depends on its The German Zollverein draws attention to ability to resist calls for distinctive national the fact that, in the past, monetary macroeconomic policies. unification has followed political Some studies (for example, Bergman, unification, not the other way around, 1999) proved that the three Scandinavian which is the main distinction between the countries did not form an optimum currency German case and the EMU. area during the period 1873-1913. The same The lesson offered by the Latin Monetary study, applying a frequently used indicator Union is that monetary unions of large of the desirability of monetary unions and sovereign states which do not have political analyzing the symmetry of country-specific union eventually disintegrate. structural shocks in these countries, finds The case of the Scandinavian Monetary that country-specific shocks are not highly Union averts that non-cooperative behavior symmetric. can be solved with the creation of a supra-national central bank, but this 8. Concluding remarks institution should be able to resist calls for The history of monetary unions provides distinctive national macroeconomic some lessons to be taken into consideration. policies. Under metallic money in the gold The general implication of all these standard epoch, Europe was actually a de preceding experiences is that the political facto monetary union. The euro shares the factors play indeed a great role in characteristic of permanently fixed maintaining the currency unions. If the exchange rates with the gold standard, but political union is not yet possible in the EU, differs in the existence of ECB at its apex. at least cooperation and political unity Lacking such an institution, the gold should prevail within the EMU, otherwise standard only linked sovereign states and the economic shortcomings are difficult to was ultimately undermined by conflict be overcome. between them. When comparing the euro with the Acknowledgement American monetary unification, the major This paper is realized within the Project difference is that, while Europe wanted to “European Multilateral Research Group on integrate (inclusively in monetary terms) in the Political Economy of the EMU”, order to avoid new wars on the continent, in no. 528832-LLP-2012-GR-AJM-RE, Agreement no. 2012-2896/001-001. USA the Civil War provided the immediate reason and means for federalizing monetary Notes control. The monetary unification of Italy does not 1] Economic and Monetary Union check the findings of Frankel and Rose 2] The period 1914-1946 was excluded (1998), who demonstrate at the European because it was neither a period of the level that a monetary union create the classical gold standard nor a period conditions for its own success. The reason during which governments understood Tache, I.: Historical record of monetary unions … 169

how to manage monetary policy. find a strong positive relationship 3] In the interval 1871-1913 economic between the degree of bilateral trade growth measured a booming 4.1 intensity nand the cross-country percent the whole 42-year while correlation of business cycle activity. (according to Christina Romer’s This has important implications for the dataset, 2003). OCA criteria, that is a country is more 4] As a result of Californian and Australian likely to satisfy the criteria for entry gold discoveries of the late 1840s and into a currency union ex post than ex the 1850s, there was rapid growth in ante. mine production which was first 10] In German: “Customs Union”. leveled off and then fell back in the 1870s and 1880s before surging again with the South African and Klondike References discoveries of the 1890s. 5] The Baring Crisis or the Panic of 1890 is 1. Baldwin, R. and Wyplosz, Ch., The the nineteenth century’s most famous Economics of European Integration, sovereign debt crisis. It was Mc Grow-Hill Higher Education, 2009. precipitated by the near insolvency of 2. Bergman, M.U., “Do Monetary Unions Barings Bank in London. Barings, led Make Economic Sense? Evidence from by Edward Baring, faced bankruptcy in the Scandinavian Currency Union, November 1890 due mainly to 1873-1913”, The Scandinavian Journal excessive risk-taking on poor of Economics, 1999, 101(3), pp. 363- investments in Argentina. 377. 6] Meaning money not redeemable for a 3. Bordo, M. and Jonung, L, “The Future specific amount of gold or other of EMU: What Does the History of valuable commodity. Monetary Unions Tell Us?”, NBER 7] The Italian economies before unification Working Paper 7365, 1999, were: the Two Sicilies, Piedmont + (September), pp. 1-40. Liguria, Sardinia, Lombardy, Veneto, 4. Bordo, M., “Gold Standard”, The Parma-Modena, Papal states and Concise Encyclopedia of Economics, Tuscany. Library Economics Liberty, 2008. 8] See Foreman-Peck, J. (2005). 5. Bordo, M. and James, H., “The 9] In their influential article “The European Crisis in the Context of the Endogeneity of the Optimum Currency History of Previous Financial Crises”, Area (OCA) Criteria”, Frankel and NBER Working Paper Series, Working Rose showed that the EMU will result Paper 19112, National Bureau of in more synchronized business cycles Economic Research, Cambridge, 2013. across the participating countries, even 6. Feldstein, M, “EMU and International if it may look like a bad idea before it Conflict”, in Foreign Affairs, Volume happens. EMU will work after it takes 76, Number 6, November/December, place and because it takes place. These 1997. authors present econometric evidence 7. Foreman-Peck, J., “Lessons from suggesting strongly that as trade links Italian Monetary Unification”, Cardiff between countries strengthen, their Economics Working Papers, no. national incomes become more highly E2005/4, Cardiff University, Cardiff correlated. Using a panel of 30 years of Business School, 2005. data from 20 industrialized states, they 170 Bulletin of the Transilvania University of Braşov • Vol. 6 (55) • No. 2 - 2013 • Series V

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