Historical Record of Monetary Unions: Lessons for the European Economic and Monetary Union
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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 dollars 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 dollar. 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.