The End of the Euro

The Uneasy Future of the European Union

Johan Van Overtveldt

• Publisher: Agate B2
• Year: 2011
• ISBN:
  9781572846883
• Topic: Économie
• Subtopic: Économie internationale

From the acclaimed author of Bernanke's Test, "an essential title for any reader with investments or interest in financial instruments" ( Library Journal ). The End of the Euro begins with an overview of the birth of the euro itself. Understanding this history is essential to understand the anomalies built into the project from the beginning. These anomalies form the subject of chapter two, along with how they led to the situation that turned Greece, Portugal, and Spain into euro-destroying economic disaster areas. Chapter three shows how this was not an unforeseeable situation, as Europe's history is filled with earlier failed attempts to build monetary unions. Chapter four is focused on Germany, by far the most important country within EMU, and why the chances of Germany leaving the union are much higher than is generally assumed. The book concludes with an analysis of what lies in wait for the remains of the monetary union—and for a deeply divided and troubled continent in general. Either the EMU transforms itself fundamentally or it disintegrates. "Johan Van Overtveldt is a consistently insightful and incisive writer and I await each of his books with real anticipation." —Tyler Cowen, The Marginal Revolution blog "A whole generation of Europeans has found comfort in the idea that economic cooperation has overruled the pull of power politics and even some basic laws of economics. This book forcefully squashes that illusion. A must-read!" —Jonathan Holslag, research fellow at the Brussels Free University

Chapter 1

The long march

From conception, through gestation, birth, and into its early infancy, the euro has consistently proved the sceptics wrong. Some thought that chauvinistic voters would reject the single currency in referenda. Others doubted that all the applicants would fulfill the Maastricht deficit criterion. Still others predicted that disputes over the European Central Bank’s presidency might abort the enterprise. Yet, Economic and Monetary Union has thus far proceeded according to plan.

BRITISH HISTORIAN NIALL FERGUSON WROTE THESE words in 2001.¹² Skepticism about the chances for success of the EMU and the euro was widespread, and not only among Anglo-Saxon economists and commentators.

“It can’t happen. It’s a bad idea. It won’t last.” So the Anglo-Saxon attitude was summarized in late 2009.13 This skepticism was understandable, given past failed attempts to create a durable monetary union in Europe. A brief look at some pre-1945 initiatives, specifically the German monetary unification (which succeeded) and the Latin and Scandinivian Monetary Unions (both of which failed) illustrates the lessons to be drawn from these experiences.

Bismarck’s Power Play

In 1996, Dutch monetary historian Wim Vanthoor wrote,

Two thousand years of European history bear witness to continual attempts to convert Europe, united as it had been in terms of culture and civilization since the very beginnings of our era, into a political and economic union. Philosophers and poets alike sang the praises of a united Europe.¹⁴

Attempts at monetary unification on the European continent date as far back as ancient Greece, and the history books are rich with examples. However, a strict definition of a monetary union confines those comparisons. It must involve an agreement between two or more countries that meets at least three conditions:

1. There must either be a single currency or several currencies linked to each other at immutably fixed exchange rates.

2. Only one exchange rate may exist between the union currency and each other currency in existence.

3. All countries in the union must follow one monetary policy.¹⁵

By this definition, the oldest successful monetary union was probably the one between Massachusetts, New Hampshire, Connecticut, and Rhode Island between roughly 1650 and 1750 (although these colonies could not really be considered individual and independent states).¹⁶ Obviously, the United States is an excellent example of a successful attempt.¹⁷

In Europe, the first major successful attempt at monetary union was made in what is now Germany.¹⁸ (Similar processes took place in Italy and Switzerland, but the German example is the most relevant.¹⁹) Despite continuous attempts at political unification, by the early nineteenth century the German Federation still consisted of thirty-nine independent states, each with its own currency. With the exception of Prussia, these countries were small and far behind in terms of economic development. Political and economic leaders realized that this fragmentation hindered trade and movement. In 1838, a few years after the creation of a customs union (Zollverein) that removed most of the existing trade barriers, the members of the German Federation agreed on two monetary standards: the Thaler, used mainly by the northern states, and the Gulden, used mainly by the southern states.

A decade later, the central bank of Prussia, the Preussische Bank, took over the monetary policy for most of the states. Prussia’s monetary leadership, along with its sheer size and power, allowed it to enforce compliance on the smaller states and hold the monetary union together.²⁰ Prussia’s victory over France in 1871 gave Otto von Bismarck the authority to push through political unification, creating the German Reich.²¹ Four years later, the Preussische Bank was transformed into the Reichsbank. The German monetary system shifted to a gold standard, to which the whole German territory adhered by the start of 1876. After World War II, the Reichsbank was reshaped into the Bundesbank (sometimes affectionately called the “Buba”), the institution that became the dominant central bank in Western Europe by the 1960s.

German monetary unification largely preceded political unification. The EMU sought to follow the same process. But more than a decade after its inception, political union is not yet on the horizon. No single state in twenty-first-century Europe has had the power or ruthlessness of Bismarck’s Prussia, under whose leadership nineteenth-century Germany was already a de facto political union.

Latin Bazaar

The German experience, however, does not precisely fit our definition of a monetary union, which specifies an agreement between two or more independent countries. The German states had already formed a customs union and shared a common culture and history. Nationalistic sentiments, combined with fortunate historical circumstances and Bismarck’s determined initiative, paved the way to a politically unified Germany.

In contrast, the Latin Monetary Union (LMU), formed in August 1866, was an attempt to assemble a monetary union from a group of independent states. Led by France, the LMU initially included Belgium, Italy, and Switzerland, with Greece joining three years later. Upon the formation of the LMU, Walter Bagehot, the legendary founding editor of the renowned British weekly The Economist, claimed that “before long, all Europe, save England, will have one money.”²²

While this was certainly a visionary idea, Bagehot had based it on an unfortunate example. The LMU grew out of a monetary partnership that had already existed for several decades and used the monetary model of France. Napoleon Bonaparte’s Coinage Act of 1803 placed France on a bimetallic standard, minting both gold and silver coins. With France as their main trading and financial partner, Belgium, Italy, and Switzerland followed the same practice, and their central banks guaranteed to exchange gold and silver for coins.²³

Two developments placed strain on the bimetallic standard. First, the price of gold fell substantially in the early 1850s. Pressure on the relative prices of gold and silver naturally followed, and the divergent prices led to destabilizing flows of gold and silver. Second, the countries involved began minting coins of varying metal content, mostly because of the price divergences. The LMU’s main purpose was to establish uniform coinage standards, thus paving the way for a larger economic area, where gold and silver coins could circulate freely.

There was much more to the LMU than simply a desire for better monetary arrangements. In 1867, the French government organized an international conference designed to persuade the prominent countries in the world economy to accept the bimetallic standard—and nothing came of it. According to Vanthoor, France considered the LMU “the nucleus of an international monetary system centering on the double standard…. The French government fervently advocated the double standard, hoping, among other things, to expand its economic and political power beyond its borders.”²⁴ France’s defeat in the Franco–Prussian War was a major blow to the country’s international ambitions.

The fact that the participating countries never established a common monetary standard was the downfall of the LMU. Each country kept its own central bank. Under these conditions, the obligation for each central bank to accept the other countries’ coins at par and without limit regularly destabilized capital flows. Another issue was “the insufficient convergence of the policies conducted by the member states. As a result, the country abiding by the rules most stringently was inevitably flooded by speculative capital flowing from member states whose currencies felt the pressure of their expansionary spending policies.”²⁵ During World War I, the spending policies of the LMU countries diverged even more, and some members opted for large-scale money creation to finance that spending. Currency depreciation inevitably followed. Although the LMU ended formally in 1927, it had essentially failed during World War I.

Scandinavian Failure

The Scandinavian Monetary Union (SMU) followed a similar trajectory.²⁶ Sweden and Denmark formally entered into a monetary union in 1872, and Norway joined in 1875. The ultimate intention of these already closely related countries was to form a political and economic union, and the nations believed stable monetary relations were a prerequisite.²⁷ The three countries already adhered to the silver standard and accepted each other’s coins and banknotes, which simplified the process. It was feared that the newly formed German state’s choice of a gold standard would lead to a substantial decline in the value of silver.

The SMU fixed the exchange rates of the Swedish crown, the Danish crown, and the Norwegian crown in terms a specific amount of gold. Leaving the silver standard behind allowed the SMU to avoid the bimetallism problems that had handicapped the LMU.

The Scandinavian nations exhibited considerable discipline in adhering to the rules upon which they had agreed. Monetary cooperation between the three central banks allowed the SMU to function smoothly during the first three decades of its existence. By the end of the nineteenth century, banks in each country accepted the other members’ banknotes at par, and the monetary union was considered complete.

However, problems began to surface in 1905, when Norway demanded full political independence from Sweden, and Denmark’s more restrictive policies attracted capital flows from the two other SMU members. Ultimately, World War I proved lethal to the SMU. Pressed by the circumstances of the war, each country gradually created its own monetary and budgetary policies.

By the end of 1915, Sweden had terminated the parity agreement with Denmark and Norway. Large amounts of gold flowing into the Scandinavian countries accelerated the disintegration of the monetary union. In 1924, the member countries agreed that the coins of each country were no longer legal tender in the partner countries—essentially ending the SMU (the official end came six years later, when the three countries left the gold standard).

The failure of the SMU holds important lessons for a modern-day monetary union in Europe. The Scandinavian countries were already integrated politically, economically, culturally, and monetarily when they started a full monetary union. Despite the fact that they started off with a fairly united front, their independent political authorities created monetary and budgetary policies that proved incompatible with the union. Much like the LMU, the SMU was undone by a lack of binding, enforceable agreements and mechanisms to coordinate monetary policy and economic policy in general. The twin failures of the SMU and the LMU prove that a durable monetary union is hard to achieve without parallel movement toward political union.

Between politically sovereign states, Vanthoor remarked, “monetary union is only sustainable and irreversible if it is embedded in a political union, in which competences beyond the monetary sphere are also transferred to a supranational body…. The will to adjust was limited or non-existent, due to the fact that there was no political structure enforcing such a will.”²⁸

In the early 1990s, Marcus Lusser, who at that time was governor of the Swiss National Bank, made a similar argument:

Probably, those historical monetary unions could have survived if there had been a system of financial compensation (Finanzausgleich) among the participating countries. However, such a compensation system requires a degree of political solidarity that can only be reached within a political union.²⁹

In a similar vein, economic historian Michael Bordo refers to

a key difference between the success rates of national monetary unions like the United States, Canada, Germany, and Italy compared with international monetary unions like the Scandinavian Monetary Union and the Latin Monetary Union. The key reasons for this outcome were the force of political will and greater economic integration. In case of national monetary unions, monetary integration was an integral part of the process of creating a nation state.³⁰

Monetary integration attempts in Europe were halted between 1914 and 1945 by two devastating wars, both of which were fought largely on European soil, and an interbellum period of uncertainty and turmoil. The Roaring Twenties led almost overnight to the agony and misery of the Great Depression, and during the same period, Hitler’s rise to power in Germany provoked a human catastrophe without precedent. When World War II ended, European leaders were determined to prevent these events from ever happening again.

The Road to Rome

To prevent future catastrophes on European soil, the continent’s leaders needed to end the struggle for dominance between Germany and France. British Prime Minister Winston Churchill declared in September 1946 that “a kind of United States of Europe” was absolutely necessary to prevent new wars.³¹

The U.S. also pushed for greater unity among the Western European countries, in part to create a significant counterweight to the communist bloc Stalin had formed in the east...

Table of contents

• Cover
• Title Page
• Copyright
• Table of Contents
• Foreword
• Introduction
• Chapter 1: The Long March
• Chapter 2: Unfinished Business
• Chapter 3: From Hero to (Almost) Zero
• Chapter 4: The Endgame (It’s All in Germany’s Hands Now)
• Epilogue
• Acknowledgments
• Bibliography
• Endnotes
• Index