Endgame for the Euro

A Critical History

B. Lucarelli

• Publisher: Palgrave Pivot
• Year: 2013
• ISBN:
  9781137371904
• Topic: Economics
• Subtopic: Macroeconomics
• Index: Economics

This text develops an original critical analysis of the origins and evolution of the euro and the current debt crisis that envelops the euro-zone. It provides a comprehensive critical historical narrative of the evolution of European Monetary Union (EMU). The history of the euro, culminating in the Maastricht blueprint in 1992, reveals that this deeply flawed monetary edifice was informed by the prevailing neoliberal/monetarist economic doctrines, favoured by Germany. The final blueprint witnessed the birth of an international currency which was devoid of a coherent sovereign power. The author's critique is informed by post-Keynesian theories of endogenous money. Lucarelli provides an essential contribution to the critique of the existing economic theories that continue to inform the evolution of the euro. In the absence of political union and a corresponding fiscal framework, the survival of the euro remains problematic. The imposition of harsh, neoliberal, austerity measures by the IMF/EU/ECB (Troika) on Europe's peripheral, deficit countries threaten the very existence of the euro-zone in its present form, and have set in motion powerful centrifugal forces, which could ultimately derail the entire post-war European project.

1

Origins of the Single Currency

Abstract: The European desire to establish a “zone of monetary stability” has its origins in the wake of the international turmoil that accompanied the collapse of the post-war Bretton Woods agreements and the ensuing dollar crises during 1968–73. It was in this historical context and the threat posed to the Common Agricultural Policy (CAP) by gyrating intra-EEC exchange rates that the earliest proposals were formulated to insulate the Common Market from the instability generated by the dollar crisis and US inflationary policies. Indeed, then French President Charles de Gaulle had been one of the most indefatigable critics of what was described as the “exorbitant” privileges of US dollar seigniorage. This chapter will examine these earlier proposals towards European Monetary Union and the divergent Franco-German strategies, which were reflected in the contending blueprints for EMU.¹

Lucarelli, Bill. Endgame for the Euro: A Critical History. Basingtoke: Palgrave Macmillan, 2013. DOI: 10.1057/9781137371904.

The dollar crisis, 1968–73

The demise of the international monetary system under the aegis of the Bretton Woods agreements was a seminal event in the early experiments towards European Monetary Union. With the collapse of the fixed exchange rate system governed by gold/dollar convertibility, international confidence in the dollar evaporated, which hastened an international exchange rate crisis. In stark contrast to the dollar shortage of the early post-war years, the US dollar had flooded world markets by the late 1960s. This enormous expansion of international liquidity was accentuated by the permissive financing of the Vietnam War as the US Treasury resorted to the printing press (Block, 1977). It was the emergence of US balance of payments deficits, however, that ultimately caused a loss of confidence in the US dollar/gold convertibility regime. This flight from the dollar led to a serious drain on US gold reserves, which declined from an estimated $23bn in 1950 to about $12bn in 1967. At the same time, official and private foreign dollar holdings increased from $15.1bn in 1957 to $31.5bn in 1968 (Gilpin, 1975a, p.58). The culmination of the gold drain and the loss of confidence in gold-dollar convertibility induced an unprecedented rise in the demand and market price for gold that eventually led to the demise of post-war Bretton Woods agreements. US seigniorage of the dollar had been accepted by foreign economic agents as long as it fostered the expansion of international trade. Yet the cohesion and stability of the fixed exchange rate system was ultimately dependent upon the ability and willingness of US authorities to act as a world central banker. As soon as their liabilities in the issuing of US dollars were no longer regarded as “good as gold”, the “solvency” of the US monetary authorities in their role as world bankers was imperilled (Guerrieri and Padoan, 1986). In short, the success of the system was too highly dependent upon the capacity and willingness of the US monetary authorities to defend gold/dollar convertibility.

The relative decline of American industrial productivity and international competitiveness during the post-war era contributed to the erosion of the US role as reserve currency nation. Close analogies with the demise of the gold standard under the aegis of Pax Britannica can be drawn. Just as the decline of Britain’s relative economic power had prefigured the dissolution of the gold standard, so too the relative decline of US economic power undermined its role as international central banker under the Bretton Woods system. Between 1950 and 1971, US productivity growth had fallen behind the European Economic Community (EEC) by 35 per cent and Japan by as much as 60 per cent. During the same period, average annual productivity growth in the US was estimated at only 1.7 per cent, compared to 4.5 per cent in the EEC and 10.6 per cent in Japan (Kaldor, 1978, p.64). After the demise of the Bretton Woods system, successive US governments pursued a policy of “benign neglect”, which allowed the dollar to progressively devalue (Parboni, 1981). It was assumed that successive dollar devaluations would contribute to the restoration of US international competitiveness. Dollar devaluations, however, tended to impart inflationary impulses transmitted through the expansion of international liquidity.

Under the fixed exchange rate system, only one country can set its monetary and exchange rate policies independently of all other countries. In the monetary literature this is defined as the N-th country paradox. If one assumes that a group of countries are governed by a fixed exchange rate regime, only country N is theoretically able to fix its exchange rate in relation to countries N–1. The N-th country therefore performs an anchor role or reference point in an asymmetrical system to which all of the other countries are compelled to align themselves. Under the former Bretton Woods system, the US economy performed this dominant anchor role (Moon, 1982). In the monetary sphere, this privileged position manifests itself in the financial gains accrued through seigniorage. Despite the demise of the fixed exchange rate regime, the US dollar continued to perform the role of international means of payments and reserve asset. Indeed, the US was no longer constrained by its obligations to accumulate gold reserves in order to defend gold/dollar convertibility. It was now possible for the US monetary authorities to pursue reflationary policies and dollar devaluations in order to restore their international competitiveness (Parboni, 1981). The relatively small tradeable sector of the US economy as measured as a share of GDP implied that successive devaluations of the dollar were more inflationary overseas than within the domestic economy. The US economy was therefore capable of “exporting” inflation through an increase in international liquidity. Its major industrial rivals were more vulnerable to the inflationary consequences of US expansionary domestic policies.

In Western Europe, these inflationary US policies had an adverse impact, while the demise of the gold/dollar convertibility regime generated speculative capital flows and exchange rate instability. It was in this volatile environment that General de Gaulle demanded a return to the gold standard. West Germany and Japan, however, were willing to finance the US balance of payments deficits in order to preserve the Western military alliance (Gilpin, 1975b, p.154). But as the dollar crisis intensified, exchange rate volatility within the Community threatened further progress towards closer economic union. Exchange rate convergence became necessary to prevent a general drift towards intra-EEC competitive devaluations and economic nationalism. The dollar crisis thus spurred European leaders to construct a zone of monetary stability across the Atlantic (Kruse, 1980).

The exponential growth of the private Eurodollar market was the most visible manifestation of this unregulated expansion of international liquidity and credit creation (Aglietta, 1982). After the demise of the gold/dollar regime, demand for liquidity increased as both international firms and central banks resorted to the Eurodollar market as a source of credit. The origins of this market can be traced back to the Kennedy administration in which the US Federal Reserve Bank had imposed limits on interest rates to deposits within the domestic economy (Kindleberger, 1984, p.445). With the restoration of currency convertibility in 1958, financial institutions in Europe could purchase US bonds and securities and engage in foreign exchange transactions. Since investors could earn a higher rate of return by transferring their funds from the US to the Eurodollar market, the growth of the latter was set in motion. The magnitude of this flight of capital was reflected in the expansion of US banks operating abroad; by 1972 there were 107 banks with total assets exceeding $80bn. Two years later, this figure had increased to an estimated $140bn or equivalent to one-fifth of the value of the US national product (Mayer, 1974, p.437). Most of the transactions of the Eurodollar market occurred in the London branches of US banks who would issue “certificates of deposits” against the payment of their dollar liabilities in the US. Since US banks retained possession of dollars deposited abroad, the growth of lending in US dollars by international financial agents generated a multiplier effect and increased the volume of international liquidity. The Eurodollar market therefore acted as a transmission mechanism in the expansion of international liquidity and contributed to the inflationary upsurge of the 1970s.

The “Triffin dilemma” as it became known essentially states that in order to supply the international economy with US dollars, the United States itself would be obliged to run burgeoning balance of payments deficits to avoid a drain on international liquidity. But the very growth of these US deficits would ultimately undermine the international status of the US dollar and provoke a series of crises. This contradiction would set in motion cycles of expansion and contraction of international liquidity and generate systemic instability (Triffin, 1961). The continued benefits enjoyed by the US monetary authorities as a result of dollar seigniorage suggests that the US dollar continues to perform the pre-eminent role as an international means of payments and reserve asset. The “Triffin dilemma” was therefore writ large. In the post-Bretton Woods era of the floating dollar standard, the US financial system has evolved from being simply the issuer of the reserve currency to the principal issuer of interest-bearing, short-term liabilities to the rest of the world. Indeed, the existing international monetary system is quite unique because international “money” ceases to have a standard unit of value, analogous to the dollar/gold convertibility system or the nineteenth-century gold standard regime under the aegis of Pax Britannica. In the absence of an objective standard of value, currencies possess only “fiat” values, which are governed by future expectations under the guise of hedging and speculative operations performed by the foreign exchange and derivatives markets (Lucarelli, 2011). In the event of a credit crunch, the US dollar assumes its role as an international safe haven and reserve asset.

Consequently, the entire pyramid of credit was no longer governed by the regime of regulation based upon gold/dollar convertibility. A more laissez faire system had emerged governed by what was euphemistically described as the “paper dollar” standard. Despite the demise of the Bretton Woods system, the US balance of payments and domestic US interest rates continued to act as the unofficial pivot by which international liquidity was likely to behave. This dynamic depends quite critically on the continuation of the strategic role performed by the US dollar in international trade and payments. In the absence of the regulatory function performed by a fixed exchange rate regime, international liquidity is governed by the foreign exchange markets in derivatives and futures. The cessation of gold/dollar convertibility did not necessarily imply the demise of the strategic internat...

Table of contents

• Cover
• Title
• Introduction
• 1  Origins of the Single Currency
• 2  EMU: The First Experiment
• 3  The European Monetary System, 197987
• 4  The German Ascendancy
• 5  Project 1992
• 6  The Maastricht Blueprint for EMU
• 7  The European Debt Crisis
• 8  The Break-Up of the Eurozone?
• Conclusion
• Bibliography
• Index