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The euro has parents in history - it is far from being the first monetary integration attempt that Europe has seen. Others have been tried and have failed before. The euro’s predecessors can be found in the time of the first globalisation, from the second half of the 19th century on. The Latin and the Scandinavian Monetary Unions are two of them. If any conclusions can be derived from history, the prospects for the Euro seem fatal.

Euros_parents_n
Photo: joexx / photocase.com
If monetary unions were human beings, this is what the euro's parents from history might look like today.

Scandinavian Monetary Union (1873-1920)

In 1873, Denmark, Norway and Sweden founded the Scandinavian Monetary Union, agreeing to bind their currencies to gold at a certain rate. In effect, as all currencies had the same base, you could exchange your Swedish Riksdaler, your Danish Rigsdaler, or your Norwegian Speciadaler at a fixed rate to the newly-created common currency krona. However, there was no common gold coin: every country minted their own krona. In that regard, it is just like the euro.

The monetary union tied the countries closer together, not only because of the shared fixed exchange rates but also because the central banks accepted each other's drafts at the same value as if it was handed in at the bank that originally issued it. At that time, drafts were the way to transfer money between two people or two businesses, with the help of a bank in the middle. So the three central banks acted as one bank.

A union based on gold

These close ties, the gold standard and mutual acceptance of the drafts were the hallmarks of the Scandinavian Monetary Union. With the outbreak of World War I, however, the gold standard was abandoned. The states ceased to guarantee that they would back their currency with a certain amount of gold in their banks, and the limit on money in circulation was removed. The states could now issue more notes than they had gold in exchange for them. In the 1970s this led to the collapse of the post-World War II Bretton-Woods global monetary system; in the 1920s this led to the end of the Scandinavian Monetary Union.

Sticking to the status quo, the states were reluctant to change the official exchange rates.

Money trafficking for arbitrage

Danish 2 rigsdaler reverse
Photo: Recent coinage in the world / wikimedia
The reverse of a Danish two Rigsdaler coin from 1868. In the Scandinavian Currency Union it was worth 4 krona.

The idea behind abandoning the gold standard was to give the governments more leeway in their spending. Denmark and Norway borrowed money by heavily increasing the amount of krona in circulation compared to prudent Sweden. Due to these diverging monetary policies, the national krona currencies were not considered to be equally valuable any more. So for one Swedish krona you could in fact buy more than for one Norwegian krona. However, sticking to the status quo, the states were reluctant to change the official exchange rates. So clever people took their less valuable Norwegian and Danish gold coins and brought them over the border to the Swedish central bank to convert them into Swedish notes. The Swedish bank, however, had to buy the foreign coins according to the official conversion rate, and the Norwegian and Danish Krona were officially still at par with the Swedish. Hence the Swedish central bank constantly lost money. There were two possibilities: either avoiding this trading by limiting the free flow of gold coins over the borders or by abandoning the officially equal currency rates.

The ineffective gold embargo

In several meetings with the other central banks, the Swedish nagged their colleagues to restrict the trading of minted gold. Otherwise they threatened to quit the Union unilaterally. They succeeded and such a gold embargo was established. However, clever smugglers still systematically and illegally imported foreign gold coins to Sweden to convert them. Eventually, in the early 1920s, the fixed exchange rates between the countries were abandoned. Hence, due to pressure from Sweden, who regularly had to pay for the lax monetary policies of its partners, the common currency ceased to exist.

Next page: Why France is jealous of the UK and how they created a union that was doomed to fail.


5 Franc coin Napoleon III 1868 front5 Franc coin Napoleon III 1868 back
Photo: wikipedia (CC-SA)
The French 5 franc coin from 1868, featuring the main creator of the Latin Monetary Union, Napoleon III, on the front.

Latin Monetary Union (1865 - 1926)

An even larger and earlier monetary Union was the Latin Monetary Union. The key country behind it was politically dominant but economically weak France, which was governed as the Second French Empire since 1852 by Napoleon III. While the industrial revolution roared in the net-exporters Switzerland and Belgium, the French economy looked rather weak, with their imports for years regularly outnumbering their exports, according to the German economist Theresia Theurl.

Economic integration as the remedy for French jealousy

Hence, the French peered over the channel to England with fascination and jealousy. They regarded the City of London as financially dominating the world by lending money to Chile, Peru, Austria, Spain, Turkey and Portugal. France hoped to imitate this libéralisme d’argent (monetary freedom) at the Paris Bourse. But besides all these French power aspirations, the creation of the Latin Union was a result of trade integration, the free trade movement prevalent at that time, and France's large capital supplies. It was founded in 1865 by France, Belgium, Italy and Switzerland. In 1868, Greece joined the Union, together with Spain, three years after it was founded. Just like with the euro, which Greece joined in 2002 instead of 1999.

When the states faced a dilemma between Union or national interest, they pursued their national interest.

Denying the Pope accession

The Union was regulated by a treaty. It provided strict ‘criteria’ according to which the states were only allowed to mint a certain number of coins. This amount had to correspond to the reserves of gold and silver possessed by the central banks. Every participating state had informational duties to report the activities of its national mint. And especially during the admission of new members, these criteria were carefully monitored. The Papal States, predecessors of the Vatican, were ejected from the Union, because they minted six times as many coins as they were allowed to.

Doomed to fail

The Union never really worked, however; it disintegrated over time. When the states faced a dilemma between the Union and national interest, they pursued their national interest. Sanction or control mechanisms were not present, the treaty was incomplete and the provisions were subject to unilateral interpretation. Each read the treaty to their own advantage.

Trading on Europe markets
Photo: Max Strohmeier
Lubricating trade, or lowering transaction costs, as economists put it, was the intention behind the Latin Monetary Union, as it was for most currency unions.

Already in the late 1860s, when Italy was engaged in a costly war with Austria, it took up a credit from its Banca Nazionale, freeing her in return from her obligation to back the currency with gold. This led to a similar result as in the Scandinavian Monetary Union: the value of the Italian money in the Union dropped. Also, at other occasions, the countries showed diverging monetary policies at the expense of more prudent participants. The treaty left it open as to whether this was forbidden or not. France followed with similar behaviour during the war against Germany from 1870 on. The Union's continued existence seemed doomed to fail. In practical terms it ended much earlier, before World War I, and was only shut down on paper in 1926.

Next page: Why the euro is different in important aspects.


Lessons from history?

So will the euro suffer the same fate as his parents? Two insights can be derived from this history: first, once the metallic bases of the currencies were abandoned, the unions faced their decline. And second, if there was a chance for the national governments to depart from the sometimes unclear rules for their own advantage, they usually did so. So the prospects for their son seem bad.

Countries acting in the national interest at the expense of others in the Union, a treaty open to bold interpretation, and the fact that economic heterogeneity put the past unions constantly under stress – these factors seem to suggest a dim outlook for the euro, if he has inherited such genes from his parents.

Empty Blackboard
Photo: view7 / photocase.com
States pursue their national interest. This is the main lesson to be learned. But how to tame this and how to foster fiscally prudent behaviour to keep the Euro alive, remains unclear.

But the son is also very different from the parents: conclusions that could be drawn are very limited, because the nature of money was different at that time. Furthermore, the mints were under full control of the national rulers, which is also not the case for the European Central Bank. And, unlike in the Eurozone, there were no mechanisms present to sanction and effectively coordinate the past Unions. Finally, the euro was not born out of economic efficiency reasons, as his parents were, but out of political commitments. As long as these commitments last, with its implications to act in interest of the Union, the euro might evade the grim developments suffered by his parents.

References

Michael Bergmann, Stefan Gerlach and Lars Jonung „The rise and fall of the Scandinavian Currency Union 1873-1920“; European Economic Review 37.

Marc Flandreau „The economics and politics of monetary unions: a reassessment of the Latin Monetary Union, 1865–71“; Financial History Review 7.

Theresia Theurl „Eine gemeinsame Währung für Europa – 12 Lehren aus der Geschichte“; Österreichischer Studien Verlag 1992.

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