Changing the rules in a monetary union in historical perspective: the Latin Monetary Union and EMU
Luca EinaudiJoint Center for History and Economics
University of Cambridge and Harvard University
15 December 2010 Trinity Hall
Coin projects, from the Latin Monetary Union to the Euro
1808-14 French Empire and satellites
No central bank nor paper money.
Based on the bimetallic franc, one to one exchange rate with lira and frank.
1838-71 Münzverein, Germanic Monetary Union
No central bank, decentralised issue of paper currency not in the convention.
Common thaler of the north, with a 1 to 1,75 fixed exchange rate with the southern gulden. Silver standard.
1865-1926 Latin Monetary Union
Bank notes not included. Central role of the Bank of France remains informal and not neutral.
Multiple currencies with a fixed 1 to 1 exchange rate.. Initially bimetallic, evolved towards gold.
1872-1931 Scandinavian Monetary Union
No common central bank but intense cooperation. Bank notes in the union from 1901.
Single currency (crown) minted nationally, gold standard but with a dominant paper circulation.
1999-? European Monetary Union
European Central Bank controls monetary policy and all monetary issue.
Common and single currency. Coordination of fiscal policies (stability and growth pact).
Supranational Monetary Unions in Europe
National monetary unifications following political unification
Country Central banks, paper currency and other characters
1850 Switzerland (after a civil war)
Introduction of a single common currency but with several banks of issue and no central bank until 1907.
1862 Italy (after unification)
Banca Nazionale nel Regno d'Italia in 1861, transformed into Bank of Italy in 1893. Bank notes issued by six different private banks of issue.
1871 German Empire(after Unification)
The Prussian Bank became the Reichsbank in 1876 and centralised bank notes issue. German states within the Empire retained the right to issue coinage.
1919 Kingdom of Yugoslavia (after creation)
In 1920 the National Bank of Serbia became the National Bank of Yugoslavia, using the Serbian dinar as common currency. Entirely unified currency and coinage.
1919 Poland(after independence)
The new Polish mark, linked to the German mark was destroyed by hyperinflation in 1924, while francs and dollars constituted the real currency. The Bank of Poland was created in 1924 together with the zloty, equal to a French gold franc.
1990 Germany(after reunification)
The Bundesbank extended its functions as central bank to the new Länders. One to one exchange rate decided at political level.
200 years of oscillation between fixed and flexible exchange rates in Europe
Post 1815 Fixed Various metallic standards.
1848 Fixed, some Flex Economic crisis and revolutions bring inconvertibility in some countries
1865 Fixed Creation of the Bimetallic Latin Monetary Union
1866 Fixed, some Flex Italy, Austria, Greece, Papal states on inconvertible paper currencies
1873 Fixed Germany and US adopt gold standard, LMU suspends minting of silver
1890's Fixed, some Flex Depression and suspension of convertibility of banknotes in peripheral
Early 1900's Fixed Resumption of gold standard
1914-27 Flexible WWI and post war: Gold standard suspended
Mid 1920's Fixed Return to the Gold standard
1930's FlexibleGreat Depression. Leave Gold standard and devalue: UK and Germany in 1931, US in 1933, France and Italy in 1936
1944 Fixed Bretton Woods system
1971-73 Flexible End of dollar/gold exchange standard
1979 Partial. fixed European Monetary System (EMS), fixed readj. exchange rates
1992 Flexible EMS crisis, UK, Italy and Spain leave, others enlarge fluctuation
1999 Fixed Adoption of the Euro and Economic and Monetary Union (EMU)
2011 ???? ????
The Latin Monetary Union
Formed in 1865 between France, Italy, Belgium and Switzerland, to resolve problems of monetary circulation of silver coinage between neighboring countries in a bimetallic system (gold and silver). Include a limit of issue for depreciated silver coinage to 6 francs per inhabitant. It was aCoinage union with maintained existing national coins with different names (francs, lire and drachme) and a 1 to 1 fixed exchange rate, based on the intrinsic gold and silver content of the coins, recoining all those not in lie with the new common system.
Became also an attempt to create a European or a Universal currency through the injection of federalist ideas by the chief French negotiator and of French political ambition.
Clash between supporters of the gold standard and bimetallism hampered the LMU.
French poster of the 1880’s depicting which coins could be accepted in
France as part of the LMU.
Enlarging the Monetary Union
The French attempted to enlarge the Monetary Union by inviting all European countries and some other world powers to the 1867 International Monetary Conference of Paris, inviting candidacies on the basis of an international gold standard and the LMU-franc type of coinage.
Felix Esquirou de Parieu’s project for a “Europa” currency, a European federation, a European Union and a European parliament.
British reluctance and the conversion to Union of Gladstone’s Chancellor of the Exchequer in 1869, caused a heated debate.
Southern German favoured monetary union as a part of a strategy to resist Prussian expansionism.
Private Bankers and National banks of Issue opposed monetary unification.
The refusal of the French Treasury and Banks to abandon bimetallism destroyed the opportunity to involve the UK. The Franco-Prussian war on 1870-71 led to the creation of the German mark and to the collapse of possible extensions of monetary union.
See Einaudi Luca, ‘From the Franc to the “Europe”: Great Britain, Germany and the Attempted Transformation of
the Latin Monetary Union into a European Monetary Union (1865-73)’, Economic History Review, May 2000.
The Italians, the Pope and the Greeks
• Italian budget deficit and inconvertible paper currency from 1866 (because of a war with Austria) was followed by new forms of monetary issue not included in the Monetary Convention (paper, bronze coinage). Caused flight of Italian currency to France and Switzerland, preventing them from minting their full share of coinage. Generated tension in the LMU, but was ultimately resolved reinforcing the rules on new issues.
• Papal monetary scams: The Papal State applied to join, obtained temporary authorization to issue coinage accepted in France and then over-issued by 10 to 1, ultimately declining to join and to take back its currency which had migrated to France. The Papal State was pushed out of the LMU system.
•The problems encountered in managing the LMU convinced the strongest members of the Union to block further enlargements (refusing all other applications for membership, coming mainly from southern or central Europe and the Balkans and from Latin America) and to restrict the field of action of the LMU for the future, not extending it to paper money, as the Scandinavian Monetary Union did instead.
•After the adoption of the gold standard by Germany and the US in 1873, the price of gold started declining, the LMU suspended its new silver issues to prevent speculation and to avoid receiving demonetized German silver. New rules had to be set within the monetary union to manage the exist from bimetallism, initially on a provisional basis and then permanent.
•Greek wars for national unification and financial weaknesses led to inconvertible paper currency in 1869 and from 1877 to 1910 and debt default in 1893. This, together with sale of Greek coins at a discount in Paris (by private bankers), determined foreign control of part of Greek monetary issue from 1869, and to limitations to Greek membership of LMU.
The effect of the union on the reserves of the informal central bank of the LMU: Composition of the metallic reserves of the Bank of France
1850-77, (millions of francs)
0
500
1000
1500
2000
2500
1850
1852
1854
1856
1858
1860
1862
1864
1866
1868
1870
1872
1874
1876
Foreign coins
French silver
French gold
Source: Willis, History of the Latin Monetary Union, 90.
Managing the Union: how to change the rules during the game
The initial rules proved insufficient:1) Limits of issue of debased coinage and exchange of information on annual
monetary issue to control the respect of limits;2) The rules were incomplete, the transmission of information not credible and
political/ military disruption created financial instability
New rules emerged through an iterative process of pressure by the strongest economies on the weakest, restricting progressively the scope of the Union
1) Extend limits of issue to other forms of fiduciary money (small change paper money from late 1860’s and silver écus from 1874)
2) Attributing to the strongest government (France) an absolute control over the issue of coinage in new weak members (Greece);
3) Threatening a financial penalty through the return of divisionary coinage to issuers of non convertible paper money (Italy and Greece) in exchange for gold, and then of all types of silver coinage (partilcularly on Belgium). Italy renationalised its subsidiary coinage in 1893 and Greece in 1908;
4) Neutralizing/expelling the free riders from the Union (non completion of accession process of the Pontifical State, freezing of Greek currency);
5) Refusing membership to the states which did not guarantee sound financial conditions (Spain, Austria-Hungary, Romania, San Marino and later others).
0
500
1000
1500
2000
2500
3000
3500
4000
450018
62
1864
1866
1868
1870
1872
1874
1876
1878
1880
Divisionary silver
LMU limit
Silver 5 fr.
LMU limit
Gold
Source: elaboration on mint figures in Leconte, Bréviaires des monnaies de l'Union Latine. Figures are in millions of francs and include French, Italian, Belgian, Swiss and Greek issues.
How new rules managed to curb new issues of undesired depreciated silver currency: cumulated issue of the Latin Monetary Union coinage since 1862,
leading to the establishment of the gold standard
The exchange rates of the LMU paper currencies, in Swiss francs, showing the devaluation of Italian lire and Greek drachme during periods of inconvertibility of their paper money and the collapse of the LMU through the shock of WWI and the different
stabilization levels in the 1920’s. A coinage union is not a full monetary union.
0
0,2
0,4
0,6
0,8
1
1,218
61
1865
1869
1873
1877
1881
1885
1889
1893
1897
1901
1905
1909
1913
1917
1921
1925
1929
1933
Belgian fr
French fr
Italian lira
Greek drach
Swiss fr
Source: Einaudi Luca, Money and Politics: European Monetary Unification and the International Gold Standard (1865-1873). Oxford, Oxford University Press, 2001.
The Greek default of 1893
Greece accumulated in the 1880’s substantial foreign debt to pay for military spending and modernize the country. The 1890’s brought an international economic depression, Greek exports faded also because of French protectionist policies.
Greece suspended payment on its foreign debt in 1893, when it consumed 33% of its budgetary receipts and had reached over 160% of GDP. A depreciation of the paper drachma by 60% in early 1893 also made the payment of interests prohibitive.
Initially a new international loan had been floated at 5% to help the Greek government overtake what seemed a temporary problem, but after a few months the adverse effect of declining exchange rates was the final element for bankruptcy. The Greeks announced a 70% reduction on the interest of all gold loans on a temporary basis. Negotiation with foreign bondholders started with Germany taking a hard line and France and Britain a more lenient one, but did not produce results for several years.
In 1897 Greece was defeated in a new war against the Ottoman empire and the European powers stopped the invasion in exchange for foreign control on Greek finances to satisfy bondholders. In the end Greece paid back all its debt at par in gold until the 1940’s, with interest rates barely below the original level.
(John A. Levandis, The Greek Foreign debt and the great Powers 1821-98, New York, Columbia University Press, 1944)
Source: IMF. For 2010-2015 IMF forecasts.
0
50
100
150
200
250
1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
GreeceItalyBelgiumFranceSwitzerland
Public debt in % of GDP in the countries of the LMU (1880-2015)
Greek default
What causes monetary unions to break or to consolidate?
Breaking political unity destroys the political conditions for union1. through war: Ottoman Empire (1831-1919), Russian Empire (1918),
Austro-Hungarian Empire (1919), Yugoslavia (1991-1999)2. through peaceful dissolution of the federal pact: USSR (1991),
Czechoslovakia (1993), New Yugoslavia (2008)
Major economic shocks can destroy economic conditions for union1. Economic divergence caused by WWI: Latin Monetary Union2. Great Depression: Scandinavian Monetary Union
Successful Monetary Unions ultimately consolidate in a full political unification but this is a matter of several decade or of centuries: 1. The Münzverein becomes the German Monetary Unification (mark)
after the creation of the German Empire in 1871
In the EMU today Greece is again at the centre of the debateGreek Governments manipulated official debt and deficit statistics from 1997 to 2003
in order to join the Euro area and again in 2008 and 2009.
-16
-12
-8
-4
0
1980 1985 1990 1995 2000 2005 2010 2015
3% threshold
Current estimates(IMF October 2010)
Forged figures before2009 revision (IMF)
Forged figures before2004 revision
Austerity programme
Greek budget deficit: announced and actual deficits (1980-2010) and austerity programme
2
4
6
8
10
12
01/07/2008
30/08/2008
29/10/2008
28/12/2008
26/02/2009
27/04/2009
26/06/2009
25/08/2009
24/10/2009
23/12/2009
21/02/2010
22/04/2010
21/06/2010
20/08/2010
19/10/2010
18/12/2010
Debt crisis and policy reactions , 10 years interest rates on government bonds
Lehmancollapse
Eu guarantees and recapitalization
for banksG20
Washington summit
G20 London Summit
G20 Pittsbugh
summit
Greece reveals figures forgery
Eurozone promises help to Greece
Eu-IMF commit 45 bil €,
then 110, then 750 Greece
Portugal
USA
Italy
Ireland
Spain
USA Germany
Eu-IMF Irish loan
The Greek debt crisis has shattered interest rate convergence within EMU and has started a process of contagion, forcing continuous changes of rules not unlike what happened to the LMU (end of the no bailout clause, creation of the European Financial Stability Facility, ECB bond acquisition programs, increased Eurostat monitoring)
Managing the Union: how to change the rules during the game
The Greek crisis highlights again the persistent difficulty in:• Harmonizing national economic policies, especially fiscal policies• Monitoring effectively implementation of commitments inside the union• Changing the rules while the game is being played• Sharing the costs of intervention of support
The initial EMU rules were set to prevent inflation and unbalanced public finances:
1. Monetary policy, interest rate setting in the hand of an independent European Central Bank whose only objective is price stability. No possibility of monetization of fiscal deficits by Governments, no shared responsibility for other member countries’ debt, no common fiscal policy.
2. Irreversible membership, no rules set to leave the Union, no expulsion mechanism.
3. Tough entry criteria: Maastricht Treaty criteria (1993) on deficit, debt, inflation, interest rates and exchange rate as prerequisite to become members.
4. “Stability pact” demanded by Germany (1997), “and growth”, demanded by France. Excessive deficit procedure. Punishment in cash for countries exceeding 3% deficit over protracted time, never implemented.
The attempt to create new rules
Today the EMU faces the need to rewrite part of the rules and it is doing so like the LMU through an attempt by the strongest members (Germany in particular) to impose more stringent budgetary rules in exchange for support for the weakest. As in the LMU reform is slow, it will be continuous and certainly not a one off.
The strongest country tries to impose fiscal and monetary discipline on the weakest and least disciplined members by demanding tougher rules and controls, ultimately threatening implicitly to withdraw from the monetary union.
The first Revision of the Stability pact weakened it (2005), following German and French requests while they exceeded 3% deficit.
Now Germany is pushing to harden the Stability Pact (2010), as a reaction to the Greek crisis. Germany has also proposed in turn
• The creation of a European Monetary Fund as part of a structural European framework for crisis prevention, management, and resolution.• The introduction of the possibility to expel repeated offenders or to deprive them of
voting rights in the European council• Proposals for European economic government (or governance) or stronger policy
coordination to avoid the creation of large imbalances.• New rules to secure from 2013 a private involvement in resolution of sovereign
debt default.
