Making the European Monetary Union

Harold James

• Publisher: Belknap Press
• Year: 2012
• ISBN:
  9780674070943
• Topic: Économie
• Subtopic: Politique monétaire

Europe's financial crisis cannot be blamed on the Euro, Harold James contends in this probing exploration of the whys, whens, whos, and what-ifs of European monetary union. The current crisis goes deeper, to a series of problems that were debated but not resolved at the time of the Euro's invention.Since the 1960s, Europeans had been looking for a way to address two conundrums simultaneously: the dollar's privileged position in the international monetary system, and Germany's persistent current account surpluses in Europe. The Euro was created under a politically independent central bank to meet the primary goal of price stability. But while the monetary side of union was clearly conceived, other prerequisites of stability were beyond the reach of technocratic central bankers. Issues such as fiscal rules and Europe-wide banking supervision and regulation were thoroughly discussed during planning in the late 1980s and 1990s, but remained in the hands of member states. That omission proved to be a cause of crisis decades later.Here is an account that helps readers understand the European monetary crisis in depth, by tracing behind-the-scenes negotiations using an array of sources unavailable until now, notably from the European Community's Committee of Central Bank Governors and the Delors Committee of 1988–89, which set out the plan for how Europe could reach its goal of monetary union. As this foundational study makes clear, it was the constant friction between politicians and technocrats that shaped the Euro. And, Euro or no Euro, this clash will continue into the future.

1

A Napoleonic Prelude

The sixties were a wild decade. Communications improved, fiery musicians drove a culture revolution, reformers wanted to clear away odd relics of the past, the United States was involved in a bloody war of ideologies, and Europeans wanted a new money and began to negotiate over new institutional ways of providing it. Which century? Both the 1860s and 1960s were revolutionary.

History repeats itself. But in odd ways. In the middle of the nineteenth century, the world was galvanized by the transatlantic cable and the ubiquitous railroad, by Verdi’s and Wagner’s music, by the reforms of Bismarck, Cavour, Gladstone, and Lincoln. Questions of European monetary unification and a simplification of the world’s money were intimately linked, and Emperor Napoleon III provided a solution. He and his advisers had already pushed through the Latin Monetary Union, by which the coinage systems of France, Belgium, Switzerland, and Italy were homogenized, with a standard franc or lira coin of a standard weight and purity of silver that would circulate freely in the member countries of the currency union. The 1867 World Monetary Conference, held in Paris, went substantially further in its ambitions. Only a very slight alteration of parities would be required to bring into line France and Great Britain, as well as the United States, which was just recovering from the massively costly and destructive Civil War. France was on a bimetallic standard, its coinage set in terms of both gold and silver weights; Britain was on a pure gold standard; and the United States was considering a return to a stable currency based on metal.1

It would be relatively easy to change the weights of coins so as to create an equivalent of five francs to one dollar, and of five dollars or twenty-five francs to a British pound. The new gold coin would contain 112.008 grains of gold, while the existing British sovereign contained 113.001. Britain would thus need to undertake a slight devaluation in order to make the British coinage fit into the new system. Predictably, after some debate, Parliament was unwilling to take this step, which critics would have interpreted as a (small-scale) robbery of the holders of debt denominated in pounds.

The leading British monetary commentator, the editor of The Economist, Walter Bagehot, wrote enthusiastically about the new proposals. In his view, monetary unification would require France to give up a theoretically unsustainable bimetallic base, while Britain would have to give up the odd coinage of twenty shillings to a pound and twelve pence to the shilling. Decimalization would have provided a rational answer to Britain’s monetary arithmetic. Readers of Anthony Trollope’s Palliser novels encountered a political hero, Plantagenet Palliser, whose major political obsession was currency decimalization.

Bagehot gave another perspective on monetary simplification. Money, he argued, should not be seen as the creation of the state:

We commonly think, I believe, that the coining of money is an economic function of government; that the Government verifies the quality and quantity of metal in the coin out of regard to the good of its subjects, and that Government is admirably suited to this task—that it is a very reliable verifier. But in truth, if we look at the real motives of governments, and the real action of governments, we may come to think otherwise. The prevalent notion about coinage is not an economic but a mystic notion. It is thought to be an inalienable part of sovereignty; people fancy that no one but a government can coin—that it is nearly a contradiction that anyone else should coin. A superstition follows the act. Coining is called a “natural” function of government, as if nature would not permit a government without it.2

Bagehot thought it much better to conceive of money as serving the needs of commerce (and of the people more generally) rather than the interests of the state and its rulers.

Furthermore, American currency instability in the wake of the Civil War gave the world the chance of having a currency based on a British-German vision of stability. Bagehot was sympathetic to the view that a small change in the value of the pound would be costly, unnecessary, and undesirable. But Britain could take the opportunity to harness a newly powerful Germany into its monetary orbit, and then associate the United States with the new project of a strong currency. As Bagehot put it: “In that case, there would be one Teutonic money and one Latin money; the latter mostly confined to the West of Europe, and the former circulating through the world. Such a monetary state would be an immense improvement on the present. Yearly one nation after another would drop into the union which best suited it; and looking to the commercial activity of the Teutonic races, and the comparative torpor of the Latin races, no doubt the Teutonic money would be most frequently preferred.”3

Bagehot also reckoned with the possibility that some people would have to make complicated arithmetic adjustments before they could calculate in the new currency. Since he considered the northern Germans to be the best-educated people in Europe, it would be easier, he believed, for them rather than the arithmetically more lethargic Britons to make the calculations that would be needed for a new currency.

Nothing came of these bold proposals, in either the Napoleonic or the Bagehotian version, though the Latin Monetary Union remained in existence until it was broken up as a result of wildly different national inflation rates during the First World War. But the ambition was always there. In the nineteenth-century debates, there was no obvious reason why a monetary union should just be European. Indeed the logic that Napoleon and his advisers applied would just as obviously point to world monetary union. The economic and commercial calculation was compelling. At the height of the nineteenth-century wave of globalization, Carl Menger in his work The Origin of Money argued that the advantage of using the same medium of exchange as one’s potential trading partners leads a network of merchants to accept a common medium of exchange and unit of account.

In the twentieth century, an alternate tradition of national money, first really developed in the nineteenth century, reached an apogee. According to this vision, a strong link tied money to political authority. That link—and the capacity of states to manipulate value—was intensified as a result of the attractions of paper or fiat money. The German economist and politician Karl Helfferich argued that the dependence of a monetary standard on metallic metal produced price fluctuations that in theory might be eliminated by the adoption of fiat money; but he also added the rider that that fiat money would be subject to unbearably intense political pressures. He concluded that “pure paper money represents the logical culmination of the history of the development of money.” At the same time he soberly presented the political disadvantages of this quite logical development. The capacity of the state and of public policy to shape value would, he predicted, encourage a mobilization and a polarization of interests, on the one hand of those who might benefit from monetary depreciation, and on the other of recipients of fixed incomes, whether as wages or interest payments, who wanted an increase in the value of money. The capacity to manipulate value would lead to a new sort of class war, in which groups would form and mobilize in order to seize the levers of power that would give them the capacity of determining value. The conflict had the capacity to lead to a “complete demoralization of economic and social life,” he wrote quite prophetically (in fact as Germany’s finance minister during the First World War he became the major architect of the great German inflation). Helfferich’s remarks were not just a speculation about the future. He was thinking of the example of agrarian populists’ campaign at the end of the nineteenth century, both in America and in Europe, to inflate the currency in order to reduce the oppressive load of farm debt.4

The ideas on monetary unification were taken up again in the later twentieth century. In building Europe, the tie between money and political authority needed to be undone. Monetary populism and its inflationary aftermath discredited the approach of national money. One hundred years after Bagehot, the British decimalized their currency, and Europeans, prompted by a new war-induced episode of American currency disorder, again began to reflect seriously on the possibility of a European monetary union.

In February 1991 the Spanish Finance and Economics Ministry concluded its note on the preparations for the Maastricht Treaty and for European monetary union by citing Bagehot’s work:

The new system must be one which will do no violence to national jealousies. It will not do for one nation to say to any other, still less to all others—“My coinage is better than yours; my trade is larger, and my coinage better known than yours; therefore do you adopt my coinage and give up your own.” Most nations—all great nations perhaps—are too sensitive and too proud to bear such language. The desire for an international coinage is not an imperious desire. The advantages it promises are substantial and real, but they do not at once strike mankind. The mass of residents in every country will say—“We do not trade abroad; we do not travel abroad; we can use our native currency very well; why should we change it? Why should we learn a new system? We do not care about foreign currencies.” There is a great mass of stagnant selfishness in all nations which will oppose this improvement, as well as all others. We must not reinforce that selfishness by wounded national pride; if we ask the mass of English people to take the French coinage, or the mass of French to take the English, we shall not prevail; the French will say—“We will not yield to England”; the English will say—“We will not yield to France.” Any plan must be based on mutual concession. Everyone may hope to gain much, but everyone must sacrifice something.5

But negotiating the mutual concessions can be very hard. Most subsequent European discussions in consequence avoided Napoleon III’s idea that a national money could be a general or universal currency, and thought that they needed to devise an entirely fresh store of value. When most national moneys were discredited by the aftermath of war finance and inflation, it looked easier to invent a completely new currency. In the late 1920s, during the negotiations that preceded the establishment of the Bank for International Settlements in Basel, the brilliant French economist Pierre Quesnay suggested an artificial currency unit (grammor) based on a specific weight of gold in order to avoid choosing any particular national money as the basis of a world standard. The great German statesman Gustav Stresemann in a speech before the League of Nations in 1929 deplored the new customs barriers and Europe’s fragmentation, and casually asked, “Where is the European money, where is the European postage stamp?”6 In the summer of 1932, Hans Fürstenberg, the head of the Berliner Handelsgesellschaft, the only big German bank to have survived the financial crisis of 1931 without state support, called for a European currency union, with a European central bank. Fürstenberg worried about the “confusion” of price levels at the beginning of the transition to new monetary units, but thought that there would be a quick resumption of economic activity on a basis of stable prices. A new money might have provided a stabilization of expectations in the middle of the world depression and at the beginning of a period of intense currency wars and competitive devaluations. But this was not a time when anyone was prepared to sacrifice anything.

Exactly one century after Napoleon III’s conference, in 1967, Sir John Hicks concluded an analysis of the instability of credit with the claim that international credit, like international money, required to be managed. Today, credit transcends national frontiers to a much greater extent than it did when Hicks wrote his prescient warning:

We do not need, on the international plane, to feel the Keynesian fear, that purely monetary management will be unable to fight depression; on the international plane it is not Depression, in the old sense, that is the danger. National governments, taught by Keynes, however indirectly, can see to that. What is liable to happen, if there is a failure of international credit, is that nations will turn in upon themselves, becoming more autarkic or more protectionist, impoverishing themselves and each other by refusing to trade with each other. (And this means, we can already see, refusing to aid each other.) That is the danger with which we are confronted; we can already see that it is no imaginary danger at this present time. The remedy, my old nineteenth-century experience would tell us, would be an International Central Bank, an International Bank which would underpin the credit structure, but in order to underpin it must have some control over it.7

Dealing with internationally connected flows of credit requires a great deal of coordination, and the sacrifice of particular national interests.

Even more powerfully but problematically, the coordination of international money involves giving up national ideas about money. National differences in regard to monetary practice are not just formulated as clashes of interests, but usually also appear as different and contrasting philosophies. As a consequence, negotiating commonalities between national positions involves some compromise of theoretical astringency. To take the examples that will be at the center of the story set out in the following pages: throughout the whole of the postwar era, a key French demand was for a mechanism of political control over the economy, and extension of the principle of some kind of planning, or, as it was frequently termed, economic governance. By contrast, Germany was for historical reasons deeply attached to an anti-inflationary policy anchored in the strong institutional autonomy of the central bank. How could these positions be reformulated to be brought into harmony with each other? Obviously, both could be translated to a European level, even though each country feared that translation might mean dilution: that the central bank would be under more pressure, or that the economic governance might simply take the form of budgetary rules. But there might also be conflict as a result of the Europeanization of the national policy preferences, and governance and autonomy might clash.

Academic commentators are often inclined to extremes, to be either Cassandras or Dr. Panglosses. Economists are very often Cassandras, in that they are irritated by the intellectual imperfections and flaws that often accompany the compromises implied by any big project: such as European monetary integration. Many economists, particularly Americans, warned that there was in the end no strict symmetry in the progress, and some reforms got ahead of other areas of policy in which there was insufficient advance: the removal of capital controls in 1990 was not accompanied by an equivalent move in monetary and exchange rate arrangements; and the move to monetary union was not accompanied by adequate reflection on the implications of a single money and capital market on the need for banking supervision and regulation that went beyond the national level, on the need for structural flexibility and for preserving competitiveness, and perhaps also on the fiscal concomitants of monetary union. Europeans largely ignored such warnings, which they put down to a one-sided American view of the European project summed up in the flippant catch-phrase: “It can’t happen, It’s a bad idea, It won’t last.”8

By contrast, political scientists are more easygoing characters and tend to the Panglossian. The intense study of how and what actually happens inclines them to slip into the easy assumption that that is the best, perhaps the only possible outcome. Even grotesquely unjust and dysfunctional systems such as Soviet rule were uncritically justified in this way; but so too is dysfunctionality in the governance of Europe.9

Of these dangers, the greatest by far is the lulling effect that Panglossianism brings—or, to use another metaphor, the blurring of the focus that means that real problems become indistinct and incapable of being defined or solved; in this view they are merely the necessary outcome of complex political maneuvering and interest bargaining. Historical accounts present the narrative of big international developments and advances; but they need to be sensitive to the historically conditioned flaws and compromises that are often deeply embedded in a process of institutional development. And these flaws have a tendency to be exposed at precisely the least propitious moment. Such exposure is pr...