The euro: a historical perspective
The history of currency unions can tell us much about the outlook for the euro.
Jane Sydenham, Investment Director
“The one thing I would do in 2017 is short the euro”, said Professor Ted Malloch, who is apparently on President Trump's shortlist to be the new US ambassador to the European Union (EU). He tactfully went on to say that the single currency “could, in fact, collapse in the next year, year-and-a-half.”
This may sound like typical Trumpite diplomacy, yet Professor Malloch’s comments were delivered in a very sober interview with the BBC’s economics editor, Kamal Ahmed. He explained that he believes that potential political upheaval, arising from the series of elections across member states, threatens not just the euro but the EU itself.
Such predictions are not uncommon. The euro was launched in January 1999 as an electronic currency and in a physical ‘notes and coins’ form in 2002, but has faced repeated problems as some member countries have struggled to emerge from the global financial crisis. Although the last big test was the Cypriot banking collapse in March 2013, tensions have continued to dog the currency.
Eurocrats keep saying that the euro crisis is over, but it is hard to agree. There has been little movement towards the fiscal and banking unions required to solve the problems. It remains flawed, with inadequate controls over national budgets and no mechanism to redistribute wealth, particularly between Germany and the peripheral countries. Unlike the US, where banks were forced to recapitalise and write off bad debts, European banks remain burdened by loans that may never be repaid. Rumours of an impending systemic shock continue to surface.
According to a 2011 Economist Intelligence Unit report, the euro crisis was "as much political as economic" and the result of the fact that the euro area lacks the support of "institutional paraphernalia (and mutual bonds of solidarity) of a state".
Its problems should not surprise us, nor should the prospect that they could persist for years to come. Currency unions have a mixed history, with some notable successes and some long-forgotten failures, but in every case the process towards a functioning single currency was slow and difficult.
Most were established when the world was less vulnerable to the forces of global capitalism. Banking collapses and runs on currencies are hardly unique to the 21st century, but the sheer complexity and interconnectedness of the modern financial system makes it nearly impossible for politicians and central bankers to predict the consequences of their policies.
Two currency unions which failed are the Latin monetary union of 1865 to 1927, which involved France, Belgium, Switzerland, Italy, Greece and other countries on an informal basis, and the 1873-1924 Scandinavian monetary union, comprising Sweden, Denmark and Norway. The former used gold and silver coins that were legal currency across the union, whereas the Scandinavian union was based solely on gold.
Both failed because of political disagreements and tensions arising from war, but the Latin currency was also placed under strain by the disparity in value between gold and silver. Perfidy and national self-interest also played a part as the French papal treasury substituted nickel, zinc and tin for silver and used the devalued coins for trade with other member countries.
Europhiles cite the US as a model for currency union — however, it was hardly an overnight success. A central bank was first established in 1791, but in 1860 there were still 10,000 different notes and coins in circulation, and counterfeiting was rife. The dollar’s ultimate success was arguably down to the American Civil War. To fund the Union’s campaign, Abraham Lincoln’s Treasury Secretary, Salmon P. Chase, established a national banking system and issued paper currency, allowing bonds to be sold to investors. Moreover, the war created a sense of national cohesion that shifted power away from the individual states.
Given its short history, the euro is bound to experience teething troubles. Even the German Zollverein, arguably the best example of how economic union can pave the way for political union, had serious difficulties in its long gestation. Formally launched in 1834, it lasted until the Weimar Republic was established in 1919. But the Zollverein was not without its problems. Even with a shared language and national identity between the various German states, the parallel political integration was not smooth and it was temporarily broken up in 1866 by the Austro-Prussian War.
So history shows us that currency unions take years to bed in and are vulnerable to abuse by tribal self-interest. They can also fail. Although the Eurocrats say otherwise, it would be relatively straightforward for a country to leave the euro. The banks could close on a Friday, announce the new currency and exchange rate, and open on Monday to issue new notes and coins, which account for only 5% of the monetary base.
This may still happen to Greece and perhaps Italy. The UK’s experience of leaving the pre-euro European exchange rate mechanism (ERM) in 1992 shows how devaluation, which is initially seen as disastrous, can revitalise an economy.
What are the chances that the euro will survive? On the one hand, there is huge political will to make it work and many Europeans are still behind it. Having never been occupied, British people can underestimate the fear of war that drives many on the Continent who have faith in the EU and don’t wish for a return to unfettered national parliaments. The EU will try to fudge its way to a lasting solution, although this will take many years. Brexit arguably increases its chances of succeeding as there will be less resistance to the necessary federal structures.
On the other hand, there is an increasing populist shift against the political elite of the EU. After the UK referendum, this year’s elections in some member states could unleash more anti-EU sentiment. This would make further integration difficult, fatally undermining the single currency. Without these reforms and stronger political leadership, Professor Malloch may have been right to lack faith in the euro.