Transcript Slide 1

Changing the rules in a monetary union in historical
perspective: the Latin Monetary Union and EMU
Luca Einaudi
Joint 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
Supranational Monetary Unions in Europe
1808-14
French Empire
and satellites
1838-71
Münzverein,
No central bank,
Germanic
decentralised issue of
Monetary Union paper currency not in the
convention.
1865-1926 Latin
Based on the bimetallic franc,
one to one exchange rate with
lira and frank.
Common thaler of the north,
with a 1 to 1,75 fixed exchange
rate with the southern gulden.
Silver standard.
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.
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.
European
Monetary
Union
European Central Bank Common and single currency.
controls monetary policy Coordination of fiscal policies
and all monetary issue.
(stability and growth pact).
Monetary
Union
1872-1931 Scandinavian
1999-?
No central bank nor
paper money.
National monetary unifications following political unification
Country
1850 Switzerland
(after a civil war)
1862 Italy (after
unification)
1871 German
Empire
(after Unification)
1919 Kingdom of
Yugoslavia
(after creation)
1919 Poland
(after independence)
1990 Germany
(after reunification)
Central banks, paper currency and other characters
Introduction of a single common currency but with several banks
of issue and no central bank until 1907.
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.
The Prussian Bank became the Reichsbank in 1876 and
centralised bank notes issue. German states within the Empire
retained the right to issue coinage.
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.
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.
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
1848
Fixed, some Flex
1865
Fixed
1866
Fixed, some Flex
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
1914-27
Flexible
Mid 1920's
Fixed
1930's
Flexible
1944
Fixed
1971-73
Flexible
1979
Partial. fixed
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
????
????
Various metallic standards.
Economic crisis and revolutions bring inconvertibility in some countries
Creation of the Bimetallic Latin Monetary Union
Italy, Austria, Greece, Papal states on inconvertible paper currencies
Resumption of gold standard
WWI and post war: Gold standard suspended
Return to the Gold standard
Great Depression. Leave Gold standard and devalue: UK and Germany
in 1931, US in 1933, France and Italy in 1936
Bretton Woods system
End of dollar/gold exchange standard
European Monetary System (EMS), fixed readj. exchange rates
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 a
Coinage 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.
•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 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.
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)
2500
2000
Foreign coins
French silver
1500
French gold
1000
500
Source: Willis, History of the Latin Monetary Union, 90.
1876
1874
1872
1870
1868
1866
1864
1862
1860
1858
1856
1854
1852
1850
0
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).
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
4500
4000
Divisionary silver
3500
3000
LMU limit
2500
2000
Silver 5 fr.
1500
LMU limit
1000
500
Gold
1880
1878
1876
1874
1872
1870
1868
1866
1864
1862
0
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.
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.
1,2
1
0,8
0,6
Belgian fr
French fr
0,4
Italian lira
Greek drach
Swiss fr
0,2
1933
1929
1925
1921
1917
1913
1909
1905
1901
1897
1893
1889
1885
1881
1877
1873
1869
1865
1861
0
Source: Einaudi Luca, Money and Politics: European Monetary Unification and the International Gold Standard (18651873). 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)
Public debt in % of GDP in the countries of the LMU (1880-2015)
250
Greek default
200
Greece
Italy
Belgium
France
Switzerland
150
100
50
0
1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Source: IMF. For 2010-2015 IMF forecasts.
What causes monetary unions to break or to consolidate?
Breaking political unity destroys the political conditions for
union
1. 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
union
1. Economic divergence caused by WWI: Latin Monetary Union
2. 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 debate
Greek Governments manipulated official debt and deficit statistics from 1997 to 2003
in order to join the Euro area and again in 2008 and 2009.
Greek budget deficit: announced and actual deficits (1980-2010)
and austerity programme
0
3% threshold
-4
Current estimates
(IMF October 2010)
-8
Forged figures before
2009 revision (IMF)
-12
Forged figures before
2004 revision
Austerity programme
-16
1980
1985
1990
1995
2000
2005
2010
2015
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)
Debt crisis and policy reactions , 10 years interest rates on government bonds
12
10
Eu guarantees and
recapitalization
G20
for banks
London
G20
Summit
Washington
Lehman
summit
collapse
8
Eu-IMF
commit
45 bil €,
then 110,
then 750
Eurozone
promises
help to
Greece
Greece
reveals
figures
forgery
G20
Pittsbugh
summit
Eu-IMF Irish loan
Greece
Ireland
6
Portugal
Spain
USA
4
2
Italy
USA
Germany
01/07/ 30/08/ 29/10/ 28/12/ 26/02/ 27/04/ 26/06/ 25/08/ 24/10/ 23/12/ 21/02/ 22/04/ 21/06/ 20/08/ 19/10/ 18/12/
2008 2008 2008 2008 2009 2009 2009 2009 2009 2009 2010 2010 2010 2010 2010 2010
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.