The Euro history
The Euro: The Politics of the New Global Currency
By David Marsh
The motivation of the Maastricht treaty 1991 were manifold. A European money would bridge the past, the present and the future, healing social wounds, strengthening political bonds, and reviving economic fortunes. One great aim of EMU was to take further the process of European integration and recovery started after the second world war with the 1947 European aid programme of US Secreatry of State George Marshall. In a process which Britain supported but decided not to join, European copperation continued with the establishment of the European Payments Union (EPU) in 1950 and the European Coal and Steel Community (ECSC) in 1951. The 1957 Treaty of Rome, signed by the founder members of the European Community, pledged to drive Eruope on to 'ever closer union', as a means of rebuilding peace and prosperity. The six-nation customs union of the European Communities - the ECSC and the European Atomic Energy Community (for developing nuclear power) -- under a single executive body, the European Commission. The European Community took a further leap towards liberalised trade in 1986 when governments decided on a free-trade European Single Market that was then progressively implemented up to 1993. 'A single currency for a single market' became Maastricht's clarion call.
The currency market principles underlying the Maastricht decision marked an important ideological divide among the industrial countries that take the lion's share of the global economy. For the US, Britain, Japan, and many other economies, floating exchange rates had become the norm during the previous two decades, although nearly always combined with certain amounts of currency management through exchange rate pegging, mainly against the dollar. This had been the case since the 1971-73 break up of the post-war system of fixed exchange rates established at the monetary conference of Bretton Woods in 1944. Under floating, the free flow of funds on financial markets allowed currencies largely to find their own level, steered only sporadically by central banks' foreign exchange intervention. Supporters of the system believed that floating, although sometimes inconvenient, was the best way of tailoring exchange rates to individual countries' economic circumstances, allowing maximum leeway for growth, trade and investment.
For the architects of Maastricht, the lesson of the past, seen most ruinously in the 1920s and 1930s, was that fluctuating currencies produced economic and political disruption. Since the second world war, Europe had participated in a series of attempts to stabilise exchange rates, the failures of successive exchange rate regimes had contributed since the 1970s, to economic stagnation, rising inflation and persistent unemployment. The founder members of the European Community formed the core membership of two semi-fixed exchange rate arrangements that started in 1972 and 1979 respectively: the Currency 'Snake' and the European Monetary System (EMS). Crucially, the UK was the only member of the nine-nation European Community that decided in 1978 against joining the Exchange Rate Mechanism (ERM) of the EMS. The extraordinary story of Britain's long flirtation with the ERM, its delayed entry in 1990 and departure (under disastrous circumstances) in 1992 provides important reasons why the UK did not join EMU and, in 2008, continued to look at the EURO with a jaundiced eye.
Both the Snake and the EMS/ERM were conceived as zones of European currency stability to protect the continent from the perils of floating exchange rates. But, as controls over flows of international capital were progressively eased from the 1980s onwards, leading to enormous increases in the mobility of funds, both European monetary arrangements were prone to frequent, increasingly politicised, currency upsets. Additionally, both the Snake and the EMS became ever more dominated by the D-Mark as the 'anchor currency', in line with the growing strength of Germany's economy and that of its legendarily independent central bank, the Bundesbank. In a world where fixed exchange rate systems were becoming ever more vulnerable to marauding flows of international capital, a succession of currency strains confirmed European governments' view that the EMS was not, and could never become, a permanent recipe for stability.
The Snake and EMS/ERM experiences provided backing for the economic theory of the so-called 'Impossible Trinity' that gained ground during the 1980s, according to which countries could not simultaneously maintain fixed exchange rates, capital mobility and autonomous monetary policies. By the late 1980s, many European countries, either voluntarily or with varying degree of unwillingness, had effectively given up monetary autonomy to the Germans. So, the formation of a European Central Bank -- in which the Bundesbank's power would be heavily diluted -- gradually became an aim that could attract even countries like France that held strong traditional reservation about sacrificing national sovereignty.
The progenitors of the Maastricht Treaty -- led by France and Italy, as well as Belgium and the Netherlands and most of Germany's leading politicans -- foresaw a variety of benefits. Stabilizing Europe's internal contours would ward off past strife and proper the continent to greater cohesion. Subsuming Germany's D-Mark into a new European monetary order would consolidate the renascent German nation within a stable Europe. The Germans, made prosperous by peace, would forever forswear war. Ending European exchange rate fluctuations would provide the means for increasing growth, investment and employment. The Euro was called upon to improve the continent's prowess in competition with the emerging economies ranging from china and India to Russia, Brazil and Indonesia. The Germans believed that the European Central Bank, modelled on the Bundesbank, would quell inflation and secure political and social progress. The French wanted a globally strong European money to counter the international pre-eminence of the American dollar. The whole of Europe saw the Euro as striking a blow for the continent's self-sufficiency and esteem in international politics and economics. Never before had a new currency been so replete with hope.
The results of the political deal-making that led to the Euro have in some ways confirmed original expectations, and in other ways confounded them. The ECB's 'one-size-fits-all' monetary policy -- under which interest rate-setting is unified across the EMU area, but fiscal and general economic policies remain in the hands of separate governments -- has produced interest rates that have been too low for the good of domestic economics in some fast-growing states (Spain and Ireland), too high in countries beset by economic weakness (Germany in the early 2000s). On the other hand, the rivalry between the Euro and the dollar was more potent that many expected, as the result of the US currency's long decline from 2003 to 2008.
The greater economic security and absence of foreign exchange market pressures afforded by fixed currencies and stable interest rates led to both positive and negative results. Positive consequences include a more propitious environment for companies expanding their businesses across Europe. The negative outcomes include a slackening of economic reforms in EMU members like Italy, Portugal and Greece, which had earlier been spurred into necessary adjustment either by the need to qualify for EMU, or by periodic foreign exchange crises - and, in the absence of such immediate pressures, saw their economic structures and performances decline relative to other nations. Measured against US, Europe's performance as a whole has stalled since the heyday of post-war reconstruction in the 1950s and 1960s. The first decade of EMU made little difference to relative output per capital across the Euro area, above all because of poor growth in Germany, France and Italy.
Perversely, but inevitably, ordinary people across Europe appear to blame the Euro both for unfavourable developments that EMU has helped accelerate-- such as restructuring of uncompetitive businesses across the Single Market -- and for more general consequences of globalisation where the Euro does not have a crucial influence. The advent of the single currency and the ECB has given voters -- and, to a certain extent, governments too -- a convenient scapegoat. A Europe-wide opinion poll in January 2007 -- six months before the onset of the credit crisis -- indicated that more than two-thirds of French, Italian and Spanish citizens, and more than half of the Germans, believed the Euro had a 'negative impact' on their national economies. Regular opinion polls for the European Commission among people throughout the EU show widespread hostility to globalisation as a threat to jobs and livelihoods. Antagonism has been greatest in France and Greece and lowest in Denmark, Sweden (both non-members of the Eur) and the Netherlands.
The uneasy co-existence between the fixing of European currencies, on the one hand, and almost untrammelled capital mobility, on the other: ease of capital transactions provided on of the reasons of speculative upheavals from the late 1960s, in turn, provided important reasons for EMU. The freedom with which international investors, companies and financial institutions can deploy capital across and within national borders frequently incites public suspicion and resentment. Yet the liberalism of an integrated European financial market is one of the essential conditions with the Euro area required to provide the economic flexibility and financial lubrication to offset the rigidity of permanently fixed exchange rates. This is a devilish bargain, a conundrum that many EMU politicians have not yet been able adequately to explain to themselves, let alone to their electorates.
The lower the barriers to cross-border trade, financial, investment and labour flows, the smoother will be the adaptation to different economic performances in different countries. However, the steps that are needed to make the Euro work more effectively will themselves often prompt public discontent. This is a task for politicians rather than central bankers.
The ECB establishes a single basic interest rate based on average conditions throughout a relatively heterogeneous currency area. In the absence of Euro, there will be inevitable disparities between the interest rate set for all EMU countries to meet their purely domestic requirements. Countries expanding more slowly than average, with a lower inflation rate, are constrained by a higher rate of interest. These punitive circumstances create incentives for increases in efficient and productivity that eventually push down costs for manufacturing and service businesses, improving competitiveness and working through over time -- though not without the negative side-effect of higher unemployment -- into higher growth. As Bundesbank president Axel Weber explains, this was the mechanism that contributed to Germany's slowdown in the first five years of EMU, and to its ensuing recovery. 'The low inflation rate combined with the irrevocable fixing of intra-European exchange rates gave Germany a competitive advantage over higher-inflation countries. The important point is that the competitive advantage is maintained for a lengthy period of time, far outweighing the negative effect of the disadvantage of slightly higher real interest rates.
The corollary is that countries that are expanding faster than the Euro average, with a higher inflation rate, will have lower interest rates than would otherwise be the case. This will tend to increase their inflation, reduce their competitiveness, increase imports, worsen their balance of payments positions, and eventually reduce growth rates towards more sustainable levels around the Euro average. Spain and Ireland found themselves in this more expansive group of EMU members, profiting from low interest rates in real (inflation-adjusted) terms. But they were either unable or unwilling to use fiscal policy to counter effects of economic overheating -- and were suddenly precipitated into the category of slower-growing countries after the 2007 credit crunch.
Miguel Fernandez Ordonez, Governor of the Banco de Espana, said the large initial fall in Spanish interest rates, together with other structural changes in the economy, promoted the 'prolonged expansionary phase of the Spanish economy, the strong reduction in the unemployment rate (in spite of the increase in the labor force) and a rise in per capital income towards the Euro area average. Notwithstanding the post-2007 slowdown, he believes the Spanish economy is sufficiently flexible to recover a high growth path once economic adjustment is concluded.
The Euro was designed to shackle Germany. In fact, after a difficult period of adaptation, monetary union appears to have helped revive its economic prowess. Germany's still sluggish domestic demand and its exposure to the broad streams of the world economy make it vulnerable when currents turn adverse, as happened towards the end of 2008. But the Germans exude considerably greater self-confidence than at the start of EMU. This is not simply a matter of revived economic output and exports. As a result of below average German growth for much of the past twenty years, the French economy in 2007-08 was exactly the same size in relation to Germany as it had been before unification, when Germany had twenty million fewer people. The French wanted European institutions to protect high-growth policies from external monetary disruption; Germany wanted Bundesbank-style principles to protect Europe from inflation. The extraordinary upheaval in the European and world economy at the end of 2008 could yet unleash a change in the balance of power between the ECB and European governments. However, it appears as if german precepts, for the moment at least, have won the upper hand. A Bundesbank-style system that worked well in germany for most of the post-second world war era has been spread to the rest of Europe -- with consequences that appear to have benefited the germans more than others.
Some realities are clear, though painful. EMU has contributed to strengthening, not weakening, Germany, but has also made Europe's largest economy more vulnerable to unfavourable alliances of other countries, especially if they feel threatened by a perception of new German power, or irritated by the Berlin government's reluctance to take more active economic stimulus measures to counter the recession. The corrective economic action that EMU members most urgently require is the most difficult to enact. The countries that have done best to diversify their trade and investment outside Europe are likely to fare best within it. The repercussions on Europe of the international credit upheaval may in some ways prove longer-lasting and more pernicious than those on America. Without better economic coordination, much of what the Euro area has built up could be lost. History is written by the victors, not the vanquished. EMU's unfinished history so far contains neither. In coming years there will be both. The lesson of the first decade is there is no certainty that the single currency will survive the next one unscathed. Yet if the Euro overcomes its trials and becomes a durable success, that accomplishment, measured by all that has gone before, will truly be the richest of triumphs.
By David Marsh
The motivation of the Maastricht treaty 1991 were manifold. A European money would bridge the past, the present and the future, healing social wounds, strengthening political bonds, and reviving economic fortunes. One great aim of EMU was to take further the process of European integration and recovery started after the second world war with the 1947 European aid programme of US Secreatry of State George Marshall. In a process which Britain supported but decided not to join, European copperation continued with the establishment of the European Payments Union (EPU) in 1950 and the European Coal and Steel Community (ECSC) in 1951. The 1957 Treaty of Rome, signed by the founder members of the European Community, pledged to drive Eruope on to 'ever closer union', as a means of rebuilding peace and prosperity. The six-nation customs union of the European Communities - the ECSC and the European Atomic Energy Community (for developing nuclear power) -- under a single executive body, the European Commission. The European Community took a further leap towards liberalised trade in 1986 when governments decided on a free-trade European Single Market that was then progressively implemented up to 1993. 'A single currency for a single market' became Maastricht's clarion call.
The currency market principles underlying the Maastricht decision marked an important ideological divide among the industrial countries that take the lion's share of the global economy. For the US, Britain, Japan, and many other economies, floating exchange rates had become the norm during the previous two decades, although nearly always combined with certain amounts of currency management through exchange rate pegging, mainly against the dollar. This had been the case since the 1971-73 break up of the post-war system of fixed exchange rates established at the monetary conference of Bretton Woods in 1944. Under floating, the free flow of funds on financial markets allowed currencies largely to find their own level, steered only sporadically by central banks' foreign exchange intervention. Supporters of the system believed that floating, although sometimes inconvenient, was the best way of tailoring exchange rates to individual countries' economic circumstances, allowing maximum leeway for growth, trade and investment.
For the architects of Maastricht, the lesson of the past, seen most ruinously in the 1920s and 1930s, was that fluctuating currencies produced economic and political disruption. Since the second world war, Europe had participated in a series of attempts to stabilise exchange rates, the failures of successive exchange rate regimes had contributed since the 1970s, to economic stagnation, rising inflation and persistent unemployment. The founder members of the European Community formed the core membership of two semi-fixed exchange rate arrangements that started in 1972 and 1979 respectively: the Currency 'Snake' and the European Monetary System (EMS). Crucially, the UK was the only member of the nine-nation European Community that decided in 1978 against joining the Exchange Rate Mechanism (ERM) of the EMS. The extraordinary story of Britain's long flirtation with the ERM, its delayed entry in 1990 and departure (under disastrous circumstances) in 1992 provides important reasons why the UK did not join EMU and, in 2008, continued to look at the EURO with a jaundiced eye.
Both the Snake and the EMS/ERM were conceived as zones of European currency stability to protect the continent from the perils of floating exchange rates. But, as controls over flows of international capital were progressively eased from the 1980s onwards, leading to enormous increases in the mobility of funds, both European monetary arrangements were prone to frequent, increasingly politicised, currency upsets. Additionally, both the Snake and the EMS became ever more dominated by the D-Mark as the 'anchor currency', in line with the growing strength of Germany's economy and that of its legendarily independent central bank, the Bundesbank. In a world where fixed exchange rate systems were becoming ever more vulnerable to marauding flows of international capital, a succession of currency strains confirmed European governments' view that the EMS was not, and could never become, a permanent recipe for stability.
The Snake and EMS/ERM experiences provided backing for the economic theory of the so-called 'Impossible Trinity' that gained ground during the 1980s, according to which countries could not simultaneously maintain fixed exchange rates, capital mobility and autonomous monetary policies. By the late 1980s, many European countries, either voluntarily or with varying degree of unwillingness, had effectively given up monetary autonomy to the Germans. So, the formation of a European Central Bank -- in which the Bundesbank's power would be heavily diluted -- gradually became an aim that could attract even countries like France that held strong traditional reservation about sacrificing national sovereignty.
The progenitors of the Maastricht Treaty -- led by France and Italy, as well as Belgium and the Netherlands and most of Germany's leading politicans -- foresaw a variety of benefits. Stabilizing Europe's internal contours would ward off past strife and proper the continent to greater cohesion. Subsuming Germany's D-Mark into a new European monetary order would consolidate the renascent German nation within a stable Europe. The Germans, made prosperous by peace, would forever forswear war. Ending European exchange rate fluctuations would provide the means for increasing growth, investment and employment. The Euro was called upon to improve the continent's prowess in competition with the emerging economies ranging from china and India to Russia, Brazil and Indonesia. The Germans believed that the European Central Bank, modelled on the Bundesbank, would quell inflation and secure political and social progress. The French wanted a globally strong European money to counter the international pre-eminence of the American dollar. The whole of Europe saw the Euro as striking a blow for the continent's self-sufficiency and esteem in international politics and economics. Never before had a new currency been so replete with hope.
The results of the political deal-making that led to the Euro have in some ways confirmed original expectations, and in other ways confounded them. The ECB's 'one-size-fits-all' monetary policy -- under which interest rate-setting is unified across the EMU area, but fiscal and general economic policies remain in the hands of separate governments -- has produced interest rates that have been too low for the good of domestic economics in some fast-growing states (Spain and Ireland), too high in countries beset by economic weakness (Germany in the early 2000s). On the other hand, the rivalry between the Euro and the dollar was more potent that many expected, as the result of the US currency's long decline from 2003 to 2008.
The greater economic security and absence of foreign exchange market pressures afforded by fixed currencies and stable interest rates led to both positive and negative results. Positive consequences include a more propitious environment for companies expanding their businesses across Europe. The negative outcomes include a slackening of economic reforms in EMU members like Italy, Portugal and Greece, which had earlier been spurred into necessary adjustment either by the need to qualify for EMU, or by periodic foreign exchange crises - and, in the absence of such immediate pressures, saw their economic structures and performances decline relative to other nations. Measured against US, Europe's performance as a whole has stalled since the heyday of post-war reconstruction in the 1950s and 1960s. The first decade of EMU made little difference to relative output per capital across the Euro area, above all because of poor growth in Germany, France and Italy.
Perversely, but inevitably, ordinary people across Europe appear to blame the Euro both for unfavourable developments that EMU has helped accelerate-- such as restructuring of uncompetitive businesses across the Single Market -- and for more general consequences of globalisation where the Euro does not have a crucial influence. The advent of the single currency and the ECB has given voters -- and, to a certain extent, governments too -- a convenient scapegoat. A Europe-wide opinion poll in January 2007 -- six months before the onset of the credit crisis -- indicated that more than two-thirds of French, Italian and Spanish citizens, and more than half of the Germans, believed the Euro had a 'negative impact' on their national economies. Regular opinion polls for the European Commission among people throughout the EU show widespread hostility to globalisation as a threat to jobs and livelihoods. Antagonism has been greatest in France and Greece and lowest in Denmark, Sweden (both non-members of the Eur) and the Netherlands.
The uneasy co-existence between the fixing of European currencies, on the one hand, and almost untrammelled capital mobility, on the other: ease of capital transactions provided on of the reasons of speculative upheavals from the late 1960s, in turn, provided important reasons for EMU. The freedom with which international investors, companies and financial institutions can deploy capital across and within national borders frequently incites public suspicion and resentment. Yet the liberalism of an integrated European financial market is one of the essential conditions with the Euro area required to provide the economic flexibility and financial lubrication to offset the rigidity of permanently fixed exchange rates. This is a devilish bargain, a conundrum that many EMU politicians have not yet been able adequately to explain to themselves, let alone to their electorates.
The lower the barriers to cross-border trade, financial, investment and labour flows, the smoother will be the adaptation to different economic performances in different countries. However, the steps that are needed to make the Euro work more effectively will themselves often prompt public discontent. This is a task for politicians rather than central bankers.
The ECB establishes a single basic interest rate based on average conditions throughout a relatively heterogeneous currency area. In the absence of Euro, there will be inevitable disparities between the interest rate set for all EMU countries to meet their purely domestic requirements. Countries expanding more slowly than average, with a lower inflation rate, are constrained by a higher rate of interest. These punitive circumstances create incentives for increases in efficient and productivity that eventually push down costs for manufacturing and service businesses, improving competitiveness and working through over time -- though not without the negative side-effect of higher unemployment -- into higher growth. As Bundesbank president Axel Weber explains, this was the mechanism that contributed to Germany's slowdown in the first five years of EMU, and to its ensuing recovery. 'The low inflation rate combined with the irrevocable fixing of intra-European exchange rates gave Germany a competitive advantage over higher-inflation countries. The important point is that the competitive advantage is maintained for a lengthy period of time, far outweighing the negative effect of the disadvantage of slightly higher real interest rates.
The corollary is that countries that are expanding faster than the Euro average, with a higher inflation rate, will have lower interest rates than would otherwise be the case. This will tend to increase their inflation, reduce their competitiveness, increase imports, worsen their balance of payments positions, and eventually reduce growth rates towards more sustainable levels around the Euro average. Spain and Ireland found themselves in this more expansive group of EMU members, profiting from low interest rates in real (inflation-adjusted) terms. But they were either unable or unwilling to use fiscal policy to counter effects of economic overheating -- and were suddenly precipitated into the category of slower-growing countries after the 2007 credit crunch.
Miguel Fernandez Ordonez, Governor of the Banco de Espana, said the large initial fall in Spanish interest rates, together with other structural changes in the economy, promoted the 'prolonged expansionary phase of the Spanish economy, the strong reduction in the unemployment rate (in spite of the increase in the labor force) and a rise in per capital income towards the Euro area average. Notwithstanding the post-2007 slowdown, he believes the Spanish economy is sufficiently flexible to recover a high growth path once economic adjustment is concluded.
The Euro was designed to shackle Germany. In fact, after a difficult period of adaptation, monetary union appears to have helped revive its economic prowess. Germany's still sluggish domestic demand and its exposure to the broad streams of the world economy make it vulnerable when currents turn adverse, as happened towards the end of 2008. But the Germans exude considerably greater self-confidence than at the start of EMU. This is not simply a matter of revived economic output and exports. As a result of below average German growth for much of the past twenty years, the French economy in 2007-08 was exactly the same size in relation to Germany as it had been before unification, when Germany had twenty million fewer people. The French wanted European institutions to protect high-growth policies from external monetary disruption; Germany wanted Bundesbank-style principles to protect Europe from inflation. The extraordinary upheaval in the European and world economy at the end of 2008 could yet unleash a change in the balance of power between the ECB and European governments. However, it appears as if german precepts, for the moment at least, have won the upper hand. A Bundesbank-style system that worked well in germany for most of the post-second world war era has been spread to the rest of Europe -- with consequences that appear to have benefited the germans more than others.
Some realities are clear, though painful. EMU has contributed to strengthening, not weakening, Germany, but has also made Europe's largest economy more vulnerable to unfavourable alliances of other countries, especially if they feel threatened by a perception of new German power, or irritated by the Berlin government's reluctance to take more active economic stimulus measures to counter the recession. The corrective economic action that EMU members most urgently require is the most difficult to enact. The countries that have done best to diversify their trade and investment outside Europe are likely to fare best within it. The repercussions on Europe of the international credit upheaval may in some ways prove longer-lasting and more pernicious than those on America. Without better economic coordination, much of what the Euro area has built up could be lost. History is written by the victors, not the vanquished. EMU's unfinished history so far contains neither. In coming years there will be both. The lesson of the first decade is there is no certainty that the single currency will survive the next one unscathed. Yet if the Euro overcomes its trials and becomes a durable success, that accomplishment, measured by all that has gone before, will truly be the richest of triumphs.
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