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The monetary union progress report: Europe versus US

As Europe speeds towards greater fiscal and monetary union, a process accelerated by the debt crisis, it’s worth remembering that it took close to 150 years for the world’s other great and enduring monetary union to take shape.

Indeed, full monetary union in the United States of America did not happen overnight, or over 14 years, but took 147 years to fulfill the same conditions that the eurozone’s critics say must be achieved before they will be content that the union is secure, according to Deutsche Bank strategist Stuart Parkinson. He argues that “too much of the debate about the euro-areais of the ‘half empty’variety”, and that when considering a more positive stock-take of the eurozone in 2013 versus the US in 1802, both being 14 years after their initial monetary union, the eurozone is actually doing pretty well when compared to the US.

For Parkinson, there are four necessary conditions the skeptics require to be satisfied for the eurozone to be an optimal currency union, all of which the eurozone has made decent progress on.

The first is the creation of one unit of account, and the second, a single circulating medium of exchange.

On the first, Parkinson says the US Constitution took effect in 1788 and that “Article 1 Section 8 of it gave Congress the exclusive power to ‘coin Money [and] regulate the Value thereof’”. But that wasn't the first attempt at US monetary union, as earlier articles of confederation in 1781 also granted the central government powers with respect to money and taxes.

Charles Sumner Hamlin. the first
chairman of the Federal Reserve

On the second, he says it could easily be assumed that the principles of one unit of account and one circulating medium of exchange are the same thing – a single currency – but not quite. While the euro’s inauguration was in 1999, it took until 2002 for the first euro currency to circulate. Furthermore, legacy currency banknotes may have ceased being legal tender afterwards but they are still legally exchangeable at national central banks until 2022. Plenty of time then to exchange holiday drachmas.

This, however, is very different to the US, according to Parkinson, and particularly with respect to bank notes, which, at the time, were issued by State-Chartered banks and not by the government until passage and implementation of the National Banking Act of 1863 – 70-years after the dollar was declared the exclusive unit of account. In the interim, there was no uniform paper currency.

Interestingly, around 1,500 banks’ notes traded in the economy at varying discounts from their stated par value. And, naturally, some very interesting things happened in this period, most notably that some of the note issuing banks defaulted or at least rescheduled their scheduled payments along the way.

So, as Parkinson points out: “US states defaulted and rescheduled during the era of US monetary union without destroying it.”

The third and fourth conditions are a fully functioning central bank, and an optimum currency area, respectively.

Once again the US is different to Europe, where, for instance, Sweden’s Riksbank opened its doors in 1668. The Federal Reserve will only celebrate its centenary this year, having been signed into being by President Woodrow Wilson in 1913 as a result of the 1907 Crash precipitated by JP Morgan’s failure to rescue the Knickerbocker Trust.

Parkinson adds: “In fact, such was Congress’ aversion to even having a central bank that the first two efforts – imaginatively called the First & Second Bank of the United States – both failed to have their original 25-year charters renewed.”

Indeed, even in 1913 President Wilson only got approval for the institution we think of today as the US central bank by calling it the Federal Reserve System instead. And even then, the Fed’s modus operandi needed to be updated as part of the 1935 Banking Act after its poor performance during the Great Depression.

Lastly, Parkinson says that while the critics argue that the euro-area cannot be an optimal currency area because of any number of reasons – there is no common language spoken and different countries within the union are hit by different shocks, for example – seeing the US as being an optimum currency area is not as clear cut as presumed.

“In fact, I’ve seen estimates that the US didn’t become an optimum currency area until well into the 1930s when the main pillars of the New Deal (e.g. Federal Unemployment Insurance) were introduced,” says Parkinson.

He adds: “So, the US was not an optimum currency area the day the constitution took effect; actually it took the small matter of 150 years!”

Parkinson concludes: “The US has endured countless crises since the advent of its union, yet it has stayed the course through thick and thin, payment rescheduling and even default. To me at least, there’s no reason to suspect that the euro area will be any different anytime in the foreseeable future – sometimes annoying; sometimes faltering; sometimes wobbling; but still enduring.”

“And let’s face it (and let’s hope!) – it is unlikely to have to endure a global financial crisis of the order of the 2008 variety again anytime soon,” says Parkinson.