17. Campaign against Currency Choice: The Euro

Europe will be made through a currency, or it will not be made.93
– JACQUES RUEFF

The proponents of a “United States of Europe” realized at some point that the way to merge a multitude of nation-states into one central state could not be a direct one. The resistance of the populations concerned about their sovereignty was too great for this; this was explained in chapter 13. The objective therefore had to be achieved by other means. Democratic socialism therefore recommends a single currency for Europe, because it forces the nation-states to merge into a single central state, as it were—and this is due to the consequences that arise from this decision: the creation of a politicized single currency should be the compelling force for the unified state.

The decisive step was taken on January 1, 1999. On that day, the currencies of eleven nation-states—all of them unbacked paper currencies—were converted into a single currency, the euro. In addition to Belgium, Germany, Finland, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, and Spain, eight more countries eventually joined: Greece (2001), Slovenia (2007), Malta and Cyprus (2008), Slovakia (2009), Estonia (2011), Latvia (2014), and Lithuania (2015). The euro was declared the sole legal tender in all participating countries. The production monopoly for the euro is held by the European Central Bank (ECB).

It was a long and sometimes arduous path to the euro.94 As early as 1969, a step-by-step plan to establish an economic and monetary union in Europe was drawn up (the Werner Plan). In its second and third stages, it was intended, inter alia, to make Europe’s currencies fully convertible, liberalize capital movements across borders, reduce exchange rate fluctuations, and ultimately irrevocably set fixed parities between national currencies. In response to the end of the Bretton Woods system in the early 1970s, a European “snake in the tunnel” (EST) was launched. Its purpose was to limit exchange rate fluctuations. However, the first oil price crisis in 1973 and the associated economic consequences led many countries to withdraw from the EST.

A European unit of account (gold UA) had existed since the early 1950s. It was defined in gold, like the US dollar: 1/35th of an ounce of fine gold was equivalent to one US dollar. However, the European UA did not develop an independent profile and was not usable in transactions. After the IMF’s SDR was redefined from gold to US dollars in mid-1974, the European UA was retroactively redefined on July 1, 1974, from gold to merely a basket of European currencies.

In 1979, the European Monetary System (EMS) was adopted as the successor to the EST. Like the EST before it, the EMS was intended to reduce exchange rate fluctuations and thus strengthen economic and monetary cooperation in Europe. The EMS provided that exchange rate fluctuations between the individual currencies were not to fluctuate more than ± 2.25 percent upward or downward around the central exchange rate parities—which were politically determined. Following the establishment of the EMS, the European UA was replaced by the ECU (European currency unit) on January 1, 1981.

The EMS was in many ways imperfect. For example, it provided for a mutual obligation to intervene. An example: if Italy inflated more strongly than Germany and therefore depreciated the Italian lira against the German mark, the Bank of Italy had to buy lira on the foreign exchange market and sell German marks. At the same time, the Bundesbank was required to buy lira and pay for them with (newly created) German marks. This led to a tightening of the money supply in Italy and an expansion of the money supply in Germany. Inflation was by tendency contained in Italy and increased in Germany. The EMS thus ensured that the inflation policies of one state had to be at least partially adopted by the other states.

In addition, the central bank whose currency depreciated had to have currency reserves in the revaluing currency—otherwise it would not have been able to fulfill its intervention obligations in the EMS. To this end, the European Monetary Cooperation Fund (EMCF) was set up in 1973. It was to handle the necessary foreign exchange intervention within the framework of the then “European currency snake.” Within the EMS, the EMCF was also responsible for managing the credit mechanism in the EMS mutual assistance agreement. The EMCF was dissolved in 1994 and became the European Monetary Institute (EMI), the forerunner of the ECB.

In the EMS, there was some realignment of currency parities: the change in exchange rates was occasionally allowed as an adjustment parameter to compensate for shifting competitiveness between the economies participating in the EMS. This was completely incompatible with the spirit of a system of fixed exchange rates. In 1992 there was a serious crisis: the monetary policy in the wake of German reunification caused inflation in Germany to rise. The Deutsche Bundesbank—which consistently geared its monetary policy toward domestic requirements—reacted with strong interest rate hikes.

The German central bank thus decided to fight domestic inflation, even if this would lead to tensions in the EMS. As a result, many of the currencies participating in the EMS were subject to devaluation speculation. The central banks concerned attempted to maintain their exchange rate parities by raising interest rates and intervening in foreign exchange markets. But in vain. On August 2, 1993, it was announced that the previously applicable exchange rate fluctuation margins from 4.5 percent were widened to 30 percent. Basically, this seemed to be the end of fixed exchange rates in Europe. After only a few weeks, however, the exchange rates of the major ERM (European Exchange Rate Mechanism) currencies (the German mark, the French and Belgian francs, the Dutch guilder, the Danish krone) had returned to the narrow fluctuation band that prevailed before the crisis. Following the EMS crisis, the exchange rate fluctuation margins were extended to ±15 percent. The idea was to reduce intervention pressure and speculative incentives.

Above all, the crisis of the British pound made it clear to everyone that a system of fixed exchange rates composed of national sovereign currencies is ultimately an extremely unstable affair. The pound was only included in the EMS in October 1990, at a rate of 2.95 German marks to the pound. On September 16, 1992, “Black Wednesday,” there was massive speculation against the British currency. Then, the Bank of England raised its key interest rate twice. When the exchange rate did not stabilize, it announced its exit from the EMS that same evening. The pound fell below 2.35 marks. The British had preferred to devalue the pound in the hope of preventing high interest rates and a slowdown in their economy.

The sterling crisis drew attention to a special feature in the EMS: Germany was not only the economically largest and most populous participant, it was also one of the countries with the greatest (partly historically explainable) “dislike of inflation.” If the other countries pursued an inflation policy that was not desired in Germany, they either had to abandon it or they had to reckon with a devaluation of their currency in the foreign exchange market. As long as the German mark’s sovereignty remained in place, monetary policy in Europe could only be conducted with, but not against, Germany.

Under this condition, there were only two ways to achieve the political objective of monetary unification: (1) Germany would be allowed to determine monetary policy in Europe. This would have been technically possible if the other EU countries had renounced their own monetary policies and completely transferred their currency sovereignty to Germany. Politically, that was not desired. (2) The only alternative, therefore, was for the German mark to merge into a common currency—a currency which is issued by all countries, in a manner of speaking. And that’s exactly how it happened.

In particular, two important decisions were necessary. First, national monetary sovereignty had to be abolished once and for all. This means that control over the domestic money supply, key interest rates and inflation had to be irrevocably transferred to a supranational central bank. A departure from this decision should no longer be possible. Second, the name of the national currency (German mark, French franc, Italian lira, etc.) had to disappear from people’s minds, from daily business transactions. The new supranational currency had to have a name that replaced the names of the national currencies.

The path to the euro monetary union was designed entirely in this spirit. The EMS ended on December 31, 1998. On that day, the exchange rates of the countries participating in monetary union were fixed (on the basis of ECU parities) and on that basis they were irrevocably converted into the single currency, the euro, on January 1, 1999. The national central banks became branches of the ECB subject to instructions. The Governing Council, the supreme decision-making body of the ECB, has since determined the fate of monetary policy. The Governing Council of the ECB comprises all countries participating in the monetary union, with the weighting of “one country, one vote.”95

In the run-up to the introduction of the euro, politicians tried to make the advantages and opportunities of monetary union and the single currency palatable to the public—while the costs of the single currency were mostly ignored or at least played down. A single currency would, it was said, bring fixed exchange rates. And this would increase planning security for companies with regard to foreign trade and cross-border investments. Individual countries could no longer gain unfair advantages by devaluing their currency.

Transaction costs would fall, especially for consumers and companies: it would no longer be necessary to constantly exchange one currency for another. In addition, there would be no costs for currency hedging. The improved price transparency would also be booked on the credit side of the single currency: without exchange rate fluctuations and without transaction and hedging costs, it would be easier to compare prices in different countries. This in turn would improve the ability to make economically meaningful decisions.

Last but not least, the European single currency is associated with the political desire to compete with the US dollar, the world’s reserve currency. Having only a single currency in Europe would make it possible to create a large and liquid securities market. Such an achievement would make it more attractive for international investors to invest in Europe. This in turn would lower credit and capital costs and promote investment, production, and employment in the European community of states.

All these arguments are all very well. But they hide the fact that the introduction of the euro ultimately grew out of a different objective: states strive for power expansion and control. The domination of money plays a decisive, indispensable role in this. Every state strives to ensure that its money is used and to discourage, and, if necessary, to rigorously prevent, the use of alternative currencies (as they would arise in the free market). And if states are large and powerful enough, they will act out this urge not only on their own territory, but also internationally. In Europe, democratic socialism launched something at the beginning of 1999 that prior to that had long been considered impossible: eleven nations agreed to terminate their monetary sovereignty, gave up their right of self-determination in the choice of money, and submitted to a political supranational institution, the ECB.

But even the introduction of the euro does not yet mean, of course, that international currency competition is eliminated. The euro countries and their ECB do not yet have a carte blanche. As long as the international capital market is open and the euro can be exchanged for other currencies, the euro competes with other currencies. For example, if the ECB were to pursue a monetary policy of high inflation, euro money holders would switch to less inflationary currencies as far as possible. As long as other currencies are still available to which euro holders can switch, inflationary policy in the eurozone is at least subject to certain limits.

But of course, the euro single currency is not the end of the story. In recent years it has become apparent that monetary policies in the currency areas have converged markedly. Not only are the state fiat currencies that exist internationally structured according to the same blueprint, but national monetary policies have also converged markedly. This is mainly due to the ever-closer cooperation between the central banks. Without exaggerating, one can speak of a worldwide central bank cartel. This is the subject of the next chapter.

MAKING ONE CURRENCY OUT OF MANY

The euro monetary union began on January 1, 1999, with eleven nations whose currencies were fixed to the euro on December 31, 1998, at predetermined irrevocable exchange rates (the “official parities”)—and thus exchange rates were fixed once and for all between themselves.96 The illustration below shows the exchange rate development of selected currencies (quoted in euros) since the early 1970s and, from the beginning of 1999, the exchange rate of the euro against the US dollar. If a line in the chart rises (falls), this means that the respective currency has depreciated (appreciated) against the US dollar. But how was it possible to convert the national currencies into the euro?

The central banks have forced through the politically desired fixed exchange rates in the market. As monopolists of money production, this was possible for them. Let us assume that the French franc depreciates against the German mark and falls below the politically desired exchange rate. The Bank of France then buys francs on the foreign exchange market and offers German marks for them. It can only do this if it has currency reserves in German marks or if it receives German marks from the Deutsche Bundesbank.

Selected exchange rates of the participating nations for the euro*

[[{”fid”:”139105”,”view_mode”:”default”,”fields”:{”format”:”default”,”alignment”:””,”field_file_image_alt_text[und][0][value]”:”chapter_17_chart Polleit”,”field_file_image_title_text[und][0][value]”:”chapter_17_chart Polleit”,”field_caption_text[und][0][value]”:””,”field_image_file_link[und][0][value]”:””},”type”:”media”,”field_deltas”:{”1”:{”format”:”default”,”alignment”:””,”field_file_image_alt_text[und][0][value]”:”chapter_17_chart Polleit”,”field_file_image_title_text[und][0][value]”:”chapter_17_chart Polleit”,”field_caption_text[und][0][value]”:””,”field_image_file_link[und][0][value]”:””}},”attributes”:{”alt”:”chapter_17_chart Polleit”,”title”:”chapter_17_chart Polleit”,”style”:”height: 284px; width: 450px;”,”class”:”media-element file-default”,”data-delta”:”1”}}]]

Source: Thomson Financial; own calculations.
*Expressed as the number of national currencies to be paid for a US dollar.

At the same time, the Bundesbank buys French francs and in return offers German marks. This “maneuvre” leads to a shortage of francs and an expansion of the supply of marks. In France there will be downward pressure and in Germany upward pressure on goods prices. If the central banks credibly assure the foreign exchange markets that they are willing to keep exchange rates at the politically desired level, they will be successful: The markets will then not speculate against the prices announced by the central banks.

• 93Jacques Rueff, “L’Europe se fera par la monnaie ou ne se fera pas,” in L’âge de l’inflation (Paris: Payot, 1963), p. 128.
• 94See for example Arwed M. von Poser, Europäische Währungsunion: Der Weg zum Euro-Kapital-markt, 3d ed. (Stuttgart: Deutscher Sparkassen Verlag, 1998).
• 95Germany thus has the same voting rights in the Governing Council as Luxembourg or Slovenia.
• 96See for example Thorsten Polleit, A. M. Poser, “Wieviel Euro für eine D-Mark?” in Zeitschrift für das gesamte Kreditwesen (14/1997).