Will the Eurozone Collapse? Lessons from the 19th Century

Not a week went by in 2012 without some much-echoed warning about the Eurozone’s imminent collapse. Every election in some European fringe state, every meeting of the ECB board, every phone call by Angela Merkel was interpreted as an event that would either save or doom the common currency. Behind this panic lay the belief, regularly expressed in The Economist’s briefings, that the Eurozone was so flawed in its construction that it either had to choose the path of radical reform and become some form of fiscal union, or break apart.

Surprisingly, the crisis of the European treasury bond markets appears to be over now, and yet the Eurozone has neither collapsed nor transformed itself into a fiscal union. This development defies the logic of everything we have read over the past year. And yet, a look at the 19th century indicates that a breakup of the Euro was perhaps never as likely as most journalists and economists liked to claim.

The Euro is usually portrayed as a bold experiment without precedent. This view ignores the fact that much of 19th century Europe had something of a common currency for many decades: The Latin Monetary Union. Last summer, I wrote a lengthy feature on the union for Die Welt am Sonntag. Those who can read German can take a look at it here: http://www.welt.de/finanzen/article108413049/Schon-1908-tricksten-die-Griechen-beim-Geld.html.

The Latin Monetary Union was formed by Belgium, France, Italy and Switzerland in 1865 and soon included Greece, Spain, Romania, Bulgaria, Serbia and Austria-Hungary. Unlike the Euro, back then the coins of each state could keep their name, but they became mutually exchangeable at a fixed rate of 1:1.

The union soon slid into serious crisis because, guess what, fiscally irresponsible Greece and Italy abused the union’s flawed construction for their own financial gain. I will spare you the economic details (you can read more about it in Luca Einaudi’s “From the franc to the ‘Europe’: the attempted transformation of the Latin Monetary Union into a European Monetary Union, 1865-1873“, in Journal of Economic History, Vol. 53, No.2, 2000), but essentially the coins were based on a bimetallic standard that overvalued silver. Italy and Greece, chronically on the verge of bankruptcy, printed a myriad of silver coins and paper banknotes that soon led to an outflow of coins into the union’s other member states, where they caused inflation.

The states of the south lived above their means, and the fiscally prudent states of the north, in this case Belgium and France, paid the bill. The nature of public opinion in the latter was quite similar to that in Germany today, and Belgium came very close to leaving the union at least once. The union never really worked, and yet it weathered numerous financial crises and stayed intact until World War I. This longevity was due to the fact that a breakup would have cost France and Belgium dearly, since the overvalued silver coins would have immediately lost a lot of value.

Even though the union was dysfunctional and in an almost permanent state of crisis, it lasted for more than 30 years after Belgium first threatened exit and was only destroyed in the wake of the disastrous First World War that took down the old European economic order.

There are many differences between the Latin Monetary Union and the Euro and I do not mean to imply that the Euro will last a long time because its predecessor did. Compared to the Euro, the LMU was a rather loose network that didn’t even apply to banknotes. But what the example of the LMU shows us is that a monetary union can be quite resilient even if it doesn’t really work. As long as the political will is there and the cost of breakup significant enough, we shouldn’t be surprised if it survives without radically reforming itself. It took a World War to break up the Latin Monetary Union, and it may take a lot more than an election victory by Silvio Berlusconi on Sunday to doom the Euro.

 

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