“The man who in the view of gain thinks of righteousness; who in the view of danger is prepared to give up his life; and who does not forget an old agreement however far back it extends – such a man may be reckoned a complete man” – Confucius  

Throughout history, agreements have been made and broken.  In the Ukraine, Russia is breaking its agreement signed in 1994 that stipulates Ukraine will be an independent state.  Agreements give people a sense of security and assurance that the rules of the game are set.  When agreements are broken, uncertainty and sometimes chaos ensue.  Europe is very concerned about Russia’s advance in the Ukraine, as they should be.  History is replete with occurrences’ like this.  Even one of Angela Merkel’s role models, Catherine the Great, was responsible for conquering Crimea and annexing it to Russia in 1783 saying “from now until the end of time.”  This is why it is so important to remember and learn from history.

The Euro turned 15 years old in January.   This is not the first time Europe has tried to have a homogenous currency.    Below is a brief history of the more successful agreements:

Gold Based Agreements:

Latin Monetary Union (1865-1927) 62 years

This was a monetary union comprised of five countries – France, Italy, Belgium, Switzerland and Greece.   It was a union very much like the current European Union.  It was created to promote trade among members while also serving as a stepping stone to a full monetary union.   The one noticeable difference was that the currencies of each country had to be backed by gold and/or silver.  There was a central bank like the ECB whose purpose it was to coordinate monetary policy around the five countries.  This union lasted until 1927.  It had lost steam long before that as the will to coordinate policy between members lost momentum.  It finally collapsed when both France and Italy, under pressure to re-inflate their domestic economies, started issuing paper money that was backed by neither gold nor silver.

Scandinavian Monetary Union (1873-1920) – 47 years

This was a monetary union consisting of three countries – Denmark, Sweden and Norway.  All three recognized each others’ gold coinage as well as token coins as legal tender.  As Scandinavian schemes go, this one worked very well.  Between 1905 and 1924, no exchange rates among the three currencies were available as the one currency among the three countries prevailed.   The SMU had an unofficial central bank with pooled reserves.  It extended credit lines to each of the three countries.  As long as the gold supply was limited, the Scandinavian Kronor held its ground.   The beginning of the end began when governments started to finance their deficits by dumping gold during World War I (and thus erode their debts by fostering inflation through a string of devaluations).  In an unparalleled act of arbitrage, central banks then turned around and used the depreciated currencies to buy gold at official (cheap) rates.  When Sweden refused to continue to sell its gold at the officially fixed price – the other members declared economic war.  They forced Sweden to purchase enormous quantities of their token coins.  The proceeds were used to buy the much stronger Swedish currency at an ever cheaper price (as the price of gold collapsed).  Sweden found itself subsidizing an arbitrage against its own economy.  It inevitably reacted by ending the import of other members’ tokens. This internal currency war destroyed the union.

Non- Gold based Agreements:

The Snake (1971-1979) 8 years

The snake was created by and between Belgium, Denmark, France, West Germany, Ireland, Italy, Luxembourg, Netherlands and the United Kingdom.  Because currencies were not backed by gold, each member agreed to limit, by market intervention if necessary, the fluctuations of its exchange rate against other members’ currencies.  The maximum permitted divergence between the strongest and weakest currencies was 2.25%.  The agreement meant that, for example, France would ensure that the value of the French franc would experience only very limited fluctuation against the Italian lira, or the Dutch guilder, but that there was no commitment to limit or smooth out fluctuations against the US dollar, Japanese Yen, or any other currencies outside the agreement.  The idea was that while there might be frantic volatility against other major currencies, the European currencies would never move very much against each other.  It would encourage trade among members of the Snake and it would start to behave as a single block.  The trouble was it didn’t work very well.

Britain and Ireland tried it for a month and then gave up and withdrew.  The French found it too hard to stay the course and so did the Italians.  Only the Germans, with typical determination, remained members to the end of the system.  Countries stayed in when it was easy to maintain membership, but generally opted out as soon as the exchange rate mandated by the system became to difficult to defend.  The flaw in the system was simple.  It was created to fight currency markets.  The only way, for example, the franc-deutschmark rate could be defended was if the Bank of France intervened to buy francs as soon as currency traders started selling them, but that quickly became ruinously expensive to the central bank.  By 1979, the system became a joke: it was merely a way of transferring wealth from taxpayers to bankers.

European Monetary System – ECU (European Currency Unit) (1979-1992) 13 years

The ECU was a basket of each member’s currencies, weighted in terms of the respective size of their economies.  Each member of the system undertook to manage the value of its currency against the value of the ECU.  It worked in much the same way as the Snake in that it stabilized exchange rates between member states of the ECU, while allowing them to fluctuate against the rest of the world’s currencies.  The standard maximum exchange rate fluctuation permitted for each EMS currency was 2.25%.  However, there were wider bands for weaker members, such as with Italy from 1979 and thereafter, Spain from 1989 and thereafter and UK from 1990 and thereafter.  The trouble was there wasn’t a huge amount of stability in the system when any one country might suddenly need to revalue the rate at which its currency was traded against the notional ECU.  The system blew apart after Britain joined.  In 1992, with a deep recession in the UK, currency traders were selling the pound.  The bank of England was finding it impossible to defend the rate against the ECU (and, in effect, against the German Deutschmark).  The German central bank showed no inclination to help out by intervening in the markets on behalf of the pound or by adjusting its own interest rates to bring them more into line with Britain.  After a desperate battle with the markets, which cost the Bank of England billions of pounds in foreign exchange reserves, the British were forced out of the system.  Soon afterward, the trading bands for the EMS were widened to 15% and the EMS was in effect dead.

Final Thoughts:  As history shows, currency unions work when things are good, but are difficult to maintain under stress.  The Euro has lasted the longest of any union not backed by gold, but there are visible signs of significant problems.  The potential May election to the EU parliament of anti-Euro candidates is one example.    Putin’s taking over Crimea and the Ukraine’s need for billions in aid to help stabilize the country are others.  These will certainly add stress to the Euro.