Benjamin J. Cohen, University of California at Santa Barbara
Monetary tradition has long assumed that, in principle, each sovereign state issues and manages its own exclusive currency. In practice, however, there have always been exceptions — countries that elected to join together in a monetary union of some kind. Not all monetary unions have stood the test of time; in fact, many past initiatives have long since passed into history. Yet interest in monetary union persists, stimulated in particular by the example of the European Union’s Economic and Monetary Union (EMU), which has replaced a diversity of national monies with one joint currency called the euro. Today, the possibility of monetary union is actively discussed in many parts of the world.
A monetary union may be defined as a group of two or more states sharing a common currency or equivalent. Although some sources extend the definition to include the monetary regimes of national federations such as the United States or of imperial agglomerations such as the old Austro-Hungarian Empire, the conventional practice is to limit the term to agreements among units that are recognized as fully sovereign states under international law. The antithesis of a monetary union, of course, is a national currency with an independent central bank and a floating exchange rate.
In the strictest sense of the term, monetary union means complete abandonment of separate national currencies and full centralization of monetary authority in a single joint institution. In reality, considerable leeway exists for variations of design along two key dimensions. These dimensions are institutional provisions for (1) the issuing of currency and (2) the management of decisions. Currencies may continue to be issued by individual governments, tied together in an exchange-rate union. Alternatively, currencies may be replaced not by a joint currency but rather by the money of a larger partner — an arrangement generically labeled dollarization after the United States dollar, the money that is most widely used for this purpose. Similarly, monetary authority may continue to be exercised in some degree by individual governments or, alternatively, may be delegated not to a joint institution but rather to a single partner such as the United States.
In political terms, monetary unions divide into two categories, depending on whether national monetary sovereignty is shared or surrendered. Unions based on a joint currency or an exchange-rate union in effect pool monetary authority to some degree. They are a form of partnership or alliance of nominal equals. Unions created by dollarization are more hierarchical, a subordinate follower-leader type of regime.
The greatest attraction of a monetary union is that it reduces transactions costs as compared with a collection of separate national currencies. With a single money or equivalent, there is no need to incur the expense of currency conversion or hedging against exchange risk in transactions among the partners. But there are also two major economic disadvantages for governments to consider.
First, individual partners lose control of both the money supply and exchange rate as policy instruments to cope with domestic or external disturbances. Against a monetary union’s efficiency gains at the microeconomic level, governments must compare the cost of sacrificing autonomy of monetary policy at the macroeconomic level.
Second, individual partners lose the capacity derived from an exclusive national currency to augment public spending at will via money creation — a privilege known as seigniorage. Technically defined as the excess of the nominal value of a currency over its cost of production, seigniorage can be understood as an alternative source of revenue for the state beyond what can be raised by taxes or by borrowing from financial markets. Sacrifice of the seigniorage privilege must also be compared against a monetary union’s efficiency gains.
The seriousness of these two losses will depend on the type of monetary union adopted. In an alliance-type union, where authority is not surrendered but pooled, monetary control is delegated to the union’s joint institution, to be shared and in some manner collectively managed by all the countries involved. Hence each partner’s loss is simultaneously also each other’s gain. Though individual states may no longer have much latitude to act unilaterally, each government retains a voice in decision-making for the group as a whole. Losses will be greater with dollarization, which by definition transfers all monetary authority to the dominant power. Some measure of seigniorage may be retained by subordinate partners, but only with the consent of the leader.
The idea of monetary union among sovereign states was widely promoted in the nineteenth century, mainly in Europe, despite the fact that most national currencies were already tied together closely by the fixed exchange rates of the classical gold standard. Further efficiency gains could be realized, proponents argued, while little would be lost at a time when activist monetary policy was still unknown.
“Universal Currency” Fails, 1867
Most ambitious was a projected “universal currency” to be based on equivalent gold coins issued by the three biggest financial powers of the day: Britain, France, and the United States. As it happened, the gold content of French coins at the time was such that a 25-franc piece — not then in existence but easily mintable — would if brought into existence have contained 112.008 grains of gold, very close to both the English sovereign (containing 113.001 grains) and American half-eagle, equal to five dollars (containing 116.1 grains). Why not, then, seek some sort of standardization of coinage among the three countries to achieve the equivalent of one single money? That was the proposal of a major monetary conference sponsored by the French Government to coincide with an international exposition in Paris in 1867. Delegates from some 20 countries, with the critical exception of Britain’s representatives, enthusiastically supported creation of a universal currency based on a 25-franc piece and called for appropriate reductions in the gold content of the sovereign and half-eagle. In the end, however, no action was taken by either London or Washington, and for lack of sustained political support the idea ultimately faded away.
Latin Monetary Union
Two years before the 1867 conference, however, the French Government did succeed in gaining agreement for a more limited initiative — the Latin Monetary Union (LMU). Joining Belgium, Italy, and Switzerland together with France, the LMU was intended to standardize the existing gold and silver coinages of all four countries. Greece subsequently adhered to the terms of the LMU in 1868, though not becoming a formal member until 1876. In practical terms, a monetary partnership among these countries had already begun to coalesce even earlier as a result of independent decisions by Belgium, Greece, Italy, and Switzerland to model their currency systems on that of France. Each state chose to adopt a basic unit equal in value to the French franc — actually called a franc in Belgium and Switzerland — with equivalent subsidiary units defined according to the French-inspired decimal system. Starting in the 1850s, however, serious Gresham’s Law type problems developed as a result of differences in the weight and fineness of silver coins circulating in each country. The LMU established uniform standards for national coinages and, by making each member’s money legal tender throughout the Union, effectively created a wider area for the circulation of a harmonized supply of specie coins. In substance a formal exchange-rate union was created, with the authority for management of participating currencies remaining with each separate government.
As a group, members were distinguished from other countries by the reciprocal obligation of their central banks to accept one another’s coins at par and without limit. Soon after its founding, however, beginning in the late 1860s, the LMU was subjected to considerable strain owing to a global glut of silver production. The resulting depreciation of silver eventually led to a suspension of silver coinage by all the partners, effectively transforming the LMU from a bimetallic standard into what came to be called a “limping gold standard.” Even so, the arrangement managed to hold together until the generalized breakdown of global monetary relations during World War I. The LMU was not formally dissolved until 1927, following Switzerland’s decision to withdraw during the previous year.
Scandinavian Monetary Union
A similar arrangement also emerged in northern Europe — the Scandinavian Monetary Union (SMU), formed in 1873 by Sweden and Denmark and joined two years later by Norway. The Scandanavian Monetary Union too was an exchange-rate union designed to standardize existing coinages, although unlike the LMU the SMU was based from the start on a monometallic gold standard. The Union established the krone (crown) as a uniform unit of account, with national currencies permitted full circulation as legal tender in all three countries. As in the LMU, members of the SMU were distinguished from outsiders by the reciprocal obligation to accept one another’s currencies at par and without limit; also as in the LMU, mutual acceptability was initially limited to gold and silver coins only. In 1885, however, the three members went further, agreeing to accept one another’s bank notes and drafts as well, thus facilitating free intercirculation of all paper currency and resulting eventually in the total disappearance of exchange-rate quotations among the three moneys. By the turn of the century the SMU had come to function, in effect, as a single unit for all payments purposes, until relations were disrupted by the suspension of convertibility and floating of individual currencies at the start of World War I. Despite subsequent efforts during and after the war to restore at least some elements of the Union, particularly following the members’ return to the gold standard in the mid-1920s, the agreement was finally abandoned following the global financial crisis of 1931.
German Monetary Union
Repeated efforts to standardize coinages were made as well by various German states prior to Germany’s political union, but with rather less success. Early accords, following the start of the Zollverein (the German region’s customs union) in 1834, ostensibly established a German Monetary Union — technically, like the LMU and SMU, also an exchange-rate union — but in fact divided the area into two quite distinct currency alliances: one encompassing most northern states, using the thaler as its basic monetary unit; and a second including states in the south, based on the florin (also known as the guilder or gulden). Free intercirculation of coins was guaranteed in both groups but not at par: the exchange rate between the two units of account was fixed at one thaler for 1.75 florins (formally, 14: 24.5) rather than one-for-one. Moreover, states remained free to mint non-standardized coins in addition to their basic units, and many important German states (e.g., Bremen, Hamburg, and Schleswig-Holstein) chose to stay outside the agreement altogether. Nor were matters helped much by the short-lived Vienna Coinage Treaty signed with Austria in 1857, which added yet a third currency, Austria’s own florin, to the mix with a value slightly higher than that of the south German unit. The Austro-German Monetary Union was dissolved less than a decade later, following Austria’s defeat in the 1866 Austro-Prussian War. A full merger of all the currencies of the German states did not finally arrive until after consolidation of modern Germany, under Prussian leadership, in 1871.
The only truly successful monetary union in Europe prior to EMU came in 1922 with the birth of the Belgium-Luxembourg Economic Union (BLEU), which remained in force for more than seven decades until blended into EMU in 1999. Following severance of its traditional ties with the German Zollverein after World War I, Luxembourg elected to link itself commercially and financially with Belgium, agreeing to a comprehensive economic union including a merger of their separate money systems. Reflecting the partners’ considerable disparity of size (Belgium’s population is roughly thirty times Luxembourg’s), Belgian francs under BLEU formed the largest part of the money stock of Luxembourg as well as Belgium, and alone enjoyed full status as legal tender in both countries. Only Belgium, moreover, had a full-scale central bank. The Luxembourg franc was issued by a more modest institution, the Luxembourg Monetary Institute, was limited in supply, and served as legal tender just within Luxembourg itself. Despite the existence of formal joint decision-making bodies, Luxembourg in effect existed largely as an appendage of the Belgian monetary system until both nations joined their EU partners in creating the euro.
Monetary Disintegration
Europe in the twentieth century has also seen the disintegration of several monetary unions, usually as a by-product of political dissent or dissolution. A celebrated instance occurred after World War I when the Austro-Hungarian Empire was dismembered by the Treaty of Versailles. Almost immediately, in an abrupt and quite chaotic manner, new currencies were introduced by each successor state — including Czechoslovakia, Hungary, Yugoslavia, and ultimately even shrunken Austria itself — to replace the old imperial Austrian crown. Comparable examples have also been provided more recently, after the end of the Cold War, following fragmentation along ethnic lines of both the Czechoslovak and Yugoslav federations. Most spectacular was the collapse of the former ruble zone following the break-up of the seven-decade-old Soviet Union in late 1991. Out of the rubble of the ruble no fewer than a dozen new currencies emerged to take their place on the world stage.
Outside Europe, the idea of monetary union was promoted mainly in the context of colonial or other dependency relationships, including both alliance-type and dollarization arrangements. Though most imperial regimes were quickly abandoned in favor of newly created national currencies once decolonization began after World War II, a few have survived in modified form to the present day.
British Colonies
Alliance-type arrangements emerged in the colonial domains of both Britain and France, the two biggest imperial powers of the nineteenth century. First to act were the British, who after some experimentation succeeded in creating a series of common currency zones, each closely tied to the pound sterling through the mechanism of a currency board. With a currency board, exchange rates were firmly pegged to the pound and full sterling backing was required for any new issue of the colonial money. Joint currencies were created first in West Africa (1912) and East Africa (1919) and later for British possessions in Southeast Asia (1938) and the Caribbean (1950). In southern Africa, an equivalent zone was established during the 1920s based on the South African pound (later the rand), which became the sole legal tender in three of Britain’s nearby possessions, Bechuanaland (later Botswana), British Basutoland (later Lesotho), and Swaziland, as well as in South West Africa (later Namibia), a former German colony administered by South Africa under a League of Nations mandate. Of Britain’s various arrangements, only two still exist in some form.
East Caribbean
One is in the Caribbean, where Britain’s monetary legacy has proved remarkably durable. The British Caribbean Currency Board evolved first into the Eastern Caribbean Currency Authority in 1965 and then the Eastern Caribbean Central Bank in 1983, issuing one currency, the Eastern Caribbean dollar, to serve as legal tender for all participants. Included in the Eastern Caribbean Currency Union (ECCU) are the six independent microstates of Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines, plus two islands that are still British dependencies, Anguilla and Montserrat. Embedded in a broadening network of other related agreements among the same governments (the Eastern Caribbean Common Market, the Organization of Eastern Caribbean States), the ECCU has functioned without serious difficulty since its formal establishment in 1965.
Southern Africa
The other is in southern Africa, where previous links have been progressively formalized, first in 1974 as the Rand Monetary Area, later in 1986 under the label Common Monetary Area (CMA), though, significantly, without the participation of diamond-rich Botswana, which has preferred to rely on its own national money. The CMA started as a monetary union tightly based on the rand, a local form of dollarization reflecting South Africa’s economic dominance of the region. But with the passage of time the degree of hierarchy has diminished considerably, as the three remaining junior partners have asserted their growing sense of national identity. Especially since the 1970s, the arrangement has been transformed into a looser exchange-rate union as each of South Africa’s partners introduced its own distinct national currency. One of them, Swaziland, has even gone so far as to withdraw the rand’s legal-tender status within its own borders. Moreover, though all three continue to peg their moneys to the rand at par, they are no longer bound by currency board-like provisions on money creation and may now in principle vary their exchange rates at will.
Africa’s CFA Franc Zone
In the French Empire monetary union did not arrive until 1945, when the newly restored government in Paris decided to consolidate the diverse currencies of its many African dependencies into one money, le franc des Colonies Françaises d’Afrique (CFA francs). Subsequently, in the early 1960s, as independence came to France’s African domains, the old colonial franc was replaced by two new regional currencies, each cleverly named to preserve the CFA franc appellation: for the eight present members of the West African Monetary Union, le franc de la Communauté Financière de l’Afrique, issued by the Central Bank of West African States; and for the six members of the Central African Monetary Area, le franc de la Coopération Financière Africaine, issued by the Bank of Central African States. Together the two groups comprise the Communauté Financière Africaine (African Financial Community). Though each of the two currencies is legal tender only within its own region, the two are equivalently defined and have always been jointly managed under the aegis of the French Ministry of Finance as integral parts of a single monetary union, popularly known as the CFA Franc Zone.
Elsewhere imperial powers preferred some version of a dollarization-type regime, promoting use of their own currencies in colonial possessions to reinforce dependency relationships — though few of these hierarchical arrangements survived the arrival of decolonization. The only major exceptions are to be found among smaller countries with special ties to the United States. Most prominently, these include Panama and Liberia, two states that owe their very existence to U.S. initiatives. Immediately after gaining its independence in 1903 with help from Washington, Panama adopted America’s greenback as its national currency in lieu of a money of its own. In similar fashion during World War II, Liberia — a nation founded by former American slaves — made the dollar its sole legal tender, replacing the British West African colonial coinage that had previously dominated the local money supply. Other long-time dollarizers include the Marshall Islands, Micronesia, and Palau, Pacific Ocean microstates that were all once administered by the United States under United Nations trusteeships. Most recently, the dollar replaced failed local currencies in Ecuador in 2000 and in El Salvador in 2001 and was adopted by East Timor when that state gained its independence in 2002.
Europe’s Monetary Union
The most dramatic episode in the history of monetary unions is of course EMU, in many ways a unique undertaking — a group of fully independent states, all partners in the European Union, that have voluntarily agreed to replace existing national currencies with one newly created money, the euro. The euro was first introduced in 1999 in electronic form (a “virtual” currency), with notes and coins following in 2002. Moreover, even while retaining political sovereignty, member governments have formally delegated all monetary sovereignty to a single joint authority, the European Central Bank. These are not former overseas dependencies like the members of ECCU or the CFA Franc Zone, inheriting arrangements that had originated in colonial times; nor are they small fragile economies like Ecuador or El Salvador, surrendering monetary sovereignty to an already proven and popular currency like the dollar. Rather, these are established states of long standing and include some of the biggest national economies in the world, engaged in a gigantic experiment of unprecedented proportions. Not surprisingly, therefore, EMU has stimulated growing interest in monetary union in many parts of the world. Despite the failure of many past initiatives, the future could see yet more joint currency ventures among sovereign states.
Bartel, Robert J. “International Monetary Unions: The XIXth Century Experience.” Journal of European Economic History 3, no. 3 (1974): 689-704.
Bordo, Michael, and Lars Jonung. Lessons for EMU from the History of Monetary Unions. London: Institute of Economic Affairs, 2000.
Capie, Forrest. “Monetary Unions in Historical Perspective: What Future for the Euro in the International Financial System.” In Ideas for the Future of the International Monetary System, edited by Michele Fratianni, Dominick Salvatore, and Paolo Savona., 77-95. Boston: Kluwer Academic Publishers, 1999.
Cohen, Benjamin J. “Beyond EMU: The Problem of Sustainability.” In The Political Economy of European Monetary Unification, second edition, edited by Barry Eichengreen and Jeffry A. Frieden, 179-204.Boulder, CO: Westview Press, 2001.
Cohen, Benjamin J. The Geography of Money. Ithaca, NY: Cornell University Press, 1998.
De Cecco, Marcello. “European Monetary and Financial Cooperation before the First World War.” Rivista di Storia Economica 9 (1992): 55-76.
Graboyes, Robert F. “The EMU: Forerunners and Durability.” Federal Reserve Bank of Richmond Economic Review 76, no. 4 (1990): 8-17.
Hamada, Koichi, and David Porteous. L’Intégration Monétaire dans Une Perspective Historique.” Revue d’Économie Financière 22 (1992): 77-92.
Helleiner, Eric. The Making of National Money: Territorial Currencies in Historical Perspective. Ithaca, NY: Cornell University Press, 2003.
Perlman, M. “In Search of Monetary Union.” Journal of European Economic History 22, no. 2 (1993): 313-332.
Vanthoor, Wim F.V. European Monetary Union Since 1848: A Political and Historical Analysis. Brookfield, VT: Edward Elgar, 1996.