Making the European Monetary Union

Harold James' history of the Euro, Making the European Monetary Union - The Role of the Committee of Central Bank Governors and the Origins of the European Central Bank was directly commissioned by the European Central Bank (ECB) and the Bank for International Settlements (BIS) both of whom made their archives containing protocols and minutes available for the author. I have no idea to what extent the Euro crisis played a role in this commission, but it is what makes a rather tedious piece of bureaucratic history a fascinating read.

What is maybe the most important lesson of this history, is how little the issues discussed in years leading up to EMU have fundamentally changed. The following clearly applies to the situation today as much as it refers to the 1950s and the following decades:

"One way of thinking about these imbalances is as a reflection of changes in relative competitiveness. Thus a German surplus was a reflection of favourable development of productivity gains and of wage costs contained by a collaborative and collective approach to wage setting."

What still escapes me to some extent is that "there was a clear economic as well as as political logic behind the creation of a single European economy." James describes this economic logic as the forefathers of the ECB (the aforementioned Committee of Central Bank Governors (the CoG)) looking to overcome "genuine problems of currency instability and misalignment at the international level [meaning the dollar]." Yet, this logic of course contrasts starkly with the misalignments at the European level clearly visible today and also directly runs counter the Bundesbank's preference, expressed here by the President of the New York Fed as late as 1992, for "what they think is the single most important principle of the mechanism [the ESM], i.e., that it be flexible."

People clearly understood the problems associated with a common currency, see the Bundesbank's President Karl Otto Pöhl:

"In a monetary union with irreversibly fixed exchange rates the weak would become ever weaker and the strong ever stronger. We would thus experience great tensions in the real economy of Europe. [...] In order to create a European currency, the governments and parliaments of Europe would have to be prepared to transfer sovereign rights to a supranational institution."

Or the the Italian Finance Minister Giuliano Amato:

"Indeed, there is a "fundamental problem" in the EMS; which can be attributed to the fact that there is no "engine of growth." Not only is the pivot currency of the system fundamentally undervalued, but the growth of domestic demand in Germany is lower than the average; the result is that the country has structural surpluses also vis-à-vis the rest of the EEC. These surpluses, both commercial and current, on the one hand induce tension within the exchange system, pushing up the D-mark, particularly when the dollar drops, and, on the other hand, they remove growth potential from the other nations. In the long run, the cohesion of the system could suffer."

"Pöhl [...] thought that the best option was for the European governments to call on the CoG to investigate a currency union as the endpoint of a process of economic integration,"a point that is still off into the future then. Yet, the Delors Committee, which paved the way for EMU really and of which the European central banks' presidents were members, believed that the "maximum possible extent adjustment should occur by way of market mechanisms" with a Community budget of around 3% providing an additional escape valve. The problem of course today is that the EU's budget still hovers near the 1% mark.

The ECB to large extent has to be seen as the successful upload of the Bundesbank's preferences to the European level ("astonishingly all the committee members agreed with the German position") including central bank independence, the absence of an "explicit role for the ECB in supervising banks," and strict inflation targeting.

Harold James describes the Bundesbank's support for EMU very interestingly - and convincingly - as a way for German central bankers to preserve their independence, which was constantly being threatened by the international agreements German politicians entered into and which undercut the Bundesbank's control over the DM's money supply figures. 

"The Bundesbank was really not strong enough to stand up to such an orchestration of demands, so it needed to cast around for allies. [...] the Bundesbank needed to look more to a European mechanism for building support for its bargaining position in a German context."

History is an inaccurate social science. It is far from clear what lessons James' detailed account offers us then. Most interestingly maybe is the repetitiveness of the arguments we believe to be du jour and the conclusions which were drawn from them then (banking union, reinforced intra-EU financial support mechanisms, deeper economic integration/convergence) as much as today without truly having been put into place neither then nor now.