single currencies are never the product of debates about optimal economic solutions. Instead, currencies like the U.S. dollar itself are the result of political battles, where motivated actors try to centralize power. This has most often occurred “through iron and blood,” as Otto van Bismarck, the unifier of Germany put it, as a result of catastrophic wars. Smaller geographic units were brought together to build the modern nation state, with a unified fiscal system, a common national language that was often imposed by force, a unified legal system, and, a single currency. Put differently (with apologies to sociologist Charles Tilly), war makes the state, and the state makes the currency.
The U.S. case is instructive. America used to have a chaotic multitude of state currencies and privately issued bank notes, with complex exchange rates between them. This only changed thanks to the Civil War. The American greenback was created in 1863 when Abraham Lincoln’s Republican Party muscled through legislation giving the federal government exclusive currency rights. It was only able to do this because Southern legislators, who opposed more centralization of power, had seceded from the American union.
Pointer from Mark Thoma, who comments, “whether the euro was politically motivated for the most part, or not, economics matters for the sustainability of a political union.”
Ouch.
The implicit analogies in McNamara’s article seem pretty shaky.
Admittedly, in the free banking era prior to 1863, the US did sometimes have “a complex multitude of… privately issued bank notes, with complex exchange rates between them”. (It did not have “state currencies”, which had long since been proscribed by the Constitution.)
But these were not multiple currencies in the sense of modern multiple fiat currencies. Private banknotes issued by state-chartered banks were promises to pay specie in terms of a common national standard defined by the federal government, namely the US dollar (which had been defined as “the money of account of the United States” since at least the Coinage Act of 1793!).
The exchange rates of these notes fluctuated because of doubts about the creditworthiness of the state banks that issued them (along with practical difficulties of communication and transportation – if you’re in Maine in 1850, what do you know about an obscure Kentucky bank, and what can you do with its notes?). But these notes were never legal tender, and (as far as I know) they were never used as units of account in their own right. Instead, prices were quoted and contracts written in terms of the US dollar — and bank notes just acted as, well, notes valued at varying dollar prices. The existence of these notes did not offer an easy way for relative dollar prices across regions of the US to adjust, and therefore did not address the traditional shortcoming of monetary union, the one we’re seeing play out in Europe today.
There’s *some* similarity here to the gold standard in its heyday, where multiple currencies existed across countries, but each was defined and redeemable in gold. In this case, too, the existence of multiple currencies did not *directly* allow for cross-country adjustment. The catch is that a gold standard country could – and sometimes did – devalue its currency in terms of gold while maintaining the currency’s legal tender status, which (assuming contracts and prices were specified in units of currency rather than gold itself) automatically realigned all contracts and prices relative to gold and other gold standard currencies. Private banks had no such power.
Basically, McNamara seems to be obscuring distinct roles of currency – which (as economics texts once said) has four functions: “Money is a matter of functions four, a medium [of exchange], a measure [or unit of account], a standard [of deferred payment], a store [of value].”
In the free banking era preceding the Civil War, the US had a national unit of account and standard of deferred payment (the dollar), and to some extent a national medium of exchange and store of value (the dollar coinage); all that it lacked was a national *paper* medium of exchange and store of value. We got that with greenbacks and then national bank notes. This was certainly an important change for several historically contingent reasons (the most immediate of which was that the US printed so many greenbacks during the Civil War and its credit was so in doubt that it had to suspend convertibility for almost 2 decades). But it’s deeply misleading to view this process as analogous to the monetary union of Europe, unless perhaps you’re talking about the very last – and relatively trivial – stage of union (the part where each country’s notes were literally replaced with euro notes).
Also, can I complain about how inaccurate this passage is? How many subtle inaccuracies can you fit into one sentence?
“The American greenback was created in 1863 when Abraham Lincoln’s Republican Party muscled through legislation giving the federal government exclusive currency rights.”
No, the first “greenback” was created in 1861 when the US government printed Demand Notes to pay its bills (suspending convertibility into specie near the end of the year), which were followed up by the United States Notes in 1862. The latter was declared by Congress to be legal tender for most purposes, and effectively defined the “dollar” unit for the purpose of prices and contracts.
I assume that the “1863” reference is to the first National Bank Act, which began the system of national currency that would ultimately last until the Federal Reserve Act 50 years later. But that law and its immediate successors hardly gave the federal government “exclusive currency rights”; it did create a unified system by which national banks could pay a tax to issue notes, which would be printed by the government and backed by government bonds deposited by the national banks. (As the tax and requirement of government bonds as collateral made clear, this was largely a revenue-raising project by the government.)
Compared to the direct issuance of greenbacks, though, the system of national bank notes was actually less “exclusive” to the federal government; and it was not very exclusive at all until the federal government got around to taxing state bank note issuance out of existence in 1865.
Of course the Euro was both politically motivated and known to be economically problematic in its inaugural form (with apparent cynicism, cheating, and willful blindness on all sides regarding what it took to get Greece and others into the club).
But the idea was that, “Yes, a lot more is required to make this economically sustainable, but those measures are politically unpalatable and infeasible at present. So (1) we need to prepare the battlefield and soften the hard targets and gradually win hearts and minds, and (2) the panic-induced sudden politically-flexibility caused and justifiable by the occasional crisis can be leveraged to agitate for more, politically-hard convergence (i.e. fiscal prudence and neoliberal reforms) from the periphery states, and more centralization overall, including the “fiscal transfer mechanisms” (in exchange for the dominance of fiscal policy by Brussels) that help to smooth out the gaps, distortions, and frictions in non-optimal unified currency areas.
But those best laid schemes gang aft agley.