AS Europe moves towards a single currency at a steady, albeit slightly uneasy pace, it is worth examining previous attempts to achieve a system of fixed exchange rates between different countries or trading areas. Typically, these systems worked for a while before eventually disintegrating in the face of some unanticipated event which highlighted the inadequacies of the particular arrangement.
The Gold Standard was a system whereby each domestic currency was convertible into a fixed quantity of gold. So in effect different currencies were linked to each other at fixed rates through gold. The first country to go on the Gold Standard was Great Britain in 1816 and the system had a very checkered history until it eventually collapsed in the aftermath of the Wall Street crash in 1929 and the subsequent Great Depression.
One of the main problems with the system was that the value of gold fluctuated and consequently countries had different inflation rates and large imbalances arose on the current account. Countries left and rejoined the system on various occasions but as often as not political pride forced them to reenter at previous parities, which were often too high.
In 1944, a major international conference was held in Bretton Woods in the United States to try once more to achieve international monetary cooperation, promote exchange rate stability and avoid competitive exchange rate depreciation. Two years later the Bretton Woods system of pegged but adjustable exchange rates was formed. This system delivered long periods of stability, but was also punctuated by numerous crises, including two very disruptive devaluations of sterling in 1949 and 1967. The system was formally abandoned in 1973 having failed to cope with changed economic circumstances.
This experiment was followed in Europe by the "Snake", which was an arrangement to limit fluctuations between participants' exchange rates to +/- 2.25 per cent. This system had a very difficult life. Sterling was forced out after a brief period, it was followed by the lira, and France was forced out twice. It failed to work because participants were unwilling to take the measures needed to cope with the changed economic circumstances following the first oil crisis.
However, this first attempt at European currency stability provided the necessary encouragement to launch the EMS and its fixed but adjustable exchange rate parities in 1979. This system had a rocky start, with a number of realignments in the early years, but gradually it became more stable as economic convergence occurred. However, once again it failed to cope with the external shock represented by German unification.
The unwillingness of participants to devalue against the Deutschmark forced them to live with interest rates which were totally inappropriate to their own domestic situations but totally appropriate to Germany's changed circumstances. After much huffing and puffing and considerable displays of political machismo, the system was effectively dismantled in August 1993.
In looking at the current move towards a single currency, a number of problems can be identified. The "hard core" group of countries are closely linked and broadly satisfy the economic requirements for a stable currency arrangement. However, when the peripheral countries are included, the situation becomes less clear cut. At a minimum the broad group of countries would all need wage and price flexibility to cope with asymmetric shocks, flexible labour markets, similar trade structures and correlated business cycles.
Furthermore, various Bundesbank officials and others argue that political union should precede economic and monetary union and certainly it would appear that Europe is still some distance away from a single fiscal entity, a common foreign policy, the removal of border controls and a federal government structure. On top of all this, Europe is facing a serious unemployment crisis and if this is not successfully addressed, a broad based single currency could have a difficult birth and afterlife.
