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First try at European money union didn’t work either

Politics – not profligate spending – could be the ultimate stumbling block for the euro.

As Greece and its euro zone lenders hammer out the details of its third bailout package, the focus is on budget deficits and other financial fixes. But if history is any guide, politics – not profligate spending – could be the ultimate stumbling block for the euro.

More than a century after Europe’s last failed attempt at a currency union, countries on the Continent are again ignoring the political consequences of their economic endeavours. That oversight could have dire consequences. “Currency and money are much more interconnected with political control than most people think,” said Charles Goodhart, emeritus professor at the London School of Economics and formerly a member of the Bank of England’s monetary policy committee.

Politics was the undoing of the Latin Monetary Union, created in 1865 to help European countries trade more easily and boost their weight in the global financial system. That year delegates from Belgium, France, Italy and Switzerland convened in Paris and agreed to standardise their metal-backed currencies to stabilise their economies, which were being hammered by new gold and silver discoveries around the world.

In reality, the currency union, which expanded to include Greece, Serbia and other countries, lurched from crisis to crisis as members pursued their own economic fate at the expense of others. Even the Papal State treasurer, Cardinal Giacomo Antonelli, tried to game the system by minting less-than-pure silver coins. At one point Greece left the Latin Monetary Union for a few years – foreshadowing German finance minister Wolfgang Schäuble’s proposal for a similar solution to the latest euro crisis drama.

When World War One hit, winning the war became more pressing than economic concerns, and the union fell apart, as did a similar currency union in Scandinavia. All told, the currency union lasted about 60 years before it dissolved completely.

Currencies that have endured, like the pound sterling and the dollar, exist in sovereign states where financial decisions are closely tied to policymaking. They’ve lasted through different financial arrangements – from the gold standard to Bretton Woods, through war and inflation.

A currency, more than anything, is a symbol of modern statehood, said Jacob Funk Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington. Currencies tend to last as long as the country that mints them. The Yugoslav dinar, for example, fell out of circulation when the country split. When the Soviet Union splintered, new independent states abandoned the ruble for their own currencies. Money “has a lot of political symbolism,” said Kirkegaard.

There is a lot of political symbolism behind the euro as well. A common currency was supposed to bring countries closer together and fend off the threat of a European war. However, the Maastricht Treaty, which set up the original parameters of the euro, put money-making power in the hands of a supranational body independent of individual governments. European policymakers broke the traditional links between political sovereignty and money creation to a far greater extent than ever before.

The result is a currency union where monetary policy again pays little heed to politics – which is especially problematic today, when European politics are infinitely more complicated. Leaders of euro zone countries are democratically elected and the euro is freely floating, not backed by gold or silver. That provides far more uncertainty for how to solve economic issues.

Just look at the referendum that Greek Prime Minister Alexis Tsipras called last month in order to get leverage with his euro zone partners. In the end it had the opposite effect on the negotiations – and was a brutal lesson in realpolitik for the new leader.

For a country to leave the euro and successfully introduce its own currency, it would have to limit cross-border travels for its citizens and implement capital controls, not to mention more logistical and legal overhauls like rewriting pages of existing labor, mortgage other financial contracts as well as lines of computer code in payment machines, according to Barry Eichengreen, economic history professor at the University of California, Berkeley. None of those measures would sit well with voters, but they would be necessary to keep cash from fleeing while a country introduces a new currency.

The opposite extreme – true political integration – is unlikely as well. While euro zone countries have moved toward more centralisation, they are far from repairing the link between politics and monetary policymaking.

So what does the future hold?

The examples of Ireland, Greece and other smaller euro zone countries that have run into trouble over the years show that for the most part, when countries weigh the cost of leaving versus a monetary policy that is less than ideal for their economies, they will choose to stay.

It also means that the euro will likely continue to lurch from crisis to crisis, in many cases fuelling existing problems in countries with policies that tend to magnify economic fluctuations. For example, even when the Irish housing market was on fire, the European Central Bank threw gas on it by lowering interest rates. If Greece had control over its own money-making, it would have a host of options to boost its economy that it is lacking today.

What once started as a hopeful project intended to bring peace and prosperity to Europe has in just two decades been transformed into a symbol of confinement and dread. While voters in many countries have soured on the idea of a common currency, fear over the alternatives keep them fettered for now.


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