The blueprint for lopsided monetary union

Making the European Monetary Union, by Harold James, Harvard University Press, RRP£25, 480 pages

It is sometimes said that the euro’s creation was the price demanded by Germany’s European allies for supporting German reunification during the collapse of eastern European and Soviet communism. Reunification supposedly filled Europe’s Lilliputian nations with such fright that they scrambled for a means to tie down the new German Gulliver. The single currency fitted the bill.

In his careful reconstruction of the political, financial and bureaucratic processes that led to the euro’s launch in 1999, Harold James demonstrates that the trail towards European monetary union was, in truth, blazed long before anyone dared even imagine the anti-communist revolutions of 1989-91. It was an aspiration first formulated in 1970 in the so-called Werner plan, named after Pierre Werner, a prime minister of Luxembourg.

A much more elaborate blueprint was developed by a committee chaired by Jacques Delors, the then European Commission president, in a series of meetings held between September 1988 and April 1989 – before the Berlin Wall’s fall in November 1989 and the Soviet Union’s demise two years later. “Those geopolitical events created a new fear in France and other European countries about the extent of the new German power, and led to a search for ways of controlling and circumscribing Germany. But the thinking about the road map to European monetary union was already in place before the dramatic political upheavals that followed from the end of the cold war,” James writes.

A UK-born professor now based at Princeton University, James is one of the world’s leading authorities on the financial history of modern Europe and of Germany in particular. Making the European Monetary Union is a detailed and authoritative text, whose value added comes from its use of previously sealed archival material at the European Central Bank and the Basel-based Bank for International Settlements. The ECB and BIS, a club of world central banks, commissioned the book and so, exceptionally for James, waived the rule that restricts access to their archives for 30 years.

What emerges is a stack of evidence showing that the euro’s origins to a considerable extent lay “in an attempt to devise mechanisms that would generate a more stable global exchange rate regime”. As the postwar Bretton Woods system of fixed exchange rates fell apart and the dollar see-sawed wildly on currency markets, European policy makers searched for ways to limit the disruption to their currencies, economies and common market.

The European “currency snake”, established in 1972, gave way seven years later to the European Monetary System. Neither was entirely successful in limiting exchange rate fluctuations. But the necessity of making a more ambitious attempt became pressing in the 1980s as Europe went ahead with plans for a single market, a measure that heralded the full liberalisation of capital controls.

Among the politicians who pushed hard for monetary union were Edouard Balladur, France’s finance minister, Hans-Dietrich Genscher, West Germany’s foreign minister, and Giuliano Amato, Italy’s Treasury minister. Among the more sceptical voices was Karl Otto Pöhl, the head of Germany’s Bundesbank, the most powerful and credible central bank in Europe.

With almost prophetic insight Pöhl wrote in 1988: “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.”

James covers events from the 1957 Treaty of Rome to the exchange rate crises of 1992-93. The book’s scope therefore does not extend to the euro’s first decade. James nevertheless makes some penetrating comments about why the eurozone is now in such danger.

“The fundamental problem of European monetary union lies in its incompleteness or lopsidedness. There was a much better preparation for the monetary side of monetary union than for the fiscal concomitants that should have underpinned its stability [and prevented the threat of large-scale monetisation of fiscal debt burdens]. No adequate provision on a European basis existed for banking supervision and regulation, which, like fiscal policy, was left to diverse national authorities,” James writes.

Europe’s leaders are, of course, making strenuous efforts to address these deficiencies. Some even suggest that the worst of the crisis is now over. James’s history is a timely reminder that the construction of a multinational currency union was an extraordinary feat – but making a success of it is even harder.

The writer is the FT’s Europe editor

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