The euro is still a very young currency. When watching the struggles of the European Union over the the euro, it\’s worth remembering that it too the US dollar a long time to become a functional currency. Jeffry Frieden looks at \”Lessons for the Euro from Early American Monetary and Financial Experience,\” in a contribution written for the Bruegel Essay and Lecture Series published May 2016. Frieden\’s lecture on the paper can be watched here. Here\’s how Frieden starts:
\”Europe’s central goal for several decades has been to create an economic union that can provide monetary and financial stability. This goal is often compared, both by those that aspire to an American-style fully federal system and by those who would like to stop short of that, to the long-standing monetary union of the United States. The United States, after all, created a common monetary policy, and a banking union with harmonised regulatory standards. It backs the monetary and banking union with a series of automatic fiscal stabilisers that help soften the potential problems inherent in inter-regional variation.
Easy celebration of the successful American union ignores the fact that it took an extremely long time to accomplish. In fact, the completion of the American monetary, fiscal, and financial union is relatively recent. Just how recent depends on what one counts as an economic and monetary union, and how one counts. Despite some early stops and starts, the United States did not have an effective national currency until 75 years after the Constitution was adopted, starting with the National Banking Acts of 1863 and 1864. And only after another fifty years did the country have a central bank. Financial regulations have been fragmented since the founding of the Republic; many were federalised in the 1930s, but many remain decentralised. And most of the fiscal federalist mechanisms touted as prerequisites for a successful monetary union date to the 1930s at the earliest, and in some cases to the 1960s. The creation and completion of the American monetary and financial union was a long, laborious and politically conflictual process.
Freiden focuses in particular on some seminal events from the establishment of the US dollar. For example, there\’s a discussion of \”Assumption,\” the policy under which Alexander Hamilton had \”the Federal government recognise the state debts and exchange them for Federal obligations, which would be serviced.This meant that the Federal governments would assume the debts of the several states and pay them off at something approaching face value.\” But after the establishment of a federal market for debt, the US government in the 1840s decided that it would not assume the debt of bankrupt states. A variety of other episode are put into a broader context. In terms of overall lessons from early US experience for Europe as it seeks to establish the euro, it suggests that while Europe has created the euro, existing European institutions are not yet strong enough to sustain it:
One of the problems that Europe has faced in the past decade is the relative weakness of European institutions. Americans and foreigners had little reason to trust the willingness or ability of the new United States government to honour its obligations. Likewise, many in Europe and elsewhere have doubts about the seriousness with which EU and euro-area commitments can be taken. Just as Hamilton and the Americans had to establish the authority and reliability of the central, Federal, government, the leaders of the European Union, and of its member states, have to establish the trustworthiness of the EU’s institutions. And the record of the past ten years points to an apparent inability of the region’s political leaders to arrive at a conclusive resolution of the debt crisis that has bedevilled Europe since 2008. …
The central authorities – the Federal government in the American case, the institutions of the euro area and the EU in the European case – have to establish their ability to address crucial monetary and financial issues in a way acceptable to all member states. This requires some measure of responsibility for the behaviour of the member states themselves, which the central authority must counter-balance against the moral hazard that it creates. In the American case, the country dealt with these linked problems over a sixty-year period. Assumption established the seriousness of the central government, but also created moral hazard. The refusal to assume the debts of defaulting states in the 1840s established the credibility of the Federal government’s no-bailout commitment. Europe today faces both of these problems, and the attempt to resolve them simultaneously has so far failed. Proposals to restructure debts are rejected as creating too much moral hazard, but the inability to come up with a serious approach to unsustainable debts has sapped the EU of most of its political credibility. Both aspects of central policy are essential: the central authorities must instil faith in the credibility of their commitments, and do so without creating unacceptable levels of moral hazard.
This is not, of course, to suggest that the European Union should assume the debts of its member states. Europe’s national governments have far greater capacity, and far greater resources, than did the nascent American states. But the lack of credibility of Europe’s central institutions is troubling, and is reminiscent of the poor standing of the new United States before 1789.
The US monetary and financial architecture evolved over decades, but in a country that was somewhat tied together with a powerful origin story–and nevertheless had to fight a Civil War to remain a single country. The European Union monetary and financial organization is evolving, too, but I\’m not confident that the pressures of a globalized 21st century economy will give them decades to resolve the political conflicts, build the institutions, and create the credibility that the euro needs if it is to be part of broadly shared economic stability and growth in Europe.