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1.1.1. What is a currency?

According to Aristotle, in order for a currency to be accepted as such, it ought to be, simultaneously, a unit of account*, a reserve of value*, and a means of payment*.

There are two types of money:

• fiduciary money*, represented by coins and banknotes.  Its value is founded on confidence in the institution which issues the money, normally a central bank*;

• scriptural money, or money as an accounting unit, used for transfers from one account to another through the simple act of writing: transfer orders, cheques, credit cards, etc.  It is money which is needed only in the short term.

It is necessary for any form of money to be supported by an efficient financial network and a lender of last resort*, that is to say, a central bank which guarantees its value

1.1.2. What is the International Monetary System?

International exchanges of money take place in what is called the "exchange market", which is global and permanent.  Global because there is only one price which can be applied to each currency, and permanent there is always a market which is open somewhere in a time zone.  The rates of exchange* take into consideration the rates of interest for the relevant currencies.

Only some currencies are convertible*.  These can be freely exchanged on the international market.  The others, mainly the currencies of developing countries, cannot be exchanged, other than with the agreement of the relevant government.

The International Monetary System has gone through a number of phases.  Under the system of exchange known as the "gold standard", the rate of exchange for each currency is determined by its equivalent in gold.  This system  was in use up until the First World War.

It was replaced by the system of " gold exchange ", in which certain key currencies played the role of money in the sense that these currencies where supported by sufficient gold reserves.  This system was established at the Genoa Conference of 1922: the international reference currency was, at that time, the pound sterling (GBP).  The system collapsed as a result of the great economic crisis of 1929 and the decoupling of the GBP from the price of gold in 1934.  This period demonstrated the need for a greater international cooperation and it lead to the creation of the Bank for International Settlements (BIS), which has its headquarters in Basle, Switzerland.

The Bretton Woods Conference* of 1944 established the US Dollar (USD) as the key currency in the International Monetary System, which was based on a system in which each convertible currency could be exchanged in USD or in gold.  The rate of exchange was 0.888g of fine gold for one USD.

Bretton Woods Agreement

The system was supported by the International Monetary Fund (IMF), guardian of the fixed rates of exchange* and the International Bank for Reconstruction and Development, better known today under the name "World Bank", whose objective is to reduce the disparities in income between member countries by aiding reconstruction and development.  In the Bretton Woods system, the rates of exchange between currencies are fixed: the central rate of exchange was determined by the IMF, which also had the power to alter these rates.  It took till about 1960 for the system to be fully effective, when the major industrialised countries accepted the principles.

The search for a world currency resulted in the creation, in 1969, of a paper currency: the special drawing rights (SDR).

The Bretton Woods system collapsed in 1971, as a result of the development of Europe as a new economic centre, and the persistence of negative current account balances on the part of the United States, which followed lax budgetary policies, especially with respect to expenses related to the war in Vietnam.  Once again the International Monetary System foundered as a result of the use of a single national money (USD) as an international reference currency.

The economist Robert Triffin* believes that the monetary disorders of the 20th Century can be attributed largely to the use of national currencies as a world standard.

Robert Triffin reference :
cepa.newschool.edu/het/profiles/triffin.htm

With the object of adapting the International Monetary System to economic reality, a system of floating rates of exchange was introduced.  All references to gold were eliminated, including in the revised statutes of the IMF, and the rates of exchange floated according to market conditions.  The difference between the purchase and the selling prices represented the risk for those operating the exchange.  Soon after, in 1972, the search began in Europe for a means of limiting these risks, particularly through the creation of "snakes" or "tunnels" amongst a group of fairly similar economic entities.

1.1.3. What is a monetary union?

Issuing a currency constitutes under all circumstances a right to regulate* reserved exclusively to the governing authorities of independent regions (counties, cities, and later, states).
 
Generally the monetary relation between States can be classed into one of three systems: fixed exchange rates (within narrow margins), floating exchange rates (where the exchange rate is determined by the market) and monetary union.

Compared to floating rates, the system of fixed exchange rates assumes an effort toward convergence in the monetary and economic policies in the countries which participate.  In the absence of an equilibrium between the economies which participate, the monetary authorities achieve constant exchange rates by varying the rates of interest which apply to their currency.

A monetary union implies a single monetary policy, and especially a single reference rate of interest.  According to circumstances (political, economic, or other) it is possible to have either a common currency in parallel to the national currencies or a single currency which replaces the national currencies.

1.1.4. Why form a monetary union?

Money is the common denominator of commercial transactions (sales and purchases).   A transaction within a single country takes place in the national currency, which is common to seller and buyer.  In the case of an international transaction (import and export), seller and buyer normally operate in different currencies.  As a consequence, there is a lack of transparency of the prices and a risk resulting from the exchange.  Where international transactions form an important part of the revenue of a country, then it is in the country's interest to use a common currency with its partners.  In 1997, within the  European Union (EU), more than 60% of international transactions were invoiced in US dollars (USD).

At the international level, experience demonstrates that using the currency of a single country to serve as an anchor for the International Monetary System fails to guarantee stability in the long term.  Sooner or later, the specific interests of the individual country whose currency is used as anchor take priority over the interests of the international community.  That is why a monetary union between several independent countries reduces this risk and guarantees a greater stability.  The euro will progressively eliminate the risk linked to the current use of the USD in most commercial exchanges with the Union and within the Union.  It is an example of a method of establishing a common currency amongst countries which form part of the same civilisation.  A common monetary policy enables the most effective response to an external economic or financial crisis.

The history introduction

1.1.5. Why a single currency for Europe?

The European Union created a single market without commercial or financial barriers.  The disorder linked to the persistence of national currencies endangers the long-term survival of the single market.  This disorder comes mainly from the coexistence of "strong currencies" and "weak currencies" on the one hand, with a free movement of goods and capital on the other. Divergent monetary and economic policies associated with significant and persistent differences in the rates of inflation* act as a barrier to planning for the future on the part of businesses and prevent taking full advantage of a single market.  As an example, the efforts made in the years 1990 to 1993 by the United Kingdom to overcome inflation lead to a over-valuation of the pound sterling (GBP) and a deep recession, while the rest of the Union benefited briefly from the economic windfall from the fall of the iron curtain.  The divergences in national political and economic policies supported by autonomous national currencies were incompatible with a single market.  Thus a monetary union is necessary for the harmonious development of Europe.

History shows us that, in Europe, a monetary system based on national currencies, with exchanges subject to regulation, gives no guarantee of a long-term equilibrium and leads to economic distortions between countries.  The persistence of the economic crisis within Europe during the 1990s and the seriousness of the financial crisis of 1992-1993 show that this is the case.  A single currency implies growing economic coordination - hence the importance of the "E=Economic" in the economic and monetary union "EMU".

The elimination of exchange rate fluctuations in Europe and the emergency of a European currency are resulting in a fundamental modification in world-wide economic and monetary relations, which, in the future, will be based on three or four international currencies: the dollar,  the yen, the euro, and (very probably) the Chinese yuan.

The single currency ought to permit the achievement of the full potential of the single European market and be favourable to the economic development of the Union, mainly thanks to the transparency of prices and the elimination of distortions linked to the risk of exchange between national currencies and unnecessary bank charges.  Of the commerce within the single market in 2001, 40% was between two or more countries.  This figure is growing at the rate of 1% per year.  Given that money is the common denominator for commercial transactions, it is therefore a more coherent system if there is a single currency for the European Union.  It is the logical complement of the free circulation of persons, goods, services and capital within the single market.

The single currency also implies a sound monetary and budgetary discipline, assuring both price stability and the absence of  competitive devaluations/revaluations between members of the EMU and the achievement of interest rates which are both low and stable, hence favouring economic development and the growth of employment.

Short-term variations in the exchange rates between the currencies of the Union with respect to the ecu.
© Promeuro -Illustration 1.1.a  

Europe is thus in a position to acquire a truly international political status.  To demonstrate the point by an absurd proposition: What would be the importance of the United States if there existed a Texas dollar, an Alabama dollar, an Oregon dollar, etc.?  With the euro, Europe has its own accounting unit, its reserve of value and a common means of payment.

1.1.6. How can the success of a monetary policy be measured?

(Inspired by François Bilger, "Have the Maastricht criteria been achieved?" 1995.)

A monetary policy is sustainable only if it meets four criteria, referred to as the "four corners of the magic".  It should ensure:
 

• internal stability:  the rate of inflation or increase in prices must be small.  A stable currency is considered as a necessary condition for sustainable growth.  The central bank has the responsibility of maintaining the intrinsic value of its money.  that is why, in general, the bank ought to be independent of political influence, given the pressure to satisfy the immediate aspirations of the electorate, sometimes at the expense of the it long-term well-being;

• external stability, or the stability of the currency in the foreign exchange markets, taking particular notice of the balance of payments*, which should be neutral or positive. This figure is a measure of the flow of exchanges between the monetary zone and its international partners.  If it is neutral or positive, that means that the zone is preserving its monetary reserves; if it is consistently negative, that indicates that a growing proportion of the money is held outside the zone, or that its reserves are being exhausted.  The object is to maintain long-term stability in the rates of exchange between the currency and the international reference currency (or currencies - today, the euro, the USD and the JPY) thus promoting the stability of the International Monetary System and the stability of international  commercial exchanges;

• economic growth,  which leads to an increase in incomes.  It can be influenced by a decrease or increase in the reference rate of interest, by the mass of liquid money* put in circulation by the central bank and by rates of exchange;

• employment, which provides the social basis for monetary policy.  It is to a large extent determined by economic growth and fiscal management.

The first two factors are primarily the responsibility of the monetary authorities, and the last two factors the that of the economic authorities.  Therefore a co-operation between the monetary and economic authorities is necessary to assure the achievement of the four criteria, but without bringing into question the independence of the central bank, which is responsible for monetary policy and the stability of the currency.

1.1.7. Which countries participated in the construction of the European Union (see also chapter 7 about European political integration)?

The construction of the European Union began with the Treaty of Paris, signed the 18 April 1951, and which came into force on the 23 July 1952,  establishing the European Community of Coal and Steel (ECCS).  The ECCS established a common market for coal and steel between Belgium, France, Italy, Luxembourg, the Netherlands and West Germany.
 

Video : The founding fathers of Europe  

In 1954, European integration suffered a serious setback: by a majority of a single vote, the French parliament rejected the creation of the European Defence Community (EDC), which launched Europe as a political entity between these six countries.

These same countries formed the European Economic Community (EEC) - or Common Market - and the European Atomic Energy Community (EAEC - or Euratom) under the Treaties of Rome, signed in March 1957 and coming into force on 1 January 1958.  The United Kingdom, Denmark and Ireland joined the EEC in 1973; they were joined by Greece in 1981, by Spain and Portugal in 1986. and by Austria, Finland and Sweden in 1995.  On 1 May 2004, Cyprus, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, the Czech Republic, Slovakia and Slovenia joined the European Union.  In 2005, several more countries were candidates for joining - Bulgaria, Rumania, Turkey and Croatia.

Norway and Switzerland rejected EU membership by referendum, with a no-vote of 53.5% on 25 September 1972 for Norway, and a no-vote of 78% on 4 March 2001 for Switzerland.

Iceland, which became self-governing in 1904 and was finally declared an independent kingdom in 1918. As a consequence of its union with Denmark, it enjoys a special status.

Greenland is a territory administratively attached to Denmark, but since 1978 it is to a large extent self-governed.  In 1982, its inhabitants decided in a referendum to cease being part of the European Union.

Map of 'Europe
© Promeuro - Illustration 1.1.b  

The Schengen Agreements* had the objective of eliminating immigration controls at the borders between states, and the intensification of police, customs and judicial cooperation.   These were signed on 14 June 1985 and 19 June 1990 by fifteen European States: France, Germany, Belgium, Luxembourg, the Netherlands, Italy, Greece, Spain, Portugal, Denmark, Austria, Sweden, Finland, Norway and Iceland.  The five countries of the Nordic Passport Union (Denmark, Sweden, Finland, Norway and Iceland) entered the Schengen Zone on 25 March 2001.   Following the Treaty of Amsterdam, the United Kingdom and Ireland have been offered the possibility of joining: finally the countries which joined the European Union in 2004 are expected to apply the Schengen Agreements from the moment they join the EU.

1.1.8. Is the Euro the final stage in European construction?

Walter Hallstein*, the Prime Minister of the European Economic Commission (EEC), established by the Treaty of Rome in 1957, declared in 1958 that Europe would be constructed in three phases: the first consisted of the construction of an economic community, the second would lead to the creation of a single currency and the third stage would be political and it would lead to the creation of a European state.

Walter Hallstein  

The euro was launched as the basis of the European economic and monetary union.  The free movement of persons, goods, services and capital within the single market implied inevitably the use of a single currency.

The creation of a single market, the Schengen Zone and the euro facilitates to a great extent this free circulation, but the benefits remain limited due to a lack of harmonisation in fiscal management, judicial systems and social security, financial markets and national administrative procedures.  The elimination of these remaining obstacles requires an engagement by citizens to support the profound reforms which are still necessary.
 
The introduction of the euro resulted in the elimination of  one of the last non-tariff barriers between countries of the EU which form part of the "Euro Zone"  But its creation is just one phase in a vast plan.  Rather than the end of a process, the euro is an indicator of future challenges for European construction.

"The best Europeans are not those with the brightest or the most magnanimous ideas, who become disheartened when they don't bear fruit.  The good Europeans are those who know how to identify the difficulties and attempt to resolve them, but without ever allowing themselves to be discouraged."

Paul-Henri Spaak*, former Prime Minister of Belgium.