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A reasoned history of Monetary Unions: the lessons from EMU after the subprime crisis

and the Greece collapse useful for West Africa

Abstract:

Monetary integration is not a new phenomenon with the euro zone and also the Greek

sovereignty debt collapse despite its participation to a monetary union is not a new event.

Many example of debt crisis of countries belonging to a monetary union could be given as far

a reasoned history of Monetary Unions is mobilized. Doing that here, it is welcome to say that

the hypothesis of life cycle of monetary unions is relevant if we look around the world these

kinds of arrangements. After presenting achieved and aborted experiences of monetary

integration in the past, this paper gives also the surviving experiences and their new problems

like nominal convergence, real heterogeneity and their answers to supply and demand shocks,

particularly for European and African most representative process of monetary integration. In

this line, the focus is to show how fragility is possible in a monetary union process. Under this

perceptive, it is possible to keep in mind some useful lessons of monetary integration looking

for the recent history of euro zone.

References JEL: E63; F15; F33; F35; E58;E61.

0. Introduction

The term “monetary integration” is very controversy as far as its definition is concerned. It

may correspond to many institutional configurations; hence, we can talk about “degrees” of

monetary integration. At its first level, monetary integration is in accordance with all forms of

fixed exchange rates even with the currency-board or a pooling of reserves denominated in

foreign currencies. But this narrow definition of the term is by far the easiest, given the fact

that, each nation concerned by the immutability of its exchange rate with another till the

achievement of a single currency cannot pretend to a national autonomy of its monetary

policy. Theoreticians of monetary integration such as Corden (1972) thinks that there are even

pseudo-currency unions or Padoa-Schioppa (1992) who highlights the difficulties to realize

successfully the followings: the stability of exchange rates; the amortization of monetary

shocks induced by the high mobility of capital; the isolation of the real economy to external

shocks or against speculative capital flows. Recognizing the existence of “degrees” of

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monetary integration means monetary integration is a non-linear process. This gradualist

approach assumes that the coherence of the whole depends on political will, even if real

integration and convergence of economies are the bases of a bright success (Balassa, 1975).

The European Union, for example, for the past 60 years, has been in a process of ever-greater

integration, ever-greater progress toward the idea of Europe as a single democratic entity as

opposed to a bunch of quarreling countries. Currently, all of that is in danger with the Greek

tragedy. But this unfortunate situation is not particular to this monetary union. Therefore,

researchers have to investigate the history of single or common currency unions.

Monetary integration has a history that had concerned and/or is still concerning:

-regions of a same country;

-developed countries (United States, European Union);

-developed countries and their colonies (CFA zone, sterling zone, escudo zone);

- current relationships between independent developing countries and developed countries

today (CFA zone and euro zone)…

Thus, we must learn about the process of monetary integration at this crucial time of

European experience. Indeed, “there is a possibility that one or more countries may resort to

being forced off the euro: it is about 50 percent odds for Greece and lower for the others,

although if one goes there might be a chain reaction here" as predicted Krugman in July

2012 on his blog. In the following lines we are first going to relate interrupted and achieved

experiences in the past (1), before giving the fundamental aspects of the ongoing experiences

of European Union and CFA zone concerning the process of monetary integration (2). Finally

(3), we are going to answer the question why monetary unions are exposed to a life cycle

hypothesis, till born to death with intermediate steps like survival.

The purpose of all of this reasoned history is to bring useful lessons from monetary

integration at this step of euro zone dealing with exogenous shocks and the PIGS’ debt.

1. Achieved and Aborted experiences of Monetary Integration in the past

Authors such as Kramer (1971), Nielsen (1933), Bitar (1955), Jensen (1911), and Willis

(1901) have carefully described the attempts of monetary integration in past centuries. Some

have gone to an end successfully (USA, Germany, Japan, and Italy); others did not survive

(the Latin Monetary Union, the Scandinavian Union, the Sterling area, the Belgian-African

zone, and the Escudo zone). Regions with common culture, history, language, can achieve

their will to have a single currency (1.1). Political facts and economic gaps between countries

could constitute an obstacle to realize a fully integrated space (1.2). Also, the experiences of

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Latin and Scandinavian Union and currency boards established with their colonies by Britain,

for example, are meaningful to highlight big failures or success stories during the past

centuries and today.

1.1 One nation and the need for Monetary Unification

Specific examples of monetary unifications are given thereafter, and they concern Germany,

Italia, Japan and the United States. Some common elements could be driven in the context of

nations searching to coordinate their real exchanges via a single currency. Cultural and

political facts are very important in these cases.

1.11 Germany and the choice of a single currency

At the end of the eighteenth century, Germany had at least three hundred and fifty states, and

was federated with two powerful nations: Austria and Prussia. From state to state, bank notes

and coins in circulation are not the same. Respective central banks do not impose the same

legal restrictions and not a single inflation tax, except two of them. In fact, thirty-three banks

of issue of currency co-exist without coordination till 1873.

The monetary unification was done in several steps before the adoption of the gold standard

system in 1873: In 1837, the Treaty of Munich between the southern states established silver

as standard and the guilder as the unit of account. In April, 1st 1838, Prussia and the northern

states signed the first Convention of Dresden: the thaler and silver are both legal tender. They

can be used as a means of payment in the sphere of monetary circulation with a new Custom

Union named the Zollverein. In July, 30th

1838, the southern and the northern states signed

the second Convention of Dresden. The following decisions were then taken: the silver

standard is maintained; the double thaler1 is created; regional monies are only used locally,

and exchange between regions is solved with guilders and the double thaler. In 1857, Prussia

and Austria liberalized fully their trade. Free trade was considered as an important step of

monetary unification. In 1871, Germany with Bismarck became independent. At this date,

seven monies were circulating and the standard used for bilateral trade was silver, but legal

restrictions were not the same. At the end of 1871, the Reich decided the creation of mark as a

unit of account. Two years after, gold exchange standard was adopted, and in 1875 the

Reichbank was born as Central Bank of the confederation of Germany. The desire to be

independent from the empire of Austria was a real guideline of this confederation.

1.12 Italian’ experience

1 The difference between double thaler and the thaler is only a matter of weight and value, the first weighing

about 30 g and the second about 60.

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The political unification of Italy was carried out prior to monetary unification. Indeed, the

Italian lira was imposed by a law in 1926. In the nineteenth century, several currencies have

circulated in this country: the Piedmont’ lira, the lira of Toscana, the Austrian guilder, the

ducat of Sicilian regions, the currency of the Vatican. The property rights on those five

monies were private and Central banks were not public dependant. In an oligopoly game, each

of them attempts to absorb the others and or to demonstrate its bargaining power. Finally, the

Central Bank of Piedmont-Sardagna becomes the leader in 1893 at the end of the game. Lira

was implemented as a public good in 1926. At this date, the Central Bank of Italia was an

emanation of the Central bank of Piedmont-Sardagna.

1.13 The road to a single currency in Japan

Despite a centralized state, Japan was a country where in 1861; circulated at least one

thousand seven hundred banknotes issued by private central banks of two hundred forty

provinces. With the restoration of the Meiji era (1868), the government imposes the yen as the

unit of account, medium of payment. Techniques to remove the monetary bank notes issued

by provincial banks are varied: high devaluations, purchases of securities, financial

compensation. In 1882, the Bank of Japan is the sole authority to issue banknotes. Globally,

financial procedures are complemented by political decisions through legal provisions.

1.14 United States: the most achieved experience of monetary unification

Three periods must be considered in the American experience of monetary integration. The

first period is the colonial period, each country chooses its money and banknotes, and links its

currency to the pound sterling or a precious metal (gold, silver). The second period is the

period of the Revolution; countries trying to promote trade by establishing fixed exchange

rates between their currencies without going through a conversion to pounds. The metal coins

(gold, silver) are also used in bilateral trade. The last period is the establishment of the United

States of America as a Confederation in 1787 with a single currency: the dollar. For Rolnick,

Smith and Weber (1994), the first two periods are characterized by high exchange risk; these

currency risks arising from the conversion costs, information costs and transaction costs of

different currencies, in a space where free trade between countries is not really held. A

different rate of inflation between countries conducts to competitive devaluation or to another

protectionist measures. A region with deficit of payments does not promote multilateral trade

in those conditions. So that, it’s the common interest for all states of America to simplify the

exchange payments with a single currency. With more than two century of monetary

unification, and supremacy of the dollar in multilateral trade, it’s not a mistake to say that the

most achieved experience is the United States of America.

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1.2 Born and death of Monetary Unions during the last centuries

Scandinavian and Latin monetary integration are then first related. After that we screen a

major colonial monetary arrangement: the zone sterling. Finally, we draw some pictures about

the hypothesis of life cycle of monetary unions.

1.21 The Latin Monetary Union

In the nineteenth century, the Latin Monetary Union is an evidence of a major integration

effort, in a context of bimetallism. It was born in 1865 and died in 1926. Its history has been

turbulent. According to Thievaud (1989), in order to keep the union alive during this period,

authorities took nine conventions, three arrangements, and nine statements of intent, two

protocols and four legal acts. This union includes France, Belgium, Switzerland, Italy and

Greece. The laws governing this union were inspired by the French Code and therefore by the

French monetary system defined by the law of 7th

, year Germinal number 11 (1803). Each

country could issue coins in gold and silver equal in value to one hundred francs, fifty,

twenty, ten, and five. The coins worth less than two francs were specific to each country and

could not move between countries.

Some remarks must be made in relation to the Latin Union, and then we will highlight these

difficulties in terms of monetary and real economy:

The creation of the Union is ad hoc; it’s de facto an institutionalization. Indeed, when

Belgium became independent in 1831, it adopted the monetary system of France. In

Switzerland, the monetary system used was that of France since 1848. In Italy, while

the lira was the currency, the system was bimetallic.

The union was formed under the dominant influence of France, the second world

power.

The Union’ difficulties in the money side. The international monetary system at the time

was based on gold. The superposition of this system to national bimetallic systems caused

serious difficulties for the union, because the monetary authorities were unable to guarantee a

stable parity between gold and silver. For example, the depreciation of silver in 1870 imposed

a constraint on the gold stock holdings of the member countries, because these countries were

encouraged to supply unlimited quantities of silver coins, which aggravated inflation. The

metal silver became the preferred instrument of payment inside each country and the gold was

increasingly reserved for international payments. There was thus a specialization of monetary

instruments: the metal money for internal payments and gold for international payments.

Gresham's Law was then observed: bad money (silver metal) had come to hunt the right

(gold). In fact in a monetary union, both currencies cannot coexist, and the bi-metallic system

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eventually becomes mono-metal or a fiat system after an intermediate phase of a crisis of

confidence (Aupetit, 1901). Gold production declined worldwide and gold hoarded was

intended for international payments. Symmetrically, silver metal was abundant and therefore

impaired. Since both metals were supposed substitutable, countries such France, the most

competitive one, asked more and more payments in gold. From this attitude, I think that there

are some fundamental lesson of own interest of a country member like France with its specific

difficulties and I give that in the part 3 of our paper.

The Union’ difficulties in the real side. The union was created under the initiative of France:

the French monetary and financial system was reproduced in each country. It should be noted

that is due to the unequal development of member countries. During the first half of nineteen

century, the financial Place of London and Paris were the biggest. France and Great Britain

were major capital exporters (75% of the total world). France was more industrialized than

other member’s countries of the union and had technology advantages. Until 1873, an entry

of precious metals in a country caused a rise in prices: the quantitative theory of money

seemed to be true, but the Great Depression in France with its spill-over effects indicated that

prices must be down during long times and the explanations of such trend need more

investigation (Semedo,2000):

With the Great Depression, France was no longer in competition with Great Britain,

but also with Germany, which had become an industrial nation with market power.

Despite a recovery plan (Freycinet), the construction industry, public provisions of

goods and services and transport such railway construction are in crisis. The global

investment declined until the early twentieth century.

The housing industry and the sector of rental property were also in crisis with an

acceleration of bankruptcies.

Manufactured goods industry was facing problems of markets’ opportunity, because

prices of agricultural goods fell. The crisis in the rural sector has contributed to the

diminution in overall consumption and hence aggregate demand.

The Great Depression had also a financial dimension. Companies had to face liquidity

constraints or credit rationing. Despite the regularity of lower interest rates, domestic

investment during this period will not increase. It was rather observed capital exports

to Great Britain.

If the colonial empire was necessary to procure raw materials, the budgetary costs of

the empire increased during this crisis.

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1.22 The Scandinavian Union

In 1872, Sweden and Denmark signed a monetary convention. These two countries are

followed by Norway. Monetary systems of these countries had a common basis. Everywhere

in these countries, the metal silver was used; it was even difficult to distinguish the coins in

circulation with different denomination in each country ( spiecerdaller in Norway, rigsdaler

elsewhere). They decided a fixed parity between silver and gold in each country and adopted

the gold exchange standard. The main steps and characteristics of this union were:

Since 1872, the common unit is the krone. One krone was subdivided into one

hundred ore. The main coins were twenty and ten2 kroner gold coins. Also, a relative

price between gold and silver was adopted for the exchange of the old silver coins for

the new gold ones at 15.81 for Sweden, 15.68 for Norway and 15.67 for Denmark.

Except on pure specie matters, the three central banks retained full sovereignty over

their monetary policy.

Each nation had the right to issue subsidiary coinage, with an obligation to redeem

their coin in gold if it’s necessary.

Since 1885, each central bank open an account for the others in order to retrace

surplus or deficit of payments free for interest charge, without a need of gold

displacement and transport between country. At this time, the union was significantly

extended by this agreement whereby the three central banks could automatically draw

on each other at par and transfer each other’s draft free of charge. Neither were

businessmen to pay the otherwise normal fee for the issuing or redeeming of drafts on

the other countries ‘central banks.

In 1887, this last arrangement was further extended by a common Scandinavian

chéque law. In the short term, no interest rate can be charged on checks; the clearing

agreements didn’t imply short term balance of payments equilibrium. Loss of interest

by a creditor central bank is transferred to its reserves.

Until 1894, banks notes are excluded as means of payments, while coins in silver and

gold can circulate at par. By accepting, banks notes Norway and Sweden give a new

and large place to fiat money (paper money). Tremendous expansions in the notes

remittances followed up upon this bilateral agreement (Sweden-Norway) and thus give

to the enlarged union (to Denmark) its most complete form. This decision is not

subject to a random walk, it results from the natural composition of their stock of

2 The ten kroner coin contained 4,4803 grams of currency gold, which was 90 per cent gold and 10 per cent

cooper.

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money. According to Bartell (1974), Sweden was the pioneer in the use of notes. “In

Sweden, bank notes made up 57 per cent of the currency circulation, whereas the

corresponding figure for Norway was 41 per cent and Denmark 26 per cent”.

This monetary union is complete in 1895 with the unification of its payment systems,

but it resisted only ten years. The lesson driven is given in part 3.

1.23 Currency boards during the colonial era: the example of the West Africa under Pax

Britanica

During the colonial era, monetary unions between developed countries and their colonies took

the scheme of currency board. Alliance-type arrangements emerged first in the colonial

domains of both Britain and France, the two biggest imperial powers of the nineteenth

century, after the others European nations do the same. Different names were used to qualify

them as monetary zones: zone escudo (Portuguese former colonies and Portugal), zone

sterling (English former colonies and Great-Britain), CFA franc zone (French colonies and

France)…Only the CFA zone survive and the reason why is associated with many reforms

and added agreements to create a most adapted institutions devoted to monetary and financial

activities. Our purpose is here to screen for example the functioning of monetary union like

zone sterling and I focus on the West African currency board.

The sterling area was born long time after the British pound used as an international currency.

This currency area died with the decline of the British Empire. The important area covered by

the sterling was explained by several factors:

Britain was the leading world power in the nineteenth century and retains its

supremacy until the mid-twentieth century.

It had prosperous settlements colonies: Canada, Australia, South Africa and rich

colonies in raw materials or populated (India, Nigeria…) and ensuring markets for

British companies.

It had an important military and merchant marine.

It made a clear choice for free trade.

The City gave comparative advantages in international finance to the major British

banks and insurance companies.

British governments were in the middle of nineteen century afraid of inflation; this approach

is theoretically justified by the Currency School of David Ricardo. In 1844, the Bank act

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associated with the currency principle named Peel’s act restricted the powers of British banks

and gave exclusive note-issuing powers to the central bank: the Central Bank of England.

Under the Act, no bank other than the Bank of England could issue new banknotes, and

issuing banks would have to withdraw their existing notes in the event of their being the

subject of a takeover. At the same time, the Bank of England was restricted to issue new

banknotes only if they were 100% backed by gold or up to £14 million in government debt.

The Act served to restrict the supply of new notes reaching circulation, and gave the Bank of

England an effective monopoly on the printing of new notes. The Act exempted demand

deposits from the legal requirement of a 100-percent reserve which it did demand with respect

to the issuance of paper money. The Act in accordance with the Currency principle argued in

fact that the issue of new banknotes was a major cause of inflation .Although the Act

required new notes to be backed fully by gold or government debt, the government retained

the power to suspend the Act in special case like financial crisis. With currency board, the

Great Britain attempts to give more responsibilities its former colonies in the management of

their external reserves in accordance with inflation and their balance of payments position in

sterling or their local anchored to sterling. As a lender of last resort, the Bank of England was

always defending a global equilibrium of the overall balance of the empire and tries to

accumulate gold.

A currency board is an institution that issues notes and coins convertible on demand at a fixed

rate into an external reserve asset, such as a foreign currency. External reserves equal 100

percent of the currency board's notes and coins in circulation. The currency board makes

profits from the difference between the interest on the securities that it holds and the expense

of maintaining its note and coin circulation. It remits to the government all profits beyond

what it needs to pay expenses and maintain its reserve ratio. Market forces alone determine

the quantity of money in circulation. The mains characteristics of a currency board are as

follows:

Convertibility. The currency board system is a system of fixed exchange rates. Most

past currency boards have used securities denominated in a single foreign currency as

their reserve asset. A few currency boards have also held gold or baskets of foreign-

currency securities as reserve asset. The currency board is not typically the only

holder of reserve currency in a currency board system. Banks also hold reserve

currency.

Seignioriage. Unlike securities or most bank deposits, notes and coins do not pay

interest; hence they yield seigniorage to the issuer.

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Inflation and interest rates: Given the fixed exchange rate between the currency board

currency and the reserve currency, if trade barriers are low because tradable goods are

most important, purchase power parities hold. Interest rates should be roughly the

same in the two countries – the developed one and the smallest-, in the absence of

political risk and barriers to movement of funds between them.

Monetary policy: By design, a currency board has no discretionary power. Its

monetary policy is completely automatic. Since a currency board's role is strictly

circumscribed by a passive rule, it can be more insulated from politics than a central

bank is.

The currency board system as usually practiced has been a type of gold-exchange or foreign-

exchange standard. Under a gold standard a banking system holds all reserves in gold. Under

a gold-exchange standard banking system holds gold securities and bank deposits payable in

foreign gold-standard countries as substitutes for gold itself. The first currency board in

Africa was that of the British Indian Ocean colony of Mauritius, established in 1849. Many

British colonies established currency boards to replace competitive issue of notes by banks.

Two main currency boards were founded after the West African Currency Board opened in

1913 for British colonies in the region: The East African Currency Board (Kenya, Uganda,

and Tanzania), the Central African Currency Board (Zambia, Malawi, and Rhodesia).

What about the reasons of born of the West African Currency board? By the first years of the

twentieth century, the use of British silver coins was widespread in Britain's West African

colonies (Gambia; the Gold Coast [now Ghana]; Sierra Leone; and Nigeria [originally three

separate colonies]). The British gold sovereign (£1 piece) had too high a value to be useful to

most Africans in trade. The same was true of £1 bank notes, which in addition were

perishable because of insects and humidity. The Bank of Nigeria issued notes briefly around

the turn of the century but ceased after demand proved insufficient (R. Fry 1976, p. 74).

Demand for silver coins in British West Africa was high, exceeding demand within Britain

itself by 1910. The imperial government refused to share seigniorage from the coins with

West African governments. At the same time, the imperial government was worried about the

possibility of a sudden, massive West African demand to redeem the silver coins in gold.

At the prompting of the governor of Lagos, one of the three Nigerian colonies, the British

Colonial Secretary in 1898 proposed to the British Treasury that there be a separate West

African currency or that the Royal Mint share seigniorage with West African governments.

The Treasury rejected the idea of sharing seigniorage, so the Colonial Office appointed a

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committee to investigate the possibility of a West African currency issue. The Barbour

committee proposed to retain British silver coins while giving half the seigniorage to West

African governments and using the other half to build up a gold reserve. The Treasury

rejected the committee's proposal.

The price of silver was falling during the early years of the twentieth century, increasing the

seigniorage from silver coins. The monetization of the West African economy was increasing,

and there was talk of the advantages of a local note issue. In 1907 the governor of Southern

Nigeria suggested that the colony had become sufficiently developed to need a local note

issue by the government or banks. The Crown Agents for the Colonies in 1908 recommended

a government note issue for Nigeria, preferably by Southern Nigeria, the most important

colony. The Colonial Secretary scuttled the plan at the request of the Bank of British West

Africa, which saw the plan as a threat to the profits from its monopoly of importing British

coins. After a new Colonial Secretary came into office, he appointed a committee chaired by

Lord Emmott to examine again the possibility of a West African currency. The Emmott

Committee recommended that the British government establish a currency board to issue

silver coins and notes in British West Africa. West African governments should pay the start-

up costs of the board and also back it with their full credit should its own resources ever prove

insufficient. The board should keep reserves in gold and securities in London. At first, gold

should be at least 75 percent of total reserves, but the proportion might be reduced as notes

became generally used. The committee recommended that a low proportion of reserves beheld

as securities because it thought that the hard core of circulation was small. The board would

exchange West African pounds (WA£) for sterling, or the reverse, at a rate of one to one. It

should have offices in each West African colony and headquarters in London.

The committee assumed that sterling would remain convertible into gold at a constant rate, so

that there would be no difference between the currency boards gold reserves and its securities

except that the gold would not pay interest (Newlyn and Rowan 1954, pp. 40-3). When

Britain suspended convertibility of sterling into gold at the outbreak of World War I, though,

sterling fell against gold. The West African pound remained fixed to sterling rather than to the

former gold parity of sterling. The West African board moved quickly towards a pure sterling-

exchange standard. As a result of the Emmott Committee report, the Secretary of State for the

Colonies established the West African Currency Board. The four-member board of directors

first met on November21th

, and the Secretary of State for the Colonies promulgated its first

constitution on December 6th

. The board first issued coins in West Africa towards the end of

1913. Initially the minimum amount that the board accepted for exchange was £100. In

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practice the board dealt only with banks, not the public, and it came to restrict dealings to

increasingly large amounts. In 1949 it set a minimum of £10,000). Late in 1915 the price of

cocoa, one of West Africa's leading exports, rose rapidly, increasing local wealth and the

demand for coins. The West African Currency Board hurriedly imported British coins and

notes to meet the demand. The board's constitution was amended to allow it to issue notes. In

1919 the West African governments made notes legal tender and the Nigerian government

allowed the board to defer cashing notes into coin for up to three months. Note circulation

reachedWA£5.85 million in June 1920, one of the highest level of supply. ). Small-

denomination notes were

unpopular with Africans, who preferred the greater durability of coins. Africans redeemed the

small notes as coins became available (Newlyn and Rowan 1954, p. 55). A similar shortage of

coins occurred in 1936-7, coinciding with a hitch over supplies of paper for printing notes.

The board again imported British notes and issued them. A sharp rise in the price of silver

prompted Britain to reduce the silver content of British coins in 1920. The West African

Currency Board went further, making the West African coinage a pure token coinage made of

nickel brass, whose value as metal was negligible. The board made a handsome profit by

selling as bullion the silver coins that came into its possession. In its early years the West

African board's reserves were close to but not quite 100 percent. It gained its initial sterling

reserves by exchanging its own silver coins for British silver coins and redeeming the British

coins by special agreement with the Royal Treasury. By 1922, British coins had almost

disappeared from circulation in West Africa. The board's reserves first exceeded 100 percent

in 1926. Against silver coins, the board held as reserves only the difference between the face

value of the coins and their value as metal. The board began distributing seigniorage to West

African governments in January1920. Over its lifetime it distributed more than WA£37

million. To guard against losses in its portfolio of securities, the board accumulated a 10

percent reserve in addition to its existing 100 percent reserves. The board held securities

issued or guaranteed by the British government, securities of British municipalities, and

securities of non-West African colonial governments. Its administrative expenses for most of

its life were around WA£4,000 per year, plus a fee to pay interest on the storerooms that Bank

of British West Africa constructed for it at several branches (R. Fry 1976, pp.70-1, 188).

The West African Currency Board extended its operations to Togoland and western

Cameroon after Britain and France took them from Germany during World War I. Liberia,

which had no currency of its own, used the West African pound until 1944, when the U.S.

dollar became the official currency. The note and coin circulation of the board waxed and

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waned according to the prosperity of the West African colonies. For instance, it was

WA£13.59 million on June 30, 1920, and WA£7.27million during a depression two years

later. It steadily ascended from WA£11.71 million in 1939 to a peak of over WA£125 million

in early 1957, reflecting West Africa's economic growth and the spread of financial

institutions. Thereafter circulation of the board's notes and coins declined as the colonies

achieved independence and established central banks to take over the board's functions

(Schuller, 1992, p 62).

2. The surviving experiences and their new problems: CFA Franc Zone and Europe

Our purpose is to relate now the functioning and main results of CFA franc zone, particularly

the most achieved part of this zone -West African and Economic Monetary Union

(WAEMU)- and the euro zone exposed now to a systemic debt crisis. I give then the story of

Greece tragedy and all consequences imagined from this collapses and I show that measures

taken are not sufficient, as I regard the global and systemic crisis resulted from the default of

payments from Greece.

2.1 The CFA franc zone and the special case of WAEMU

211 The functioning of CFA Franc Zone

While many developing countries have adopted fixed exchange rates, few of them are

members of a monetary union. Until 1983, the only reference after the disappearance of the

sterling area is the CFA zone concerning Sub-Saharan African countries. The creation of the

Central Bank of Eastern Caribbean States in October 1st, 1983, has thus initiating the process

of monetary integration in developing countries outside Africa (Central and South America

...). In the nineteenth century, the CFA was a currency board as the sterling area. So it must

contribute to the supply of raw materials of the dominant powers. In return, France guarantees

the liquidity and convertibility of local currencies. Eventually France operates through the

French Treasury to stabilize the current account of the African balance of payments.

At decolonization, these African countries maintain a fixed parity with the French franc.

These countries hope while stabilizing their exchange rates to attract public and private

capital. Price stability contributes in this regard to increase official development assistance

and private investment. To meet the objective of price stability in West Africa francophone

countries for example, a single central bank was founded in 1962 - Central Bank of the States

of West Africa, or BCEAO in French. Monetary union of these countries is obtained before

real economic integration. In 1994, countries are aware of their low level of economic and

industrial development, and then establish an economic and monetary union called West

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African Economic and Monetary Union (WAEMU or UEMOA in French). The CFA franc

zone in West or Central Africa functions under of key operating principles: (1) a fixed parity

against the French franc before 1999-against euro after 1999, adjustable if required by

economic reasons after consultations with the French government-the European Union with

Article 109 of the Treatise of Maastricht- and unanimous decision of all member countries

within each monetary area of Africa. The two regional central bank acts independently from

each other. In practice however, giving the experience leading up to the devaluation of

January 1994, changes in the CFA parity require a complete coordination. (2) The local

currency CFA is convertible in euro without any fluctuations margins at the same rate

guaranteed since January 12th

1994 after the first devaluation of CFA. (3) This zone means

convertibility of the CFA currency into euro through the establishment by each regional

central banks of an operations account with the French Treasury with market-related yields or

charges. These accounts can have a positive or a negative balance, this providing an in

principle unlimited overdraft facility to each central bank. The French Treasury is in fact the

lender of the last resort of these African Central banks. This fact is unique in the world: A

Foreign Treasury masters Domestic Central Banks. Pouemi (1980) said in order to illustrate

that: "the franc zone based on the principle of the operations account. This expression called

the operations account is unknown in the language and the world of economists, but it is the

breviary of all financial managers of the member countries of the Franc Zone”(4) the pooling

of foreign reserves of each monetary regional area and free mobility of capital between CFA

countries and France. (5) Financial discipline is needed and number of operating rules is

stipulated. First, initially each country maintain 65 percent of its foreign assets in its “compte

d’opérations” with the French Treasury. Now the requirement is 50 percent. Secondly, every

country maintains a foreign exchange cover at least 20 percent for its sight liabilities. Thirdly

financial discipline means that Central banks limit its credits to each government of a member

country to a ceiling equivalent to 20 percent of that country’s government revenue in the

previous year. Taken together, observation of these operating rules limits in practice the

potential drawings by the two central banks from their overdraft facility with the French

Treasury.

212 The costs and benefits of WAEMU

The gains of these monetary unions are price stability and credibility of their currency. The

WAEMU members benefits from disciplinary effect of their monetary policy. They differ

from other countries in Sub-Saharan Africa by their choice of rule to issue currency and the

CFA nominal anchor to the euro since 1999. African franc zone was undoubtedly an area of

15

monetary stability, in contrast to countries that opted for an inflation tax and a large automatic

adjustment of real exchange rate. But with the nominal anchor and by the refusal of the

depreciation of their currencies, these countries are deprived of an instrument of adjustment of

their economies and seigniorage revenues. They loss therefore tools to finance development.

In fact, the BCEAO has not escaped to recurrent criticism. This Central bank has sacrificed in

the altar of price stability, the growth target. As such, the standard inflation pegged to the

anchor country is questionable.

There are currently convergence criteria for Economic and Monetary Union of West Africa.

These criteria are designed to maintain the homogeneity of the economies. Member countries

attach importance to the reduction of inflation to a level between 2% and 3% as the countries

of the euro area and limiting the budget deficit. For WAEMU, the inflation rate should not

exceed 3%.

Given the current global crisis, a deficit criterion limited to 4% is probably more realistic for

all countries (Bensafta, Semedo, Gautier, 2010). Tanimoune, Combes and Plane (2005)

showed non-linearity between fiscal policy and economic activity in the WAEMU zone. They

show that up to 83% debt to GDP ratio remains effective, but the debt criterion is no longer in

the timing of this union, because most countries arrange to be included in the group of poor

countries Heavily Indebted.

For the WAEMU countries, if the nominal convergence is observed and followed a relatively

favorable course after the devaluation of the CFA franc, it is probably more significant than

the introduction of the Stability and growth pact (SGP), because real convergence is still

inadequate.

22 European monetary constructions under risks of death now

221 The end of Bretton-Woods system and the road to euro

European interests and actions appear frequently under the pressure of global events coming

abroad ( Kühnhardt, 2010, p156). The motivation to create a monetary union in Europe was in

relation with the exchange rate turbulences affecting developed economies between 1969 and

1973, so that in 1972, member’s states of Europe create “the Monetary Snake” as a first

element of joint crisis management. The debate was a choice between pure floating exchange

rates and a fixed parity with control mechanisms on exchange market pressures. At the

beginning, large speculative capital flows resulting from the

uncertainty of the long over-valued dollar, the breakdown of the Bretton-Woods international

monetary system, and the large increase in the price of oil, pushed European to greater

coordination of their monetary policies. The long march to euro just began with a proposal

16

acted in speech of Ron Jenkins, a former President Commission in 1977. President Giscard

d’Estaing and the Chancellor Schmidt endorsed the idea to fund a European Economic system

functioning since 1979. The birth of a European currency unit was adopted and was based on

three elements: a common unit of account to harmonize imbalances of payments, a new

system of exchange rate system free from dollar and anchored to mark, and interventions and

various mechanisms concerning credits and transactions. European leaders implemented

common currency after the experiment of target zone. It had preserved the unity of common

market by giving stable exchange rates. J. Delors, President of the Commission between 1985

and 1995, renewed the functioning of the European Monetary System (EMS) and give criteria

to enforce monetary unions. In fact, the EMS had shifted European currency relations in favor

of the Deutschmark: a common currency for all European Union’s members of the single

market. On June 27th

1989, the Delors Plan was adopted. The Delors plan was characterized

by three pillars: 1 - to accelerate the exchange within the Single market, one must simplify the

mechanisms of the EMS exchange and coordination of economic policies; 2 -to set up a

European System of Central Banks in order to obtain irrevocable exchange rates, full

compensation of balance of payments and a common currency; 3-to transfer national

competences on monetary and economic matters to community institutions. At this stage of

integration, as stayed Kühnardt (2010, p167), it must be recognized that: “a common market

with a common currency...would be dependent upon intensive processes of harmonization,

compromises and legally-binding mechanisms to make it work as a Single market”. The map-

road of the Delors Plan is the single currency in Europe during the year 1999 and every

country is eligible under criterions. The convergence criteria under the Maastricht Treaty was

first to reduce nominal disparities among countries, the aim was to give credibility to the

future EMU despite the relatively high social costs in the 1990s. Such criteria based on the

convergence of inflation rates and interest rates, supplemented by standards of deficit and

public debt to GDP by 3% and 60%, seem strict, but have the merit of imposing rigor and

sacrifice for the country candidate. In the European context, the fiscal criteria also aim to

reduce inflationary pressures caused by expansive fiscal policies, which can increase the debt

of the state. When adopting the single currency in 1999, it is observed that: all candidate

countries are not elected, only eleven are qualified to start; all the candidate countries even

excluded to the qualification have reduced their inflation rates through tight control of their

monetary aggregates, and the richest countries of the Union are converging and this

convergence is both nominal and real. Finally, financial markets received euro as a good new

and there were not speculative attacks against this currency.

17

221 Birth and hope with euro to Greece collapse

The birth of a single currency in Europe was full of promise. Now with the euro crisis, it

needs an evaluation. Without going into details of various theories of optimum currency areas,

I will simply state the main points for a currency area viable. The viability of a monetary

union based on two characteristics. The first concerns the approximation of the inflation rate

(the lowest) with interest rates long. This basic pillar in the evaluation of candidate identifies

the least inflationary economies and the most restrictive in monetary terms. The second

characteristic is the similarity of shocks is to say, disturbances affecting the member countries

or potential members, the magnitude of these shocks, the speed of response to such

interference with the right tools. If these characteristics are confirmed, monetary union is

formed homogeneously, and the political will is the only lever to compensate those who stand

to lose in terms of growth, jobs.... The real economy appears as a base of the union. Two

interesting contributions emerge to ratify the place of the real economy: the thesis of the

endogeneity of Frankel and Rose (1998) and the theory of Krugman (1996) on the

specialization of activities due to regional clustering. I then use first these different canvases

to show that there are many long grain of sand in the European Economic and Monetary

Union. The Greek crisis, which I will secondly analysis is an artifact, an event over which

shows that Europe is fragile and needs serious reforms.

2211 European constraints and relativism of hope in euro

22111 Nominal convergence in Europe

With the euro, each country abandons its currency and therefore the exchange rate instrument

is not suitable for competitive devaluations. Each country coordinates its monetary policy.

Monetary policy is conducted by the ECB. The purpose or the benefit of low inflation and

interest rates must be such that all countries converge to nominally stable prices and interest

rates, and this encourages domestic investment. Indeed, it is for countries a manner to lower

their inflation rates and their long interest rates. In this order, these rates are less volatile

allowing economic agents to make calculations the least possible erroneous. To account for

the simultaneous realization of these two criteria, Semedo, Bensafta and Gautier (2010)

construct an index of nominal convergence (weighted average of inflation (index price of

consumers IPC, here CPI) and long interest rates noted LTI) on the basis of a Euclidean

distance between each country of EU 15 and the group average of the three countries the

most virtuous in terms of inflation between 1979 and 2008. With this index, they attempt to

answer to a question: how the adoption of euro gives greater nominal convergence?

The index is defined as follows:

18

2

3

2

3min )()( LTLTInfInfICN ii

i

alno

With Inf i, the rate of inflation measured by the change of the harmonized Index of Consumer

Prices and Lti, the interest rate on treasury bills to 10 years in every EU15 countries. Inf 3 is

the arithmetic average of three inflation rates lower in the region, and LT 3 is the arithmetic

average of interest rates of the three virtuous countries. The index takes positive values from

zero to infinity. A country nominally converges when the index approaches zero. Figure 1 in

annexes shows the index for the EU15, the euro area and the change in the index in the euro

area between 1979 and 2008.

Given this index, the nominal convergence of member countries of the euro area starts from

1995 with the reduction of the standard deviation intra-country (tight upper and lower bounds

in the left panel). The index of the EU-15 is coincident with the index of the euro area and the

index shows that the United Kingdom, Denmark and Sweden, although not include the euro

area, are nominally converging towards the average the euro area. These countries (outside

the euro area) have converged without the need of the European integration process and this is

probably due to their competitive and comparative advantages. This first result shows that the

criteria for inflation and interest rates alone do not explain the convergence.

The second part of Figure 1 at left shows a significant gap appears with the subprime crisis

between the core formed by Germany and France and the countries of the periphery,

described recently by a block called the PIGS (Portugal, Ireland, Greece and Spain). Although

the difference in nominal terms has narrowed since 1998, its existence highlights the fragility

of the nominal convergence within the euro area. After the introduction of the single currency,

the convergence criteria have not always been respected by the Member States, despite the

Stability and growth pact (SGP) and the existence of penalties in exceptional circumstances.

The question then arises of how to identify the uniqueness of a budget deficit if all countries

are tempted by overspending during a crisis or no crisis.

The ratio above is now extended to public deficits and to debt of the countries as in Semedo,

Bensafta and Gautier (2010, p407). This new index is an arithmetic combination. It measures

the distance from one country standards defined at Maastricht: the deficit / GDP ratio should

not exceed 3% and the debt / GDP ratio should not exceed 60% and the inflation target is

around the bounds of the average inflation of the three countries most virtuous. The index

( is called index of Maastricht and it is written as follow:

19

In this equation, DPIBi is the ratio of debt to GDP of a country i and DFPIBi the deficit ratio

to GDP of a country i as defined by the European Commission (SEC 95). To give equal

weight to each criterion we perform a normalization of all variables. Each variable (X)

normalized of this equation noted is the ratio of the difference between the observed value

and the empirical mean of the variable on the standard deviation of the sample :

.

Again, the disparity within the euro area is confirmed. The index shows that the nominal

convergence of the member countries is no longer accompanied by a convergence in terms of

budget constraints following the recommendations of the Stability and growth pact (SGP). It

also appears that the release candidate countries, and now full members, began just after the

launch of the euro. Also, the large variation in terms of the convergence criteria requires the

existence of a heterogeneous Euro zone. Figure 2 attached in annex shows the index between

1979 and 2008. The left graph is given by the average of EU15 and the Euro area. The graph

right reflects: an index for Germany, an index for France and the average of PIGS (Portugal,

Ireland, Greece and Spain). Thus, the coordination of fiscal policies in Europe has emerged as

an exercise much more difficult than the delegation of monetary instruments to a conservative

central bank achieving the goal of price stability.

22112 Similarity of answers to Demand and Supply shocks

A shock is an unanticipated event. It rises, for example abroad (the drop in demand in a third

country) and has a direct or indirect impact on the economy of a country. Shock may be

common to the countries members of a monetary union: for example the rising oil prices.

Shock may be specific or local to a country. Depending on whether the shock has an equal

impact on different countries, it is described as symmetrical. In contrast, if a common shock

has a different impact, it is called asymmetric shock. The nature of the shocks is defined by

the fact that demand shocks have a transitory effect on the volume of GDP and a permanent

effect on prices, while supply shocks (productivity, for example ...) affect permanently both

prices and production.

Since 1999, the asymmetry of shocks is evident in Europe member countries. The European

counties are not all suffering from a similar magnitude with external shocks. There are clear

now a formation of convergence clubs with a central core (Germany, France, Netherlands

Belgium and Denmark) and a periphery composed by the PIGS.

20

2212 The debt crisis, the Greece default and its treatments: an addendum to a global

fragility

The introduction of the euro in 1999 led to a vast boom in lending to Europe’s peripheral

economies, because investors believed that the shared currency made Greek or Spanish debt

just as safe as German debt. Contrary to what someone often hope, this lending boom wasn’t

mostly financing profligate government spending — Spain and Ireland actually ran budget

surpluses on the eve of the crisis, and had low levels of debt. Instead, the inflows of money

mainly fueled huge booms in private spending, especially on housing. But when the lending

boom abruptly ended, the result was both an economic and a fiscal crisis. Savage recessions

drove down tax receipts, pushing budgets deep into the red; meanwhile, the cost of bank

bailouts led to a sudden increase in public debt. And one result was a collapse of investor

confidence in the peripheral nations’ bonds. So that, Greece has surprised many observers.

The chronicle of the Greek crisis is not only the consequence of fiscal accounts made up,

corruption and fraudulent use of European aid, but also a private traffic without transparence.

Our purpose is here only to focus on macroeconomic imbalances concerning Greece. On 1

January 2009, the deficit is estimated at 3.9% of GDP. In the month of October, this is a

deficit of 12.5% of GDP and finally at the end of December, we're talking about 15.4% of

GDP. A priori, with low interest rates, the debt burden is low, but in relying on low inflation

and the reactions of financial markets expectations with regard to the information conveyed

by the agencies rating on the country risk premium. Similarly, it is important to realize that a

debt financed by domestic savings (Japan), does not have the same meaning as more and

more debt traded in the international financial markets. Greece is not treated the same way as

Germany, when it comes to debt. The heterogeneity of the euro area is safe from the core

countries well endowed with technology, industry and competitive. And financial markets

have led to increased interest rates on weaker countries in a self-fulfilling prophecy (Cohen,

2011).

The first plan of the month of April 2011 provided a budget of 30 billion euro. The second

includes 110 billion, with a program back to a deficit to 2.6% of GDP in 2014. Stock markets

react negatively and the risk of recession makes it unlikely the achievement of this objective.

Compared to the Greek crisis, this first response is inadequate at the outset.

With the entry of Spain in crisis in May, the risk of spreading the financial crisis and its

transformation into a real crisis cause summits of the French President and German

Chancellor extended to all European leaders. Markets and rating agencies do not respond

21

because these countries have curly insolvency; then it is more a crisis of confidence in relation

to the macroeconomic policies pursued.

Since October 27th

, the treatment of the Greek debt is only financial and attempts to prevent

contagion to larger countries such as Italy, Spain or France. For Greece, it is expected that the

debt be reduced from more than 160% of GDP to 120% in 2020, a level considered

sustainable by the European authorities. To do this, the governments of the euro area will set

the table 130 billion euro in loans and guarantees, while private creditors will remove 100

billion from 210 billion euro of Greek securities they hold.

The Director General of the Institute of International Finance (IIF) Charles Dallara, who

represented the banks in the negotiation, welcomed the agreement, which revises the plan of

July 21, in which the private sector was engaged only up to 50 billion euro.

As expected, the leaders of twenty-seven have also endorsed the plan to recapitalize banks to

the tune of 106 billion euro by June 30, 2012.The plan also provides government guarantees

to enable banks to secure funding in the medium and long term, similar to those that were

implemented in fall 2008. Europeans also agreed on scaling capabilities of the European

Financial Stability (EFSF), which could then be brought up to 1.000 billion euro. An initiative

likely to reassure markets on its ability to fly, if any, help from countries.

The Fund had in its creation of 440 billion euro but the support in Portugal and Ireland and

the complex financial arrangements necessary to give it a AAA rating reduced to about 250

billion today its actual capacity remaining.

The leverage will be achieved via a dual mechanism: on the one hand it will provide partial

debt issued by troubled countries and, secondly, to create a new "special vehicle" backed by

the EFSF and the International Monetary Fund (IMF) with the eventual participation of

international investors, such as China and other emerging countries. The core countries, the

Scandinavian countries also have sovereign wealth funds should help countries in trouble.

If he had been excluded from the weekend to leverage the EFSF by providing access to

unlimited liquidity to the European Central Bank, the central bank has been active in the

preliminary summit. Providing some relief to markets, the President of ECB, Mario Draghi,

stated in the beginning of November that the bank would remain present in the bond markets

as they would be unstable. Also, the main interest rate by the European Central Bank (ECB),

declined of a quarter point 1.25 October 26th

and make surprise all around the world. It is the

central tool at its disposal to influence the award credits and control the evolution of prices in

the euro zone. This instrument, used in the weekly refinancing operations the ECB to supply

the banks with liquidity, is the true barometer of the cost of credit in the 17 countries in the

22

euro area. Banks that want to refinance short-term can do so by paying interest on the amount

they borrow from central banks in their respective countries. This interest is calculated from

the current rate to the ECB. The banks then pass in principle that the interests of rent credits

they grant to their own customers. The higher the rate of the ECB, the lower the cost of credit

is likely to be cheap, which, in theory, promotes growth. Conversely, a higher credit rate can

theoretically slow demand and thus prevent overheating generating inflation.

Overall, how does Europe tried to solve these problems, if countries accept credible plans to

return to financial balance? To summarize, one can keeps in mind:

• Countries of the core (Germany and France), the Scandinavian countries with sovereign

funds should help countries in trouble.

• Some private lenders must be involved.

• The IMF is an appeal, because the IMF programs of debt restructuring reserved for

emerging countries (Brazil in the 90's) end in most cases without bankruptcy. These programs

are called Sovereign Debt Restructuring Mechanisms are applicable to European countries,

with countries to give a difficult time implementing different time markets. In this context,

interest rates sovereign benchmark Treasury rates are German, and if the thresholds are

ceilings with the ECB and the European Stabilization Fund involved.

• A European debt attached to the national debt of a country should be considered with euro-

bonds at rates lower than market rates.

Finally ECB lowered its interest rates

222 A fear of worldwide crisis

Many analysts were far from imagining that member countries of Europe could know the

risks of default on their foreign currency debt, endangering the entire area. The opting out of

the euro has considerable costs despite that such an event is not previous in the European text

without a unanimous vote. For example, the total cost for a country like Greece is the first

year, between 40 and 50% of its GDP. This issue causes a domino effect, an increase in the

debt of the country concerned, a collapse of the banking system, likely a currency war, a

return of inflation, increasing interest rates and unemployment, and finally a disaggregation of

the social welfare.

A member of the euro area that wants to leave must first devalue its currency. if the debt is in

euro or foreign currency, it must be converted into the new national currency. This debt will

increase it. Non-resident investors will be less confident because they want to be paid in

international currency. Resident investors will anticipate the decision of their government,

23

there will be capital outflows before the decision of politicians. So we can expect a

devaluation of the currency of the country that decides to leave the euro area. While capital

flows, the reactions of banks and institutional investors will cause a decline in the euro against

the dollar or the yen in the short term. But the euro must back in the future because the bad

pupils have decided themselves to leave. There will be a J-curve of the euro for insiders.

P.Artus – a well known specialist in France- as quoted by Prandi (2011) advances the

following costs in billions of euro for countries likely to respond to this big Capernaum to

leave Euroland: Greece (170), Portugal (70), Spain (90), and Italy (300). Bank runs can then

occur: bank customers wanting to withdraw their holdings in euro. The amounts of the

withdrawals will be capped and bank affiliates will close. To keep customers, banks would be

willing to raise rates on deposits. Banking competition is wild, and would increase financial

instability. Bankruptcies can then result from the transformation of sovereign debt in local

currency depreciated.

Expectations of devaluation of the currencies of these countries vary in the range of from 30

to 50% compared to the euro. Countries that remain in the euro area and the rest of the world

will not remain passive. There will be cascading devaluations and therefore a war exchange

for maintaining competitiveness, and ultimately quantitative measures, source of word wide

decline in growth. With the adjustment of long term interest rates, we can expect the inflation.

Inflation is an inevitable consequence of the monetization of public deficits after devaluation.

Indeed, to replace private investors in the market, the bank buys the securities of the public

debt with money EEC. Stagflation will again prevail in the world. Unemployment and social

distress must be in the heart of the world.

Nouriel Roubini estimates that over 50% the risk of another recession in 2012 for developed

countries (La Tribune, October, 25th

2010). This crisis shows that all countries are affected by

the crisis in Greece. Europe’s situation is really, really scary: with countries that account for a

third of the euro area’s economy now under speculative attack, the single currency’s very

existence is being threatened — and a euro collapse could inflict vast damage on the world

(Krugman,2011)

Finally, the weakening of European and American demand could weaken China, especially in

view of the high level of "bad debts" of the Chinese financial sector, real estate, for example.

"One would expect a hard landing in China in the next two to three years," he said, adding

that there is no "one example of a soft output boom caused by over-investment ". If Europe

does not deal seriously with this problem, the Economic and Monetary Union will explode,

because domino effect of this crisis is strong. Particularly, Germany has a central

24

responsibility on the solvency of this crisis. E. Chancellor ( 2011, Financial Times, November

7th

) makes some parallelism between German position under crisis and a well known

macroeconomic theorem. In one side, this theorem based on observation due to Mundell

(1960) says that : that is wall impossible for a country simultaneously under Bretton-Woods

system to maintain a fixed exchange rate and an open capital account while keeping inflation

under control. In another side, with this crisis, it appears another trinity. How German

politicians can keep the survival of euro, while wishing to limit global inflation in Europe and

their contribution to any bail-out? These demands are mutually incompatible. If Germany

chooses to leave Europe, its banks-which have made loans across Europe-would collapse.

Furthermore, a revival of deutschmark might be risky in direction of overvaluation.

3. What lessons for Europe and monetary integration?

3.1Common elements of monetary unification in building nations: United States, Japan,

Italia

Monetary systems based on fiat currencies and precious metals in each region within a

country or even a confederation of countries did not survive due to transaction costs

arising from trade in goods and services or arising from the exchange rate risks.

Systems did not survive, first because the private central banks at that time are in

competition. The Banks of the richest regions eventually prevail over the banks in

poor regions; the emerging currency depends on the relative wealth of each country.

To avoid protectionist practices, competitive devaluations for territories not subject to

the same legal restrictions and to the same rules of inflation tax, the politicians make

the choice of monetary unification.

A common currency is the issue of a political act imposing legal restrictions. Then it

becomes a social convention, because agents have confidence in an instrument

universally accepted. Initially its nature is private, and then it passes into the political

arena to become public property.

Cultural, historical and economics links like the same frontier, the same language, are

determinants for monetary unification.

Monetary unification is certainly a market process (bootstrap effect), but also a

political decision.

3.2 Lessons from Latin Union and Scandinavian Union

321. From Latin Union

25

In fact, during this period and particularly during the Great Depression, Central banks

never have price stability as a goal. They attempt to manage interest rates in order to

attract flows of capital and to gather gold. In short term, balance of payments

equilibrium depends on interest rates variation without gold movements. It appears so

difficult to pursue price stability in a heterogeneous monetary union. Thus in 1885;

France with a structural surplus compared to other EU countries will not increase its

supply of money in silver, but will seek reimbursement of its debts in gold: the so-

called clause of liquidation. Italy and Switzerland accepted the decision of France, but

Belgium rejected the clause. The survival of the Union was the result of the final

adoption of the gold standard in international payments. The silvers coins disappear

more and more in each country, and paper money, checks and bank notes are used for

internal transactions. The dissolution of the Union in 1926 began with the First World

War; the countries of the Latin Union have different political positions during the

conflict.

The Union was submitted to asymmetric shocks; the exogenous shocks from the

principal country-France- have important effects on other countries, particularly

supply shocks. The difficulties of the Union were largely caused by France

difficulties.

A sustainable monetary union needs real convergence of members. If one of them is

more developed, he has to help the others. A free-rider attitude is not optimal.

Beyond conventional analyses (Willis, 1901) which give a portrait of this arrangement

as a by-product of French power politics, Flandreau (2000) reinterprets the economic

nature of the Latin Union, focusing on the interrelations between trade, finance and

money. He argues that the Latin Union did not foster trade integration and that, as a

matter of fact, such was not its objective, according to archival evidence. Instead, he

suggested that the Latin Union was the result of the growth of France as a major

supplier of capital. The need to provide French investors with exchange-rate

guarantees led borrowing countries to tie their respective monetary systems to that of

France. This, in turn, created opportunities for international monetary action and the

French franc became the ‘natural’ focal point of projects of monetary unification. This

evolution, however, had structural limits which help to explain the downfall of the

projects for expansion of the Latin Union.

26

3.22 From Scandinavian Union

The Scandinavian had not unified the institutions responsible for real and monetary

integration. Each central bank is free in the conduct of its monetary policy-.In

addition, imbalances payments between countries appear. In fact, the elimination of

gold shipments disguised a growing imbalance in payments to Denmark’s advantages.

On 30th

September, the Swedish central bank abandoned the 1885 clearing agreement.

Beyond the political reason-as an aspiration of Norway’s to independence,

independence obtained in 1905 - there were economic reason which that participated

to the breakup of the union. Applying a frequently used indicator of the desirability of

monetary union based on supply shocks, M. Bergman (1999) study the symmetry of

country-specific structural shocks (measured net of the non-Scandinavian influence) in

these three countries. It is found that country-specific shocks are not highly

symmetric. This conclusion is also supported by the absence of clear-cut differences

between the pattern of structural shocks in Belgium and structural shocks in the

Scandinavian countries. This suggests that the three Scandinavian countries did not

form an optimum currency area during the period 1873–1913.

The outbreak of the First World War, and the end of the gold standard, effectively

sealed the fate of the Scandinavian union. Divergent growth rates and prices in the

respective countries between 1915 and 1920 are the last fact contributing to the

dissolution of the union.

Despite subsequent efforts during and after the war to restore at least some elements of

the Union, particularly following the members' return to the gold standard in the mid-

1920s, the agreement was finally abandoned following the global financial crisis of

1931.

A systemic crisis without adequate treatment is very dangerous for a Monetary Union.

3.3 Outcomes from old currency boards in West Africa

Key elements appear after the presentation of the West African currency board history:

Soon after the currency board system reached its greatest extent, in the mid 1950s, it

ebbed for several reasons. Nationalist sentiment called for an independent national

currency to accompany other trappings of independence. Economic theory of the time

accused the currency board system of needlessly tying up resources in 100 external

reserves, and touted the virtues of discretionary monetary policy as an engine of

economic growth. Sterling, the principal reserve currency for currency boards, was

unreliable.

27

The motive behind the West African currency board was not a bank failure, as in

Mauritius or Ceylon, or adherence to the doctrines of the Currency School, as in New

Zealand; it was a desire to use currency issue as a source of seigniorage while

avoiding the dangers of depreciation against sterling. One such danger was an increase

in the real burden of sterling debt.

In the system of the sterling area, each country is responsible for its debt, because

money supply of each country depends on the cycle of its economy. The convertibility

of local currency is guaranteed by the productive effort of each country and not by the

generosity of Great Britain. There is no automatic compensation of deficits by the

dominant power. There are no criteria for membership in the area (see the case of

Togo and Cameroon). Natives are associated with the management of local

currencies. Mundell (1972pp 42-43) has conjectured in this sense, not without reason

a link between legal origin and financial development, that Anglophone countries in

Africa, influenced by British activism and openness to experiment, would have a

higher level of financial development than their Francophone neighbors, influenced by

French reliance on monetary rules and automaticity. “The French and English

traditions in monetary theory and history have been different ... The French tradition

has stressed the passive nature of monetary policy and the importance of exchange

stability with convertibility; stability has been achieved at the expense of institutional

development and monetary experience. The British countries by opting for monetary

independence have sacrificed stability, but gained monetary experience and better

developed monetary institutions.”

3.4 Critical issues of the CFA Franc zone

With the CFA countries, the same and coordinated policy mix contributes to improve the

credibility of their currency, but the fact remains that there is some uncertainties upon the

objectives of convergence. These uncertainties are due to the importance of informal cross

border trade to explain the weakness of bilateral trade officials and the heterogeneity of

responses to shocks or shocks affecting these economies with non member countries. Zhao

and Yoobai (2009) explore the features of the CFA franc zone and compare them to those of

the Economic and Monetary Union (EMU) by operationalzing the criteria for an optimum

currency area. A structural vector autoregressive method is used in modeling national outputs

as determined by global, regional, and country-specific shocks. They find that domestic

outputs of the CFA franc zone countries are strongly influenced by country-specific shocks

28

while regional shocks are far more important in European countries that have joined the

EMU. The results suggest that the CFA franc zone countries are structurally different from

each other and thus are more likely to be subjected to asymmetric shocks. They do not appear

to form an optimum currency area and the monetary union may have been a costly

arrangement for the member countries unless they are compensated with some other benefits.

However, the transition to the single currency with these other non members’ countries -

within the ECOWAS desiring to realize full integration in 2020- would reduce these effects of

informal exchanges and catalyzes regional trade (Rose, 2000). The table 1 annexed to this

paper can give some useful information on bilateral trade importance in this area covered by

fifteen countries.

Some local observers (Nubupko, Combey, 2010 ) think that CFA zone is really dominated by

dogma of fiscal and monetary policies and maintain the countries members underdeveloped,

because financial repression is really functioning. For them, the situation prevailing is in this

area is worse than Currency boards.

To assume this conclusion, Combey and Nubupko use a dynamic panel model to identify

endogenously for the WAEMU countries; the existence of an optimal level of inflation and

estimated it to 8.0percent. The argument behind this research is that a lot of idle resources are

diverted to finance development and real activity through the mandatory reserve deposits

with the transaction account managed by the French Treasury, and because tax authorities and

fiscal UEMOA countries are denied the right to domestic seigniorage revenues and thus

mobilized for development. Coverage required to operate bank account transactions exceeds

the powers of a currency board (112% versus 100%) and in addition interest rates are such

that the triangle of incompatibility organizes capital flight and not their settlement in the form

of investments. English-speaking countries (Liberia, Nigeria, Sierra Leone, Gambia, Ghana

...) met in the West African Monetary Zone, and Cape-Verde, are more competitive than

countries in the franc zone. Besides the countries of the WAMZ, other African countries not

full members of a monetary union (Ethiopia, Malawi, Botswana, Uganda, Mauritius, Kenya

...) has certainly higher rate of inflation, but there are more competitive and perform better in

terms of growth.

Also the devaluation of the CFA franc in 1994 means that participating to a monetary union

never means a complete insulation from external shocks and debts of a member country can

rise to expose it to insolvency (Semedo, 1992, Semedo and Villieu, 1997). All these African

countries members of the CFA zone are now subject to conditionality and structural

29

adjustment programs of multilateral institutions, donors and private suppliers of financial

liabilities in the international financial markets.

Recent European crisis must affect this relationship between euro and CFA.

3.5 What is wrong in the treatment of the euro crisis and what we learn about monetary

integration?

351 What is false in the treatment of the euro crisis and what could be done?

Stiglitz (2011) goes against the grain of conventional wisdom on the crisis and he gives

highlights concerning the treatment of the debt crisis in Europe. The golden rule is

inappropriate for him: a remedy worse than the disease. For him, "reduce the deficit will

weaken the economy" and "spending a lot of time dealing with banks, it has forgotten the

basic problems. European politicians are focused on the financial sector, but the solution is

not just financial. "Bailing out the banks is necessary but not sufficient. And that's where the

Obama administration and those who were close to the banking system were wrong. The

banks have behaved very badly and have worsened the crisis”. According to Stiglitz, the

deficit is anything but a priority right now.

Another great economist- Krugman (2011) - says in accordance with him: “European policy

makers seem set to deliver more of the same. They’ll probably find a way to provide more

credit to countries in trouble, which may or may not stave off imminent disaster. But they

don’t seem at all ready to acknowledge a crucial fact — namely, that without more

expansionary fiscal and monetary policies in Europe’s stronger economies, all of their rescue

attempts will fail”.

Also for Krugman, elites are not ready to rethink their hard-money-and-austerity dogma. Part

of the problem may be that those policy elites have a selective historical memory. They love

to talk about the German inflation of the early 1920s — a story that, as it happens has no

bearing on our current situation. Yet they almost never talk about a much more relevant

example: the policies of Heinrich Brüning, Germany’s chancellor from 1930 to 1932, whose

insistence on balancing budgets and preserving the gold standard made the Great Depression

even worse in Germany than in the rest of Europe — setting the stage for you-know-what.

Roubini’s (2010) recommendation is a complement of this approach. In a first step Europe

needs to adjust two rates: simply devalue the euro to boost exports and lower interest rates. "If

they (European leaders) really wanted to restore growth in the short term, they would reduce

their interest rates to 0%," he said. Globally, I am agreeing with these 3 authors and as quoted

Stiglizt: “Without radical reform of the European leaders, the euro zone could collapse and

30

lead to a crisis worse than 2008. In a situation that becomes increasingly disorderly and that

several countries would be missing the euro area, leading to a collapse of the area (...) it

would be as bad or even worse, that the fall of Lehman 2008.Especially since, with a

recession as severe in the advanced economies, "collateral damage in emerging markets could

be significant."The severity of the slowdown will depend on the ability of Europe to avoid a

break in the euro area. Before specifying what really expect the markets, ie measures that can

boost economic growth in the weakest countries in the euro area. Austerity is not the solution,

and this will exacerbate European problems.

European leaders must not treat separately the Greek crisis: it is an European problem and that

is a political problem. In practice the division of problems is such that the split is always

defeated. Europe is competing with two currency areas: the dollar area, the area yen, and this

competition is mediated by China.

352 Europe need fiscal federalism to absorb shocks and to conduct public policies

appropriate for endogenous growth

As Paul Krugman tells"[T]he architects of the euro, caught up in their project's sweep and

romance, chose to ignore the mundane difficulties a shared currency would predictably

encounter — to ignore warnings, which were issued right from the beginning, that Europe

lacked the institutions needed to make a common currency workable. Instead, they engaged in

magical thinking, acting as if the nobility of their mission transcended such concerns].

Krugman (2011) explains that having a transnational currency does have obvious benefits —

it makes doing business a lot easier in Europe. But, he says, there's also a downside: By

giving up its own currency, a country also gives up economic flexibility and the benefit of

having its own federal government back it up in times of economic trouble. Monetary union

has costs and need agenda and finance resources.

What agenda for Europe in crisis? Stiglizt (2011) recommended instead of new spending to

stimulate employment, including the United States .To solve the problem of growing

inequality, we must lead, according to former Nobel Prize in Economics, “a long-term policy

on education. But also focus on environmental innovation while, until now, the private sector

has focused on innovations that create unemployment”. This is possible first with a great

coordination of fiscal and monetary policies namely policy-mix is needed. What means are

necessary to this endogenous growth?

To do with first, the ECB must participate to save the euro area. Clearly, the European Central

Bank should intervene. It should be greater involvement of the ECB. The ECB has to buy

31

massive amounts of government securities in difficulty to break the panic and speculation. In

the state of current market panic, the ECB must accept its role as lender of last resort. Italian

interest rates still evolving around 7% on Thursday, November 17th

, 2011. This level is

unsustainable in the scale of a few months. And fears of contagion from France have

propelled the difference in interest rates between Germany and France to a new record (204

basis points difference, France into debt at a cost of more than two times higher). It is a sign

of disruption of markets, interest rates of other states in the euro area AAA rated - such as

Finland or the virtuous Netherlands - are also affected. The idea of intervention is discussed at

the political level, but the fear of inflation concern to politicians. In the U.S., and Britain,

central banks do. In the United States, purchases of debt represents about 18% of GDP while

in Europe the ECB has so far bought the equivalent of 2.7% of GDP in the euro area. The

European financial stabilization can be powered this way. How could she do? First, by a

communication effort to announce, that it will play its role as lender of last resort for the most

indebted countries. Also it prevents vulnerable countries to speculative attacks of the markets.

This announcement effect, even without intervention, can calm the markets. For contracts,

this announcement is a guarantee that the debts will still be paid. The ECB would give the

assurance to creditors’ states that they can always resell them corresponding obligations if

necessary. In fact, the ECB is already supporting the debt of distressed states, but it underlines

the fact that in exceptional circumstances. She has since bought eighteen months 187 billion

euro of securities Italian, Greek, or Spanish in the secondary market. In addition, she is

careful to "sterilize" its purchases, that is to say, it decreases by an amount equivalent to its

lending banks, not to inflate its balance sheet. Ultimately, these acquisitions are not sufficient

to calm the markets. However a systematic action has already demonstrated its effectiveness.

All in all, the ECB must communicate by saying it would intervene systematically. The ECB

has now exceeded its mandate and that the inflation target is not the problem. It is not

inconsistent with fiscal discipline. However, there are risks. What are the risks? Virtuous

countries finance the deficits of the less virtuous, but solidarity before the tests should be a

principle of operation of any monetary union that seeks to be viable or sustainable over time.

As we mentioned above, Germany should lift its veto. His fear of hyperinflation is

exaggerated, given the greater threat of depression and unemployment. However, this

solidarity must be constrained. The States on the side of debt must have their hands tied and

have to meet the objectives of fiscal discipline. Clearly, it is the establishment of a priori

control of the budgets of member states, not retrospectively.

32

The second ways to explore, despite resources of EFSF obtained with banks and States of the

core, could for example indirect taxes. Just for example, raise VAT by 2.5% and of

replenishing the fund financial and it is a good and second solution to have funds to build the

new Europe and to get stability to raise capital on financial markets (leverage effect) without

alienating European sovereignty. Europe is in a "deep crisis" because each country uses a

single currency — the euro — without the benefits of a single government to make the

currency workable. In fact, the entity Europe as a whole is not indebted or insolvent and

economics of scales are possible to mobilize funds for financing utilities, public goods and

human capital accumulation.

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Annexes

Table1 : Bilateral trade between Ecowas countries in 2009

35

Imports in dollar US* Exports in dollar US**

ECOWAS WAEMU WAMZ EU27 ECOWAS WAEMU WAMZ EU27

Cape-Verde 1.06 0.79 0.26 77.60 29.21 29.21 0.00 60.73

Benin 25.39 14.38 11.02 40.02 36.10 24.70 11.40 10.01

Gambia 13.04 12.62 0.42 46.90 32.13 31.0 0.96 60.80

Ghana 11.67 2.09 9.58 36.29 22.39 19.46 2.90 47.82

Guinea 16.82 16.51 0.30 32.33 1.86 1.37 0.50 39.24

Ivory Cost 30.11 2.01 28.09 39.98 21.69 10.90 10.42 46.93

Mali 40.62 37.92 2.70 25.42 25.07 22.38 2.69 8.68

Niger 23.59 15.50 8.09 25.44 28.18 9.72 18.45 39.49

Nigeria 1.30 1.05 0.24 37.65 6.28 3.64 2.64 21.14

Senegal 7.62 4.02 3.61 50.96 36.19 29.40 6.63 26.00

Guinea-Bissau 42.61 41.01 1.57 47.32 1.38 1.33 0.03 0.44

Togo 17.18 15.00 2.18 40.54 67.62 43.22 24.39 8.73

Burkina Faso 43.37 37.31 6.05 40.17 74.92 56.12 16.95 22.33

WAEMU 24.27 11.34 12.93 39.87 25.95 15.50 10.13 41.46

WAMZ 3.83 1.90 1.93 37.30 6.87 4.24 2.62 22.43

ECOWAS 10.93 5.18 5.74 38.66 9.94 6.08 3.82 25.52

* Percent of total des imports of a country. ** Percent of total des exports of a country.

Source : COMTRADE (2010)

Figure 1 : Nominal convergence Index :1979-2008

Figure 2

36