At the Peterson Institute for International Economics, Mr. Anders Aslund has an interesting paper on the historical aftermaths of the dissolution of currency unions.
Mr. Aslund opens with a refutation of the Nirvana fallacy of the Keynesian prescription on the currency devaluation elixir. Here Mr. Aslund rebuts Nouriel Roubini. (all bold highlights mine)
While beneficial in some cases, devaluation is by no means necessary for crisis resolution. About half the countries in the world have pegged or fixed exchange rates. During the East Asian crisis in 1998, Hong Kong held its own with a fixed exchange rate, thanks to a highly flexible labor market. The cure for the South European dilemma is available in the European Union. In the last three decades, several EU members have addressed severe financial crises by undertaking serious fiscal austerity and reforms of labor markets, thus enhancing their competitiveness, notably Denmark in 1982, Holland in the late 1980s, Sweden and Finland in the early 1990s, all the ten post communist members in the early 1990s, and Germany in the early 2000s. Remember that as late as 1999, the Economist referred to Germany as “the sick man of the euro.”
More recently, the three Baltic countries, Estonia, Latvia, and Lithuania, as well as Bulgaria have all repeated this feat (Åslund 2010, Åslund and Dombrovskis 2011). Among these many crisis countries, only Sweden and Finland devalued, showing that devaluation was not a necessary part of the solution. The peripheral European countries suffer in various proportions from poor fiscal discipline, overly regulated markets, especially labor markets, a busted bank and real estate bubble, and poor education, which have led to declining competitiveness and low growth. All these ailments can be cured by means other than devaluation.
Mr. Aslund on the currency union dissolution during the gold standard eon.
It was rather easy to dissolve a currency zone under the gold standard when countries maintained separate central banks and payments systems. Two prominent examples are the Latin Monetary Union and the Scandinavian Monetary Union. The Latin Monetary Union was formed first with France, Belgium, Italy, and Switzerland and later included Spain, Greece, Romania, Bulgaria, Serbia, and Venezuela. It lasted from 1865 to 1927. It failed because of misaligned exchange rates, the abandonment of the gold standard, and the debasement by some central banks of the currency. The similar Scandinavian Monetary Union among Sweden, Denmark, and Norway existed from 1873 until 1914. It was easily dissolved when Sweden abandoned the gold standard. These two currency zones were hardly real, because they did not involve a common central bank or a centralized payments system. They amounted to little but pegs to the gold standard. Therefore, they are not very relevant to the EMU.
“Abandonment of gold standard” simply suggests that some members of these defunct unions wantonly engaged in inflationism which were most likely made in breach of the union’s pact that had led to their dissolution.
Mr Aslund tersely describes on one account of “successful” post gold standard breakup…
Europe offers one recent example of a successful breakup of a currency zone. The split of Czechoslovakia into two countries was peacefully agreed upon in 1992 to occur on January 1, 1993. The original intention was to divide the currency on June 1, 1993. However, an immediate run on the currency led to a separation of the Czech and Slovak korunas in mid-February, and the Slovak koruna was devalued moderately in relation to the Czech koruna. Thanks to this early division of the currencies, monetary stability was maintained in both countries, although inflation rose somewhat and minor trade disruption occurred (Nuti 1996; Åslund 2002, 203). This currency union was real, but thanks to the limited financial depth just after the end of communism, dissolution was far easier than will be the case in the future. In particular, no financial instruments were available with which investors could speculate against the Slovak koruna
It seems unclear why the Czech and Slovak experience had been the least worse or had the least disruption compared to the others.
Yet considering that inflation is a monetary phenomenon with political objectives, “limited financial depth” seems unlikely a significant factor the “success”. Instead it may have been that political authorities of the Czech and Slovak experience, aside from the “early division of currencies” which may have given a transitional time window, may have likely implemented some form of monetary discipline which lessened the impact.
Mr Aslund finds that the the incumbent European Union seems more relevant with three recent accounts of currency disintegration which had cataclysmic results.
The situation of the EMU is very different from these three cases. It has no external norm, such as the gold standard, and it is a real currency union with a common payments mechanism and central bank. The payments mechanism is centralized to the ECB and would fall asunder if the EMU broke up because of the large uncleared balances that have been accumulated. The more countries that are involved in a monetary union, the messier a disruption is likely to be.
The EMU, with its 17 members, is a very complex currency union. When things fall apart, clearly defined policymaking institutions are vital, but the absence of any legislation about an EMU breakup lies at the heart of the problem in the euro area. It is bound to make the mess all the greater. Finally, the proven incompetence and slowness of the European policymakers in crisis resolution will complicate matters further.
The three other European examples of breakups in the last century are of the Habsburg Empire, the Soviet Union, and Yugoslavia. They are ominous indeed. All three ended in major disasters, each with hyperinflation in several countries. In the Habsburg Empire, Austria and Hungary faced hyperinflation.
Yugoslavia experienced hyperinflation twice. In the former Soviet Union, 10 out of 15 republics had hyperinflation. The combined output falls were horrendous, though poorly documented because of the chaos. Officially, the average output fall in the former Soviet Union was 52 percent, and in the Baltics it amounted to 42 percent (Åslund 2007, 60).
According to the World Bank, in 2010, 5 out of 12 post-Soviet countries—Ukraine, Moldova, Georgia, Kyrgyzstan, and Tajikistan—had still not reached their 1990 GDP per capita levels in purchasing power parities. Similarly, out of seven Yugoslav successor states, at least Serbia and Montenegro, and probably Kosovo and Bosnia-Herzegovina, had not exceeded their 1990 GDP per capita levels in purchasing power parities two decades later (World Bank 2011).
Arguably, Austria and Hungary did not recover from their hyperinflations in the early 1920s until the mid-1950s. Thus the historical record is that half the countries in a currency zone that breaks up experience hyperinflation and do not reach their prior GDP per capita as measured in purchasing power parities until about a quarter of a century later, which is far more than the lost decade in Latin America in the 1980s.
The causes of these large output falls were multiple: systemic change, competitive monetary emission leading to hyperinflation, collapse of the payments system, defaults, exclusion from international finance, trade disruption, and wars. Such a combination of disasters is characteristic of the collapse of monetary unions.
Why hyperinflation poses as the greatest risk for the disintegration of the fiat money based currency unions?
A common reflex to these cases is to say that it was a long time ago, that things are very diferent now, and that other factors matter. First of all, it was not all that long ago. Two of these economic disasters occurred only two decades ago. Second, hyperinflation was probably the most harmful economic factor, and it is part and parcel of the collapse of a currency zone, regardless of the time period. About half of the hyperinflations in world history occurred in connection with the breakup of these three currency zones. The cause was competitive credit emission by competing central banks before the breakup. Third, monetary indiscipline and war are closely connected. The best illustration is Slovenia versus Yugoslavia. In the first half of 1991, the National Bank of Yugoslavia started excessive monetary emission to the benefit of Serbia. On June 25, 1991, Slovenia declared full sovereignty not least to defend its finances. Two days later, the Yugoslav armed forces attacked Slovenia (Pleskovic and Sachs 1994, 198). Fortunately, that war did not last long and Slovenia could exit Yugoslavia and proved successful both politically and economically
Again since inflationism essentially represents monetary means to attain political ends, previous accounts of hyperinflation in post currency union dissolution may have been a result of policy miscalculations from political leaders trying to attain the illusory positive effects from devaluation.
Or most importantly or which I think is the more relevant is that in absence of access to local and foreign savings through banking or financial markets, political authorities in pursuit of their survival have resorted to massive money printing operations.
Also since hyperinflation means the destruction of division of labor or free trade, one major consequences have been to seek political survival through plunder, thus the attendant war. Inflationism, according to great Ludwig von Mises has been “the most important economic element in this war ideology”.
Looking at history has always been deterministic. We look at the past in the account of how narrators describes the connections of the facts in them. But we must not forget of the importance of theory in examining these facts.
As Austrian economist Hans Hermann Hoppe explains,
There must also be a realm of theory — theory that is empirically meaningful — which is categorically different from the only idea of theory empiricism admits to having existence. There must also be a priori theories, and the relationship between theory and history then must be different and more complicated than empiricism would have us believe.
I concur that hyperinflation could likely be the outcome for many European countries once a breakup of the Eurozone becomes a reality. This will not happen because history will merely repeat itself, but because the preferred recourse by politicians has been to resort to inflationism. Theory and history have only meshed to exhibit the likelihood of such path dependent political actions.
occurred in the Philippines, during World War II. In 1942, during its occupation of what was then the Commonwealth of the Philippines, Japan replaced the Philippine peso with Japanese war notes. These notes were dubbed “Mickey Mouse money”, and their over-issuance eventually resulted in a hyperinflation that peaked in January 1944. It should be noted that the U.S. Army, under orders from General Douglas MacArthur, did add a relatively small amount of fuel to the Philippine hyperinflation fire by surreptitiously distributing counterfeit Japanese war notes to Philippine guerilla troops (Hartendorp 1958). (Mickey Mouse Peso image from Wikipedia.org)
