Sunday, March 24, 2013

Monetary union with capital controls

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Tim Duy writes:

Is this how the Eurozone experiment will end? Not with a formal "exit," but with a return to banking dominated by national boundaries and enforced by capital controls? No longer a true common currency, but a dozen currencies sharing the same name, each with different value?

This reminded me of, among other multinational currency arrangements, the CFA franc zones. From Barry Eichengreen:

Two special circumstances played a role in the stability of the CFA franc-Frech franc rate. First, all members countries maintained restrictions on payments for capital-account transactions, and several maintained limited restrictions on payments for current-account transactions. Here as elsewhere, capital controls appear to have been associated with the viability of the currency peg. Second, the CFA franc countries received extensive support from the French government. In addition to foreign aid (France being the largest bilateral donor to its former colonies), they received essentially unlimited balance-of-payments financing. 
The contrast with the EMS is worth noting. Where intra-European currency pegs have had to be changed every few years, the link between the French franc and CFA franc remained unchanged for nearly half a century. (first edition, page 185)

From Benjamin Cohen:

Even a minimal sense of community is missing. Mutual trade is small, at a little over 10 percent of the average of exports and imports, while historical antagonisms in some instances remain deep and persistent. (page 175)

The point is not that the franc zones (or other currency unions) are directly comparable with the Eurozone (obviously they are not). Piling on capital controls is unlikely to resolve Europe's banking sector problems, for one. But the notion of a union under a common currency (or hard peg) in which countries use various capital controls to carve out some elements of monetary autonomy is not just academic. The franc zones have done it for decades, and other arrangements like the Sterling Area or even Bretton Woods had these characteristics to some degree.

I have no idea what the Eurozone endgame looks like, but a common currency throughout a series of financially segmented states is at least a possibility. Reversing the globalization of capital, though, isn't likely to be as easy as it once was. The extent to which the proposed Cyprus rules restrict even purely domestic uses of electronic money speaks to the difficulty of preventing cross-border capital flows in the modern climate. 

As a side note, it's always important to remember that the Eurozone was not the first attempt at full currency union. They have existed all over the globe, even just in the last century. The history of currency unions is fascinating for students of economics and geopolitics; a good place to start is Cohen's Geography of Money.

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