Thoughts on: Lawrence B. Lindsey's 'The American experience of currency union: an observer from the other side of the Atlantic'

Citation

Hama, N. (1998), "Thoughts on: Lawrence B. Lindsey's 'The American experience of currency union: an observer from the other side of the Atlantic'", European Business Review, Vol. 98 No. 1. https://doi.org/10.1108/ebr.1998.05498aab.010

Thoughts on: Lawrence B. Lindsey's 'The American experience of currency union: an observer from the other side of the Atlantic'

Thoughts on: Lawrence B. Lindsey's "The American experience of currency union: an observer from the other side of the Atlantic"

Noriko Hama

Lawrence Lindsey's paper on the US experience of currency union is as lucid as it is thought provoking. Its clear-headed logical progression provides a much needed sound foothold from which to step out into the tangled web of elements that need to be examined in approaching the issue of currency unions.

Lindsey begins by setting out the advantage of having a multiple currency system. He states this to be the ability to correct divergence and differences in performance among regions in a given economic area. He points out the need for such corrective processes to be automatic, that is to say, without the intervention of discretionary policy manoeuvres. Having established this point, he goes on to say: "The key question regarding an optimal currency zone is whether or not alternative stabilising mechanisms exist". In other words, what are the elements needed if an economic area is to function smoothly without the aid of multiple currencies to iron out the disparities that would otherwise emerge among the constituent entities of that area. As Lindsey correctly states, the two most important factors in this respect are labour market mobility and fiscal transfers. An economic area that lacks these mechanisms of adjustment is unfit to function under a single currency regime, because there are no alternative forces in place that can ensure the efficient allocation of resources within the area.

Drawing on the US experience, Lindsey then considers whether the European Union is endowed with those stabilising mechanisms that would compensate for the lack of multiple currencies in the event that EMU comes into existence. His conclusion regarding labour mobility is that: "As an alternative to exchange rate variations as a form of macroeconomic adjustment, Europe simply cannot rely on cross-national labourforce mobility to the extent that it can be relied on in the USA". And what of fiscal transfers? "Again", says Lindsey, "Europe appears to lack the kind of automatic stabilising properties which a unified fiscal mechanism affords the USA potentially to act as an alternative to exchange rate variations".

What is most enlightening about Lindsey's discussion of Europe's lack of stabiliser mechanisms is the emphasis placed on the automatic nature of the adjustment process. Both labour mobility and fiscal transfers have to happen as a matter of course, without discretionary involvement on the part of policy. This distinction is important. Incentives and coercion, monetary or otherwise, are not at issue here. This point is particularly significant with regard to fiscal transfers. The inference that can be drawn from Lindsey's comments is that Europe will have to have a unified tax regime if wide and sustained disparities in regional economic performance are to be avoided. Deliberate transfers made through such mechanisms as the Structural Funds within the EU budget cannot provide the ultimate answer in this context.

On first inspection, this argument would appear to supply ammunition to the supporters of deeper economic integration in Europe: if the single currency is deemed unworkable without a single unified tax system, that is all the more reason to move to a higher level of integration, where all matters of macroeconomic policy are decided by a single European government. This, however, begs the question why the very exercise of currency union is necessary in the first place, when so much elaborate change is required to guarantee its success. Europe already has automatic stabilisers in place in the form of its multiple currencies. Multiple currencies only become a hindrance when they exist in an area where a single currency would better ensure greater resource allocation efficiency and hence greater prospects of growth and prosperity. What purpose is served in imposing a single currency on an area of vast economic diversity, where the stabilising properties of a multiple currency system would not seem fatally out of line with the kind of adjustments required ?

Lindsey observes that Europe as it stands today lacks the conditions required of a single currency zone. This statement could be rephrased to say today's Europe is a place which is endowed with conditions that call for a multiple currency zone. The outcome of introducing a single currency into such an economic area, far from encouraging the move towards unified taxation or greater labour mobility, could well be to necessitate the imposition of yet more elaborate, arbitrary and costly mechanisms of discretionary income redistribution. Or alternatively, the burden of adjustment could be diverted on to the world outside of that single currency area via a volatile currency tending towards perpetual weakness. Either way, something of a worst of all worlds.

The tour d'horizon that Lindsey gives us of America's evolution towards a single currency is quite simply fascinating. Perhaps the most instructive point, though not made explicitly by Lindsey, is that the whole process took place in a world economy whose international currency regime was itself still very much in the making. The evolution of the American currency system was a function of the evolving state of the international currency system itself. A focus on this interaction between the international and the domestic is surely critical in any examination of currency systems and optimal currency zones. Yet this is a perspective that seems conspicuously absent in the discussions to date concerning the European single currency. Europe could do well to consider the state of the international financial system as it stands today, how it got there, and where Europe sits in the general scheme of things, when contemplating the prospects for a single currency for itself. So much of the current debate concerning the Euro is so inward looking, and lacks global as well as historical perspective. Europe, whose economic history, after all, is so much longer than that of the USA, surely has much to gain from a look back at how its own currency arrangements have evolved over time, and by considering whether or not today is the point in history when the formation of a single currency zone is appropriate to the state of its economies.

Another intriguing line of thought that Lindsey's own historical perspective opens up for the reader is the question of whether or not an optimal currency zone is a permanent thing. As Lindsey reminds us, the USA evolved into a single currency area over a period of 147 years. Many developments occurred over that time to culminate in this outcome. And there have been very many further developments since. The very position of the US dollar within the global scheme of currency relationships has undergone considerable change over the time since the establishment, as Lindsey puts it, of "... a true 'single currency' zone ..." in the USA. That being the case, does the USA of today still retain all those properties that befits a single currency area? Could there never again be a case for a multiple currency USA, where the adjustments that it has to go through can be absorbed by exchange rate variations within the US economy rather than being brought out into the international financial marketplace, involving the fates of other currencies and other economies? Lindsey's historical discourse provides valuable testimony of how much of an evolving thing currency regimes have been over time. And they do have to evolve with the times. Not the other way round.

Lindsey observes that: "To say that Europe does not at this time seem to meet the properties as an optimal currency zone does not mean that this will never be the case". He is right. Events have their rightful place in history. If they are inopportune, they are apt to distort, destabilise, confuse and self-destruct. There may indeed come a day when Europe meets all the criteria for the formation of a single currency area, at a much more fundamental and suitable level than is embodied in the all too notorious convergence criteria of the Maastricht Treaty. But that day should not be forced on Europe by anything other than the endorsement of contemporary economic circumstances and the assurance of greater wellbeing and economic dynamism for its peoples into the future.