The consequences of Brexit – especially at pivotal moments in the process like the UK triggering Art.50 at the end of March 2017 – will command attention not only in the UK and the rest of Europe but also among all those around the world looking at Europe with interest and concern. While the implications of Brexit should not be downplayed, the whole subject risks becoming a distraction from the even more important question of the sustainability of the Euro. The deep effects of the chronic crisis of the Eurozone – including, arguably, contributing to Brexit – are generally overlooked, with the economic and political tensions of the Euro only resurfacing periodically when the Greek government needs to access new tranches of the bailout agreement. The fundamental tensions remaining largely unresolved. Since the Eurozone is a source of major potential shocks to the global economy and financial system, the reasons for the failure to resolve those tensions deserve continued close scrutiny.
In her latest article, Professor Brigitte Granville – CGR Director – summarizes how the experience of the short-lived and troubled Ruble Zone (RZ) in the early 1990s illustrates the tensions that result from monetary unions between sovereign states. As Prof Granville explains, the RZ came into life with the signature of the Treaty on Economic Union in October 1991 between eight of the fifteen states that emerged from the collapsing USSR. That agreement was followed on 21 December 1991 by the establishment of Commonwealth of Independent States, which adopted the rube as its common currency. The RZ lasted until early 1994. Prof Granville draws on her previous research to extract four important lessons about the challenges of creating and managing currency unions between sovereign states:
1stlesson. Monetary Union can offer opportunities to extract rent and avoid painful reform. Prof Granville shows how in the RZ, former soviet republics (FSRs) sought inflationary bailouts from Russia as a way to avoid or postpone necessary domestic reforms. In response, Russia tried to establish a rules-based transfer union, which, however, was compromised by the inadequacy of its own domestic economic reform efforts.
2ndlesson. Economic rationales for monetary union are often spurious: Prof Granville demolishes the main stated economic rationale for establishing the RZ – namely, that FSRs would have no use for each other’s national currencies. She points out that free trade and free prices would have been sufficient conditions to support beneficial trade in the FSU area. As it happened, once national currencies were introduced, inter-republican trade decreased from 57% of the FSU countries’ aggregate external trade in 1992 to 33% in 1997; but resource allocation improved. The main problem was not trade between FSRs but access to western markets. That access was constrained by Western governments’ protectionist restrictions imposed on textiles, steel, aluminium, coal, uranium and tech. Those restrictions penalized the external trade of the FSU to the tune of around US$1 billion.
3rdlesson. Monetary Unions may dissolve when economic realism prevails in the core: Tensions between FSRs and Russia came to a head with Russia’s unilateral decision to withdraw pre-1993 ruble banknotes from circulation, forcing the FSRs to choose between introducing their own currencies or agreeing to a “New Style Ruble Zone” (NSRZ). The NSRZ agreement, signed in September 1993, envisaged complementary bilateral agreements to harmonize economic policies between Russia and the NSRZ members: Kazakhstan, Uzbekistan, Tajikistan, Belarus, and Armenia. The ultimate – but unrealized – goal was to achieve convergence of legislative and regulatory mechanisms by the end of 1994. The NSRZ was a fraught union, shaped by the clash between NSRZ members, which were pressing to obtain cash in new ruble notes, and the Russian government, which was reluctant to deliver unless economic convergence was achieved first. Finally, Kazakhstan and Uzbekistan introduced their own currencies in November 1993 with the rest of the NSRZ members soon after following suit (the only exception being Tajikistan, which at that time was embroiled in civil war).
4thlesson. The mirror image of lesson three: Prof Granville, identifies the core problem of monetary unions as the reality that political unity is the necessary basis for a single currency. It follows that at some point, countries at the core and at the periphery must face a trade-off between intolerable economic consequences or political integration. In the case of the Ruble Zone countries on the periphery decided to opt out of the monetary union rather than to sacrifice their sovereignty.
This last lesson is applicable to the fundamental tension in the Eurozone, as the periphery is forced to choose between sovereignty and democracy as the price of monetary integration. Prof Granville’s insightful analysis of the development and demise of the Ruble Zone is a reminder that, sooner or later, Eurozone members must face a stark decision between furthering political integration or dismantling the single currency.
Below you can read Prof Granville full article:
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