April 2012

A PUBLICATION OF CHILTON CAPITAL MANAGEMENT
W W W.CHILTONCAPITAL.COM

Dollars and Euros
Samuel Rines

“T

here’s no limit to how complicated things can get, on account of one thing always leading to another.” E.B. White was definitely not an economist, but the quote seems to perfectly articulate the situation the Euro finds itself in today. The problems of creating a cohesive and lasting currency between multiple countries (or States) is daunting but not without precedent. The colonies, turned States, all issued currency during the War for Independence, and many colonies struggled with oppressive debt levels. The States had little fiscal uniformity and lacked understanding of the difficulties of properly constructing a monetary union. Interestingly, in its first decade of existence, the Euro has encountered many of the issues and obstacles of the early U.S. Certainly, there is no direct comparison possible between the early U.S. experience and the current Euro crisis. The Euro’s problems are modern, internationally entangled, and have the potential to severely affect present and future world growth. The colonies were young and vibrant, but managed to accumulate large debt loads both during and after the American Revolution. This debt problem of the newly minted American States is largely responsible for the creation (over an exceedingly long time frame) of the monetary union in the U.S. It is likely the current fiscal problems of the Euro members will push them into a more integrated union.

The U.S. Monetary Union It may be useful to place the current Euro issues into a historical context. This is not the first time a newly formed currency has struggled to integrate in the individual States into a cohesive monetary and fiscal whole. The States emerged from the Revolution with ominous debt loads and were loath to repay them. After the Revolution ended, many States continued to issue money and debt that rapidly depreciated in value. Individual States, during this phase of U.S. development, had the right to issue currency. The greatest culprit, a 1787 version of modern Greece, was the State of Rhode Island. To deal with their debt problem, their legislature required debt holders to accept a swap: the severely discounted currency the State printed in exchange for the debt at par. Considering the paper money had depreciated by some 85% in less than a couple years, this was a deal no debt holder would want to accept. Since no debt holder would ever want to make that deal, the Rhode Island legislature declared all debt not exchanged to be null and void. This was later overturned as contrary to the State’s Constitution, but the move was financially devastating to some investors before it could be overturned. These events did not unfold in a vacuum, and the Founding Fathers did not see this as an acceptable means of retiring obligations. The notion of a central currency, to be used by all the States, was placed into the Constitution along with a ban on States individually issuing fiat currency. It is tempting to assume this was a controversial move by a young, headstrong central government, but it really was not debated with any vehemence. Rhode Island had sealed the fate of State currency (at least the issues without gold backing) by its

irresponsibility. With such a belligerent example was difficult to determine from one area to the of State financial maleficence fresh in the minds next. Again, one thing tends to lead to another, of constituents, there were no willing defenders. and it becomes increasingly complicated. The result: There would be one currency issued This Dark Age of U.S. Banking eventually by the federal government, and it would be the came to an end. As the Civil War raged and the legal unit of account in the U.S. Union effort required financing, creative concepts The States lost the power to issue money with were sought. One idea: get rid of the competing the passing of the Constitution in 1789. It was not banknotes and gently coerce conversion to dollars. the only right States gave up in joining the Union, Thus, the National Banking Act was drafted, but it is the one of the more interesting and creating a permanent institution to promote a powerful. States could no longer tax “imported” singular U.S. currency and repay the Union’s goods from other States, and therefore banned debts. Although the Act and its various iterations State-from-State protectionism. The States found are responsible for the ultimate and complete themselves tied to a Central governing authority dollarization of the U.S. economy, it did not kill that held the keys to the Mint (it took a while for the State Bank in favor of a National only model. the mint to be built—Congress had no money to Instead, the Act, passed in a time of crisis—a build the mint) and the power to tax. Forgotten War Referendum, formed a permanent institution to the annals of history is what happened to the around which a fairly coherent banking system debt issued by the States prior to the signing of could be constructed. Nearly a century of the Constitution; the federal government assumed confusing and convoluted banking and monetary all the debt outstanding. The States without systems came to a close as the U.S. monetary debts—the creditor States—received interest union took hold. payments on the debt the Union assumed. This made the debt assumption a less controversial topic, as was the adoption of the dollar unit, than circumstances may have dictated. The next 60 years did not see the development of a singular currency union; the signing of the Constitution did not mark the beginning of the “reign” of the dollar—just the birth. The States may have lost the right to issue fiat currency, but they had the ability to charter banks. State The European Experiment Chartered Banks issued notes, and these notes There is little reference to U.S. history in current could—theoretically—be redeemed for gold or discussion of the Eurozone. It is undeniable silver. While the Constitution may have required that Europe is a much different situation than the States to cede the power to print fiat money, the Early U.S. Europeans have long and deeply the State chartered banks were free to issue notes rooted cultural identities—not as Europeans—as backed by a guarantee of convertibility to metal Germans, Italians, or Greeks. The States had all money. The U.S. dollar was an underlying unit of fought for Independence side-by-side, and largely account (supposedly), and the banknotes traveled identified with one another. The Europeans the country as a means of exchange. Interestingly have been fighting wars among themselves for (although of little relevance to issues today), some centuries. World War II ended 66 years ago—it foreign currency was considered to be legal tender. is understandable why some would not want to This system f lourished, and the US delved into a yield power to others (read France to Germany). period of what could be called currency anarchy. But yielding of power is essential to the viability The Free Banking Era, roughly the time of the Euro. There can be little improvement in between 1837 and 1863, was one of the most the Continent’s State of affairs without someone important eras in U.S. banking history no one being willing to compromise. bothers to examine. During this period, many The 100 years of slowly defining a U.S. States decided it was no longer necessary to monetary union should be studied as a model to petition the legislative body to begin operating avoid—if at all possible. The underlying premise a banking enterprise. This escalated the number was not a horrible idea. The execution was awful. of competing currencies in the U.S. and caused Possibly the most important concept for European monetary confusion. The legitimacy of banknotes Monetary Union (EMU) members to remember is

“The 100 years of slowly defining a U.S. monetary union should be studied as a model to avoid—if at all possible.”

the amount of sovereignty the States relinquished in signing the Constitution. The Constitution was a giant redistributor of power within the structure of the Union. Power shifted from the States to the Federal Government, and States lost all kinds of individual liberties. The States of Europe gave up relatively little to gain the Euro. Instead, the Euro adopters were even allowed to keep their Central Banks, albeit with severely limited authority. There was simply too little given up in the deal. Countries that subscribed to the “all of the benefits and none of the pain” mentality are bound to struggle to survive. The EU should understand that it is well and good to commit to having a currency area, but there must be sacrifices of sovereignty. The Euro cannot stand without a more concentrated fiscal and political authority to enforce the rules already in place and the terms of the bailouts now and into the future. Germany should be skeptical of saving the Euro. They remained relatively fiscally restrained and came close to upholding the Maastricht Treaty. But let’s not forget, in essence, Germany makes its money exporting to the rest of the European Continent and the world. Allowing the Euro to implode would severely hamper the Germanic economy and a slack in European consumption would leave it vulnerable. A bailout of Europe by Germany seems inevitable, and further fiscal and political integration seems ever more probable. However, a bailout needs to be worth German energy and therefore needs to create a sustainable solution for Europe. Southern Europe needs to give Germany a deal that cannot

“The Euro needs Germany, and Germany needs the Euro.”
be denied. There needs to be incentives for both Greece to repay and Germany to stay in the EMU. Germany should be enticed to save the Euro, because the currency causes the country to be incredibly competitive in export markets. Greece will likely want to leave, and default or drastically restructure its debt load. A problem for Greece is a lack of economic growth, partially due to the strength of the Euro. The awkwardness of the Euro is that it is relatively weak from the German perspective and strong in the eyes of the Greeks. The Germans enjoy a relative advantage even over Eurozone peers in competitiveness at least to some extent due to the Euro. Why then,

with the Euro at the center of their €1 Trillion export economy, would Germany not attempt to keep the charade intact? The U.S. experience would indicate the scenario of the assumption of Eurozone State debt is not necessarily absurd. This would be a step toward creating a more integrated EMU, as the assumption of debt by a central institution would not happen without significant political reform. The difficulty in completing such a maneuver would be German demands for concessions, fiscal and otherwise, in exchange for loss of any national sovereignty. Euro member States cannot afford to lose Germany credit rating. Germany is currently borrowing at Euro era lows, and presumably will continue to borrow at similarly advantaged rates to today for some time. Germany is the only European nation, a possible exception being France, with the financial capability and credibility to prop up the European experiment. The Euro needs Germany, and Germany needs the Euro. In many ways, the future success of the Euro is that simple. The simple truth is monetary unions are not simple projects, and the Euro experiment was never going to be straightforward. The political difficulty of surrendering sovereignty should be overcome by the “now or never” urgency of the crisis. If the EMU members cannot come together and figure out a long-term solution to the stability of the currency, it will never happen. Revolutionary debts motivated the first attempt to create a U.S. monetary union in 1789 and a war 100 years in the future put the union in stone. The mistakes of the U.S. experience are not likely to be repeated in modern day Europe. The EMU will never enter a period of free banking and have an explosion of banknotes f loating around the Continent. The U.S. experience should be observed, not for its elegance and efficiency, but for its ultimate success. European leaders who would like the Euro to one day function as a sensible and stable currency should understand a sacrifice of sovereignty will be necessary to move forward. States within a monetary union will always find ways to skirt the edges (U.S. States figured out how to issue currency through their banks), but the nations of the Euro must find a place of fiscal coherence. Germany cannot afford for the Euro to fail, and the Euro does not exist without Germany. The symbiotic nature of the relationship all but ensures the future existence of a united Europe. There will be austerity and decreased power

with individual Euro-States, but the union will live on. History would remind us that wars are waged over States leaving unions. Combining of sovereign nations into a coherent montage requires a long-term view and patience. Modern politics and economics tend to have neither. There will, in the end, be a stronger and more united Europe with a more stable and lasting Euro. How long we have to wade through the current uncertainty is anyone’s guess. However, the historical context of the current Euro debacle is worth noting. The U.S. struggled to find its monetary identity for over a century. The Euro will have growing pains, but in the end it is likely to remain, at least in some form, as the predominant currency of Europe.
SAMUEl RINES is an a nalyst and Economist at chilton capital m anagEmEnt in houston, tExas. dirEct quEstions or commEnts to: srinEs @chiltoncapital .com ZACH BECk is thE E ditor of chilton currEnts and an opErations spEcialist at chilton capital m anagEmEnt in houston, tExas. for furthEr information on chilton capital m anagEmEnt stratEgiEs and sErvicEs, plEasE contact christophEr l. K napp, cKnapp@chiltoncapital .com for rEprints contact srinEs@chiltoncapital .com www.chiltoncapital .com/currEnts