In 1992, the Maastricht Treaty committed the European Union to adopting a single currency, the euro. The most immediate precursor to the euro in existence then was the Exchange Rate Mechanism (ERM) which pegged several European currencies to each other, creating a system of fixed exchange rates. The ERM was established in 1979 and disintegrated in the 1990s under market pressure and runs on the British pound and the Italian lira. However, Europe’s modern currency union does have even older historic precedent.
In the late 19th century, several European countries agreed to fix their currencies to a common monetary standard based on both gold and silver. Called the Latin Monetary Union (LMU), it lasted for half a century but like currency unions since, it had its problems. It was no doubt a very different kind of institution, but given the troubles faced by the Eurozone in this decade, the failures of the LMU echo today.
Coinage in 1800s Europe
During the era of the Latin Monetary Union, currencies in Europe operated very differently than those of today. Not only were coins, and by extension money in general, backed by precious metals like gold and silver, but coins were minted on demand. In many countries, anyone could bring gold and/or silver to a mint to be struck into coins. The value of the coins that person would get in exchange for his precious metals would be determined by a specified ratio. Thus, rather than having public authorities decide how many coins to mint, the market decided. By enabling convertibility, this system of “free coinage” helped maintain the link between the coins and the precious metals backing it.
Obviously, any currency backed by precious metals is bound to be impacted by changes in their availability. Following gold discoveries in the 1840s in the United States and Australia, world silver prices rose relative to gold, which was cheapened by the increased production. Thus, to maintain the values of their currency in terms of gold, nations using silver coins adjusted their weight or purity accordingly.
For example, following the California Gold Rush, American silver coins increased in value relative to gold and as a result were exported and melted for their metal until the US reduced the amount of silver in its coins in the early 1850s. Other countries, like Switzerland, also responded to the same global phenomenon by decreasing the purity of its coins. The result was that nations had different coins with different fineness or purity which changed often as gold and silver values fluctuated; this limited commerce by complicating currency convertibility and payments. In Western Europe, the LMU was designed to resolve this problem and the issues associated with nations devaluing their currencies by reducing their purity, as Switzerland had. The solution was a system of fixed exchange rates, an approach that would return over a century later.
Latin Monetary Union
In late 1865, a conference gathered representatives from France, Belgium, Italy, and Switzerland and led to an agreement to form the LMU, effective August 1866. The agreement sought to reduce the impediments to international trade and finance between these countries by making each member’s currency legal tender in the union. This meant that coins minted in Belgium could be used to repay a loan to an Italian bank. Currency could thus move and be used freely between countries; in theory easing international commerce and finance.
By natural consequence, the LMU also resulted in a fixed specification for coins minted in member states. These specifications spelled out the purity of precious metals in the LMU area’s coinage. While each country minted its own coins, the LMU essentially made them of equal value; thus, the LMU could be thought of as being somewhere between the eurozone of today and the ERM in its effect.
However, the obvious difference between the LMU and those monetary institutions was that the former was based on a parity between the coinage and precious metals. Specifically, the LMU made use of bimetallism which fixed the value of coins to both gold and silver; as opposed to a pure gold standard. The reasoning behind bimetallism was that by allowing silver to be minted into coins, such a system could circumvent the limits a gold standard placed on the currency supply by virtue of the metal’s scarcity. A link to silver would allow the amount of currency, and by extension the money supply, to grow and would produce a healthy level of inflation. In the end, the LMU settled on a ‘mint ratio’ of 15.5-to-1 between silver and gold; close to the same ratio used by the United States during its experience with bimetallism in the 19th century.
The LMU would never be as large as its modern cousin; other major European economies, like Germany, stayed out. However, from its initial four members, the LMU expanded to include Greece in 1867. Also, Spain and Austria-Hungary became affiliated members, aligning their currency practices with the LMU though not being members themselves. This practice of ‘shadowing’ the LMU became quite common both among French colonies with their own currencies, like Algeria and Tunisia, and other independent nations altogether. Even Colombia and Venezuela shadowed the LMU starting in 1871.
The union also inspired equivalents elsewhere. For example, in 1873, Denmark and Sweden formed the Scandinavian Monetary Union. Norway was then a part of Sweden but remained in that union after its independence. In the Scandinavian Monetary Union, member states adopted a fixed exchange rate but unlike the LMU, their currencies were backed by gold rather than bimetallist standard.
End and Legacy
Despite its expansion, the LMU was not as successful as was initially hoped. Bimetallism with a fixed exchange rate between gold and silver proved problematic, even more so given the nature of the union. In the decades prior to its formation, the precious metals market was characterized by falling gold prices relative to silver, as was mentioned earlier. However, in the decades after its creation, it was silver prices that would fall. Maintaining a fixed mint ratio in the face of fluctuating metal prices was bound to be unstable.
In the late 1800s, falling silver prices led people in LMU countries to convert silver to coins at the mint ratio of 15.5-to-1. To understand why and how this was done, understanding two concepts are critical: free coinage and Gresham’s law. Recall that free coinage enabled anyone to arrive at the state mint and request that their gold or silver be struck into coins. The fluctuating prices of these metals caused large swings in the demand for coins. For example, only 5 million francs of silver bullion were brought to the French Mint to be struck into coins in 1871 and 1872. Then in 1873, as silver lost value to gold, the market dynamics changed and so 154 million francs of silver was brought to the French Mint to be struck in that year alone. The trend affected other member states too.
Gresham’s law is also important to understanding the breakdown of the LMU. Gresham’s law, named after the 16th century merchant and advisor to the English monarch, Sir Thomas Gresham, states that ‘bad money’ drives out ‘good money.’ Essentially, if there were two types of coins of differing ‘real value’ but with the same denomination, people will hoard (or melt down) the good coins and use the bad ones to meet their currency needs. In the case of the LMU, as silver’s value fell relative to gold in the late 19th century, silver coins were the ‘bad money’ and gold coins were the ‘good money.’
The fact that demand for silver coins was surging in France and other LMU members was due to the fact that, given the mint ratio, the value of silver if converted into coins was more than the actual value of the metal. In contrast, gold was worth less in coin form under the 15.5-to-1 ratio than if it were melted down and sold at the market value of its metal. As people had silver struck into coins, they either hoarded gold coins or sold them on the global market where it was more valuable than its statutory mint ratio implied. To halt this trend, nations put limits on, or even suspended, free coinage and therefore the production of new silver coins. In late 1873, the Belgian parliament gave the government authority to suspend the minting of silver coins. Just a month later, there was a union-wide limit on the creation of silver coins. This suspension essentially turned the union’s monetary standard into a de-facto gold standard.
It was not as though this was completely unanticipated. The critics of bimetallism had pointed out this issue with such a monetary standard before but supporters of bimetallism argued that this would not really be a problem at all. They predicted that if gold gained in value relative to silver, as it did in the late 19th century, gold coins would be driven out of circulation, as happened in reality and as Gresham’s law would predict. They also correctly anticipated that more silver would be brought to the mint to be struck into coins, as was underway in the LMU. However, with gold being sold abroad on the global market and more silver being struck into coins, they predicted that the prices of the two metals would trend back towards the mint ratio. The idea was that domestic gold coins being melted down and sold abroad would increase the world supply of gold while silver being struck into coins in large quantities would increase the demand for silver.
The problem was that the values did not converge; the forces pushing the metals’ prices towards the mint ratio were insufficient. Adding to the instability of the LMU was the fact that it did not regulate the printing of banknotes. In essence, there were three types of currency in the union’s member states: gold coins, silver coins, and paper money, with only the first two being regulated. During this period, some nations like Greece and Italy had a habit of printing money more prolifically than their neighbors. They saw their metal coins flee their countries for France, again a case of bad money driving out the good. The wild swings in the minting of new coins and the flows of currency between member states was problematic. While the LMU’s use of bimetallism sought to avoid the limits a gold standard placed on the supply of currency, the nature of the LMU and its dual link to gold and silver simply replaced that problem with another.
In the end, the LMU was essentially abandoned by World War I, though it continued to exist formally until 1927. Regardless though, it deviated from its bimetallist monetary standard within a few years of its creation. Also, research has come to the conclusion that the union had no significant effects on trade for most of its history. Needless to say, it also did not produce a lasting currency union. The establishment of the ERM and the eventual introduction of the euro was a second attempt at a large European monetary union; whether this one will be met with greater success appears to remain an open question to this day.
Of course, it’s unfair to use the failure of the Latin Monetary Union as an argument against the feasibility and sustainability of the euro; the two monetary arrangements operate far too differently. It may also be true that judging the LMU on its economic and financial merits is not the best way to remember it; it misses what makes the union most notable. Historically, the LMU is more remarkable as a surprising example of international monetary cooperation in an era few would expect to be fertile ground for such an agreement. It also illustrates the intriguing problems faced by those crafting such a monetary system in the 19th century and the biggest questions of the era, such as those around the suitability of bimetallism for example. Whatever its other lessons, the LMU reveals a monetary world very different from our own but perhaps no less complex.
1. Bailey, Warren B., and Kee-Hong Bae. “The Latin Monetary Union: Some Evidence on Europe’s Failed Common Currency.” SSRN Electronic Journal, 2003.
2. Doyle, Al. “World Coins – The Latin Monetary Union Gold Coins.” CoinWeek, 19 Feb. 2016.
3. Laughlin, James Laurence. The History of Bimetallism in the United States. D. Appleton, 1886.
4. Timini, Jacopo. “Currency Unions and Heterogeneous Trade Effects: The Case of the Latin Monetary Union.” SSRN Electronic Journal, 2017.