The Latin Monetary Union: Some Evidence on Europe’s Failed Common Currency

The Latin Monetary Union was initiated in 1865 by France, Belgium, Italy, and Switzerland. We find that LMU membership or adoption of a gold standard is frequently associated with lower volatility of private bill yields, bond yields, inflation, and deviations from Purchasing Power Parity. However, neither standard induces convergence with LMU leader France or gold standard leader Great Britain. Bond yield spreads indicate that adoption of the gold standard is more credible than membership of the LMU.   Italy is an outlier, perhaps due to errant fiscal and monetary policies. A comparison to the modern EMS/EMU confirms that the LMU was a weaker and less credible currency arrangement.

Excerpts

"Real world events and frictions complicated the workings of such a system. Starting in the late 1840s, large gold discoveries in California and Australia greatly increased the global supply of gold and drove up the market price of silver relative to gold..."

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"France, Belgium, Italy, and Switzerland agreed to form the Latin Monetary Union (LMU) at the conclusion of a conference on 23 December 1865 and to take effect on 1 August 1866. Recognizing the potential for lowered transactions costs and increased price transparency, the treaty confirmed standard sizes for gold and silver coins of union members, guaranteed the acceptability of each member’s coins in settling public and private payments in all member states, and attempted to constrain the stock and flow of minor silver coins to a reasonable amount based on each country’s population."

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"Less than a few months after ratification of the treaty, Italy suspended the convertibility of her banknotes into metal coins and put into circulation huge numbers of small denomination banknotes."

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"Continuing problems with silver led France, in March 1884, to demand full redemption of outstanding silver coins by their issuers, particularly if an issuing country planned to leave the Union." 

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"While the Union survived in one form or another until 1925, it was not considered a success. Some member states typically ran budget deficits and attempted to “export inflation” to others in the form of large numbers of minor silver coins."

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"The strong, leading member of the Union, France, felt a need to avoid pushing weaker neighbors to the financial brink and, in effect, subsidized them. The outbreak of the First World War in June 1914 led to the general suspension of gold coinage and effectively ended what was left of the Union."