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Comparing the Dollar and the Euro

June 8, 2010
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When the euro was created 11 years ago, there was plenty of talk comparing it to the U.S. dollar.  For instance, the Eurozone and the U.S. have similar sized economies and population, and the two currencies are governed by similar institutions.  Both the U.S. Federal Reserve Bank (the Fed) and the European Central Bank (ECB) have federal structures, consisting of a central bank and numerous regional banks (or in the case of the ECB, the national central banks).

The current Euro Financial Crisis has caused economists to return to examining what the Eurozone can learn from the U.S. dollar.  For instance, many European leaders (especially French President Nicholas Sarkozy) argue that the Eurozone, and maybe the EU, need a more unified fiscal policy to complement the unified monetary policy of the euro.  The American lesson being that the dollar’s success has rested on a large federal government being able to set uniform fiscal policies for the entire currency area.

Commentators have also started looking for clues about the future of the euro in U.S. history.  The director of the Centre for European Policy Studies recently dipped into American economic history to examine the fate of the euro.  In “Learning from the US experience?”, Daniel Gros sees similarities between the new U.S. Federal Government’s decision to buy the debt of the 13 original states in 1790 with the EU’s decision to have the ECB buy member state’s bonds.  Mr. Gros then argues that when the Federal Government decided not to bailout American states in the 1840s and allowed nine to go bankrupt, no contagion ensued.  Since these nine states accounted for a quarter of the American population at the time, it would be approximately equivalent to Greece, Ireland, Portugal, and Spain to all default.

Again, this might not be a truly equal comparison.  First of all, the global financial markets are much more integrated than 160 years ago and react very vigorously.  A few poorly chosen words by a politician can now spark panic the same day, as happened in Hungary last week.  In addition, banks across Europe and the world hold large amounts of debt in other countries (see “The Interconnectivity of Europe’s Debt”), while banking in the U.S. was much more fragmented in the 1840s.  Most American banks were chartered by their home states and actually not allowed to bank across state lines at the time, whereas Europe is now a web of international banks and their subsidiaries.

This comparison is another example of how far the euro has recently ventured into uncharted waters and how hard it is to find examples from history to guide debate.

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