Currency Union

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DEFINITION of 'Currency Union'

When two or more groups (usually countries) share a common currency or decide to peg their exchange rates in order to keep the value of their currency at a certain level. One of the main goals of forming a currency union is to synchronize and manage each country's monetary policy.
Also referred to as a "monetary union."

INVESTOPEDIA EXPLAINS 'Currency Union'

A group of countries (or regions) using a common currency. For example, in 1979, eight European countries created the European Monetary System (EMS). This system consisted of mutually fixed exchange rates between these countries. In 2002, 12 European countries agreed to a common monetary policy, thus forming the European Economic and Monetary Union. One reason why countries form these systems is to lower the transaction costs of cross-border trade.

Currency Union Traits

A currency union or monetary union is distinguished from a full-fledged economic and monetary union in that it involves the sharing of a common currency between two or more countries, but without further integration between participating countries. Further integration may include the adoption of a single market in order to facilitate cross-border trade, which entails the elimination of physical and fiscal barriers between countries to free the movement of capital, labor, goods and services in order to strengthen overall economies. Current examples of currency unions include the euro and the CFA Franc, among others.

History of the Currency Union

Currency unions have often been adopted in the past with the goal of facilitating trade and strengthening economies, while also helping to unify previously divided states.

In the 19th century, Germany’s former customs union helped to unify the disparate states of the German Confederation with the aim of increasing trade. Beginning in 1818, more states subsequently joined, sparking a series of acts to standardize coin values used in the area. The system was a success and helped secure the political unification of Germany in 1871, followed by the creation of the Reichsbank in 1876 and the national currency the Reichsmark.

Similarly in 1865, France spearheaded the Latin Monetary Union, which encompassed France, Belgium, Greece, Italy and Switzerland. Gold and silver coins were standardized and made legal tender, and freely exchanged across borders in order to increase trade. The currency union was successful and other countries joined; however, it was eventually disbanded in the 1920s with the stresses of war and other political and economic hardships.

Other historical currency unions include the Scandinavian Monetary Union of the 1870s based on a common gold currency, and the eventual adoption of a national currency by the United States in 1863.

Evolution of the European Currency Union

The European currency union in its contemporary form can be traced through various economic unification strategies throughout the latter half of the 20th century. The Bretton Woods Agreement, adopted by Europe in 1944, focused on a fixed exchange rate policy in order to prevent the wild market speculations that caused the Great Depression. Various other agreements reinforced further European economic unity such as the 1951 Treaty of Paris establishing the European Steel and Coal Community (ECSC), later consolidated into the European Economic Community (EEC) in 1958. However, the global economic hardships of the 1970s prevented further European economic integration until efforts were undertaken in the late 1980s.

The eventual formation of the modern European Economic and Monetary Union (EMU) was made possible by the signing of the 1992 Maastricht Treaty. Thus, the European Central Bank (ECB) was created in 1998, with fixed conversion and exchange rates established between member states.

In 2002, the adoption of the euro, a single European currency, was implemented by 12 member states of the EU.

Greece and the European Sovereign Debt Crisis

Certain economists have criticized the adoption of the currency union and further European economic integration established by the Maastricht treaty. Greece is cited as an example of flawed EMU policy, as well as the other member states of Ireland, Portugal, Spain and Cyprus during the European sovereign debt crisis beginning in 2009. Such critics emphasize the inflexible EMU monetary policy which forbids member states from printing money to offset government debt, among other restrictions. However, paradoxically, each member state has its own independent fiscal policies including tax structures and spending policies. Keynesian and post-Keynesian economists in particular argue that government deficit spending – a practice that EMU policy does not allow – spurs economic growth and helps unemployment rates during economic difficulties.

As the European sovereign debt crisis escalated, Greece’s economic situation deteriorated. The EMU provided bailouts for Greece and the other troubled states, while also imposing strict austerity measures that powerfully affected the economic and ultimately political and social sectors of Greece. Faced with strong social unrest, divided political leadership and a still-flailing economy, Greece has been unable to recover. In June 2015 Greece faced sovereign default, as well as a rejection of further EMU austerity measures by the Greek people on July 5, 2015. The future of Greece’s economy and membership in the EMU, as well as use of the euro currency, remains uncertain. 

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