Governing Europe Efficiently: An Analysis into the Theory of Public Goods and Democratic Legitimation for the Eurozone, with Examples from the USA and Canada
©2014
Textbook
96 Pages
Summary
Europe’s Economic and Monetary Union (EMU) is in urgent need of reform. The Euro crisis has exposed this need in a dramatic and unprecedented fashion. Yet, crisis reactions on behalf of Eurozone policy-makers have been piecemeal and hesitant, instead of constituting effective reforms capable of remedying the weaknesses of the EMU’s system of governance.<br>This book, compiled by five scholars of the University of Hamburg, provides an in-depth analysis of the flaws of Eurozone governance by means of an innovative analytical framework based on fiscal federalism theory and game theory, further enriched by insights of theories of democratic legitimation. Its major focus is on understanding Eurozone governance as the provision of different types of public goods, each of which requires an adequate governmental structure. The study is enhanced by lessons from historical developments in currency unification in the US and in Canada which help to put the Eurozone’s woes into perspective. On the whole, this book may serve as a comprehensive guide for policy-makers, scholars and all others interested in finding a long-term solution to preserving and stabilizing the Eurozone.
Excerpt
Table Of Contents
the mainly theoretical approach this paper is taking, we have also included two historic
precedents of currency union and development in the United States and Canada, respectively.
Section I, about the establishment of the US and Canadian Dollars and their evolution, are
taking an historical timeline approach and trying to analyze the impetus behind currency
union in the United States and Canada, the most decisive moments, and the collective action
problems faced by the Americans and Canadians respectively. In the US, a single currency
emerged only after more than a century of internal struggles with the costs and benefits of
centralizing monetary authority at the federal level. The creation of the Federal Reserve
system balanced a need for a federally supported, more stable money supply with fears over
concentrating too much power in the hands of too few people. That system, and the ensuing
world wars and Great Depression, led the dollar to its status as the official currency of the
United States.
The second example of the establishment of a single currency, the Canadian case, is dealing
with the Canadian dollar and why it came into existence, how its evolution was influenced by
Canada's relations with Great Britain and the United States, and finally turning an eye to
contemporary discussions about the possibility for a North American Monetary Union
(NAMU). We hope to draw conclusions from these historic examples of currency develop-
ment that will help us to understand the contemporary challenges facing the Eurozone.
The following sections build upon the two historic precedents and draw indirect conclusions
from them; these insights suggest that inter alia collective action problems arising from
common goods, their interconnectedness and their governance are the crucial factor within a
currency union and therefore it is worthwhile to formally analyze them.
Section II deals with common goods and formally analyzes why they come into existence,
who provides them, what special features they have and what their optimal form of govern-
ance would be, all the while developing an analytical framework based upon the theory of
public goods. In order to discuss the underlying problems that are caused by the features of
the different common goods, we use different applications of game theory and the theory of
fiscal federalism to determine on which level the goods should be governed.
Section III looks at three different examples of public goods and employs the developed
theory. It shows that the selected goods are all connected via a single currency and have
externalities vis-à-vis the currency or vice versa. With the analytical tools we have developed,
we can classify the goods and provide solutions for the adequate form and level of govern-
ance to the underlying problems of these goods.
Section IV of our project is dedicated to the democratic elements that need to be considered
and incorporated to make for efficient governance that represents and reflects the will of all
citizens. It takes into account previously formulated criticisms of the European Union's
legitimacy and reveals how these are exacerbated by the current institutional set-up of
monetary union, in order to then elaborate a strategy to overcome the legitimacy deficit. This
section ultimately calls for stronger democratic structures for the Eurozone.
In the Closing Remarks portion of this paper, we will emphasize our arguments and our
previous points and summarize the most important parts of this project.
I. Historical Precedents
1. Uniting the States of America - Creation and Empowerment of a
Federal Government in the United States
by Adam Kephart
1.1 Introduction
1.2 The Fight for Independence and the Years of the Articles of Confed-
eration (1776-1787)
1.3 Writing a New Constitution
1.4 Establishing a Central Bank The First Two Tries
1.5 Economic Turbulence and the Establishment of the Federal Reserve
1.6 Conclusions
2. Loonie for Your Thoughts? - An Introduction to the Co-Evolution
of Canada and its Monetary System
by Shaun Hislop
2.1
Introduction
2.2 Specifically a Problem of Specie
2.3 A Question of Dollars and Sense
2.4 It's Reciprocity, Stupid
2.5
Think
Banks
2.6 North American Monetary Union
2.7
Conclusion
1. Uniting the States of America - Creation and Empowerment of a Federal
Government in the US
- by Adam Kephart
1.1 Introduction
The distinct background and history of the United States of America has had profound effects
on the distribution of power between the states and the federal government, including over the
regulation of a single currency. European immigrants primarily came to the "New World" to
escape oppression and famine and establish new lives. As frustrations with colonial master
Great Britain began to grow and the colonies united to declare their independence, the last
thing many wanted was to supplant one monarch for a new central government seemingly
equidistant from the people and prone to abuses of power as what was common in Europe.
The independent states were united in their cause for independence but not yet the United
States of America.
The states recognized that together they had a far better chance of achieving their independ-
ence from the crown than individually. After the war was won, however, many began to
question the necessity of Congress or a federal government at all. Based on what can be seen
today in Washington, D.C. the proponents of a central government eventually succeeded in
convincing the states to confer power to the federal level. Why did that happen? What
convinced the "Free and Independent States" referred to in the Declaration of Independence
to unite and transfer powers to tax and pass laws by majority decision, without the consent of
all states?
This section seeks to provide a better understanding of how and why powers originally held
by the independent states following the Declaration of Independence were later transferred to
the federal level. Particularly in focus will be those economic factors that convinced citizens
and politicians in America to assent to the transferals power. The War for Independence,
fledgling American Confederation, push for a new Constitution after dissatisfaction with the
Articles of Confederation, and attempts at establishing a central bank for the country illustrate
how and why the federal government in Washington has taken on the shape and responsibili-
ties it has. The dollar as the official tender of debts both public and private did not emerge at
one given point but was rather the product of the interplay of these events; a recognition of
the benefits a single currency posed weighed carefully against fears of centralized, federal
control over money. Efforts to give Washington the power to tax citizens, pass laws, or even
maintain a central bank with discretion over a single currency were by no means foregone
conclusions and needed to be well-rationalized, all while maintaining the utmost vigilance of
the independence and sovereignty of the American people.
1.2 The Fight for Independence and the Years of the Articles of Confederation (1776-1787)
Framers of the Articles of Confederation, the precursor to the Constitution, sought to design a
system that brought the former colonies together in common purpose to stand against Great
Britain. It was also designed to prevent the institutionalization of those abuses of power that
precipitated the Declaration of Independence in the first place. Congress was tasked with
requisitioning the sovereign states to provide funds and soldiers for national defense and the
repayment of national debts incurred during the war. The states in the confederacy were in a
"perpetual union" (Art. III, Articles of Confederation) and explicitly retained their status as
sovereign, free and independent states. The framers recognized the necessity to unite against a
common aggressor, but clearly wanted to prevent too much centralization of power in a
distant capital. The former colonies had just experienced decision-making and taxation
without representation, determined in a distant capital at the mercy of an authoritarian king,
and they were not about to allow such a system to take hold in America.
The system of requisitions was seen as the best way for the states to provide Congress
funding for national defense. Whenever the state-appointed delegates to Congress deemed it
necessary to request funding and/or soldiers from the states, it would request a designated
amount from each one. In the spirit of the Revolution, it was believed that states would then
contribute for the public good of all states. It was soon clear, however, that this system
struggled to handle problems with free-riders.
States during the times of the Articles of Confederation did not pay anywhere near the
amounts requested of them, thus undermining the security of the union as a whole. Two
common explanations emerged as to why the national defense remained woefully underfund-
ed. Those fearful of a strong central government, known as Anti-Federalists, tended to
emphasize that a war was going on and that the states were hard-pressed to collect taxes and
fund their own activities much less send money to Congress. Federalists were instead con-
vinced that such a system where Congress was powerless to coerce states into contributing
was bound to fail and that what was needed was a federal government empowered to carry out
the actions agreed upon by the states' delegates in Congress assembled. Collective action
problems were jeopardizing the young confederacy.
Keith L. Dougherty, in his book "Collective Action Under the Articles of Confederation"
(Cambridge, 2001) acknowledged these arguments, but also sought to explain why states
defied the predictions of economic theory and still provided some of their requisitions.
Economic theory would have predicted that states, not knowing if other states would contrib-
ute to the national defense or repayment of debt, should logically withhold their contributions
for better use "domestically" if they thought that others would free ride or that they them-
selves would carry undue burden without benefit. To explain why the states contributed at all,
Dougherty defended the idea of "joint products". These joint products were public goods such
as the national defense and ability to secure international financing for the war and interna-
tional commerce that had varying levels of "publicness" (Dougherty, 2001: 14). According to
Dougherty, states were more likely to contribute their requisitions if it was of greater private
benefit to that state. If New York City were under siege by the British, those in Massachusetts
and New York had a greater incentive to contribute their requisitions than those far-removed
in Georgia or South Carolina. Taking that idea one step further, Dougherty argues that when
local priorities did not coincide with national interests, states were much less likely to put the
common well-being of the nation ahead of state interests (Dougherty, 2001: 82). Collective
action problems such as this continued to plague the union under the Articles of Confedera-
tion.
At this point in American history it was already becoming apparent that the lack of coercive
powers at the federal level was jeopardizing the confederation as a whole. It would take more
time though, until public opinion recognized the situation and coalesced around a solution.
1.3 Writing a New Constitution
The American Revolutionary War officially ended in 1783. Four years later the citizens voted
out the Articles of Confederation in favor of a new constitution that redesigned the system of
federal government in America. By that time, nearly everyone was in agreement that requisi-
tions were insufficient for funding and running a federal government from which the states
expected the provision of certain public goods and services. Debate over what those changes
should like was fiercely argued.
Prior to the Constitutional Convention, attempts to amend the Articles of Confederation were
made to solve the collective action problem of state contributions to Congress.
1
By this time
1
The Coercive Powers Amendment was designed to give Congress the ability to compel states to pay up when
Congress had justly passed a requisition, however many in America at that time feared coercive powers for
Congress over states more than an inept federal government (Dougherty, 2001: 136). Considering that Congress
would have to march an army (comprised of requisitioned soldiers from the other states) into this delinquent
however, it had already become clear that amending the existing system would not work. The
confederation as it stood could not efficiently achieve the provision of public goods intended
by the framers.
As it became evident that a new constitution and government could be the solution to provid-
ing these public goods while maintaining adequate protections for states' rights, a monumen-
tal debate in newspapers across the country took shape between those supporting a centralized
government (known as Federalists and led by Alexander Hamilton) and those averse to
centralized power (known as Anti-Federalists and led by Thomas Jefferson). They may not
have realized it at the time, but these debates put in tangible print the conflict over what the
role of a national government should be that has been continuously debated ever since. As it
was the Federalists that eventually prevailed and managed to get the Constitution passed, it
will be their arguments that will be more closely examined here.
Alexander Hamilton, John Jay, James Madison and the other Federalists saw unlimited
potential for the states united under a constitution. The economic strengths of the states, when
pooled together, would easily surpass those of any European state, making the United States
of America the dominant political-economic presence in the world (Federalist No. 11 in
Quinn, 1993: 30). Hamilton feared though that if the states remained only loosely tied and
independent, a natural tendency towards rivalry and conflict would continually divert wealth
towards wars and would stunt the growth potential that could otherwise have been achieved.
Looking at Europe at that time, one could easily see how commercial ties did not prevent all
war. In America, Hamilton firmly believed that a constitution over the states with a vigorous
national government that could resolve commercial disputes and diffuse conflicts before they
turned into wars would solve this problem of neighbors being natural enemies (Federalist No.
6 & No. 11 in Quinn, 1993: 30 & 55). Federalists firmly believed and fought to preserve the
union through a central government empowered to execute its duties and unlock the potential
economic wealth of the continent and people, preventing conflicts from within and without
from hindering that economic progress.
The framers of the Constitution also had to grapple with the reality that many of the argu-
ments they had used to justify independence from Great Britain also undermined a national
government capable of overseeing a population as widespread as that in the thirteen former
state and potentially open fire on fellow citizens, it is no surprise that such an amendment failed to gain support.
Another amendment, one that would have allowed Congress the ability to wield soft powers and impose duties
in any state not complying with requisitions, also faced tough opposition. Southern states, holding vested
interests in wanting to retain the ability regulate their foreign commerce and duties, opposed the measure and
ensured the amendment's failure.
colonies (Ellis, 2002: 7). To achieve this, they managed to shift the focus from preserving the
protection of states' interests and sovereignty to the promotion of protecting sovereignty and
liberty for individuals (Dougherty, 2001: 164). Congress would have the democratic legitima-
cy to tax individuals through the House of Representatives whose members would be directly
elected by the people. The Senate was originally designed to ensure states' interests remained
represented in the national government. Through a constitutional convention where citizens
directly elected delegates and a system that put the focus on maintaining the prosperity,
liberty and freedom of individuals as opposed to the states, the framers of the Constitution
managed to solve the collective action problems that had plagued the Articles of Confedera-
tion. The foundation for a successful and prosperous nation had been set, but debates over the
powers of the federal government would continue to rage throughout the coming decades and
centuries, including over the establishment of a central bank for the United States of America
with discretion over a single currency.
1.4 Establishing a Central Bank - The First Two Tries
The echoes of the debates between Federalists and Antifederalists continued to reverberate
throughout the history of the United States. What responsibilities should a central government
assume? What level of power is sufficient to maintain those public services delegated to the
federal level? Is there a potential for imperial abuses of power? These questions have often
surfaced whenever there has been a drive to expand the role of the federal government. The
attempts to establish a central bank for the United States uniquely illustrate how difficult it
was and still is to find consensus among the widespread economic and political interests
present there. This section expounds on the three central banks established in the US since
1787. The focus remains on the economic rationale for their creation and why the charters for
the first two failed to be extended beyond the first 20 years whereas the Federal Reserve
System has remained to the present day.
On December 14th, 1790, Alexander Hamilton sent President George Washington his
proposal for the establishment of a national bank similar to the Bank of England. Such a bank
could hold government deposits, assist in the collection of taxes, act on the government's
behalf in financial markets, make low-interest loans to the government and issue bank notes
useable as payment for taxes (McCulley, 1992: 4). Hamilton saw post-war, disaggregated
public debt across the states as a potential blessing that could be used to help the nation
prosper further. Hamilton argued successfully, and in 1791 the first Bank of the United States
(BUS) began operating. The BUS was given a twenty-year charter after which it would need
congressional approval to continue operating.
Hamilton's efforts to establish the BUS were closely tied to his struggle to have the federal
government assume states' post-war debt. Known simply as "assumption", this issue was
highly contentious and also pointed out the deep divides in political and economic thought at
the time. On the one side, Hamilton saw great economic potential in pooling states' debts and
managing them at the federal level, where financial relations with other nations could be
better managed and leveraged to further growth. At that time, regions and individual banks
could and were issuing their own banknotes. Consolidating that chaotic mix of currencies
could also simplify transactions in domestic markets and banking.
Thomas Jefferson, leading voice of the Anti-Federalists and proud Virginian
2
, was vehement-
ly opposed to assumption and the establishment of a central bank. For him, the Hamilton
financial plans would ensure the destruction of the spirit of the American Revolution (Ellis,
2002: 140). Jefferson also believed that a central bank with the constitutional power to coin
money infringed on the rights of sovereign individuals to do so (McCulley, 1992: 5). For
Jefferson, the Revolution was fought to win liberty and freedom for the individual and here
was Hamilton trying to take the wealth of the sovereign, average man and put it in the hands
of elite bankers whose goals seemed rife with greed and dangerous speculation. James
Madison also argued against assumption, defending Virginia and southern states, the majority
of whom had diligently paid back their debt and would now be unjustly compelled to contrib-
ute towards paying back the debt of "lazier" states (Ellis, 2002: 57). Virginia even implicitly
threatened secession if the federal government were to proceed with assumption.
The core tenets of Hamilton's financial plan were passed into law, but required a complicated
set of negotiations and deal-making in what would become known as the Compromise of
1790. To satisfy the concerns held by Jefferson, Madison and those fearful of federal concen-
tration of economic power, it was agreed upon that the BUS would be privately held, away
from potential for abuse by politicians. Additionally, the deal stipulated that the location for a
permanent capital of the US (which had not been officially decided yet) would be on the
banks of the Potomac River between Maryland and Virginia, far-removed from the banking
center of New York City and straddling two agrarian states (Wood, 2005: 120; Ellis, 2002: 70
& 79). In return for the assured passage of Hamilton's financial plan including assumption,
2
While drafting the Declaration of Independence in Philadelphia, Jefferson wrote back to Virginia saying that he
lamented being deployed 300 miles from his country during such precipitous times (Ellis, 2002: 11).
Jefferson and Madison managed to secure a favorable debt deal for Virginia (Ellis, 2002: 96-
97). For the BUS, a 20-year charter ensured that Congress could reevaluate the necessity of
the bank, ensuring that it had not grown too powerful in that time. Overall though, Hamilton
successfully managed to lead the effort to establish a bank that would assist the government in
securing international financing, facilitate the payment of taxes and promote industry by
enabling gold and silver to become the basis of a paper circulation (Wood, 2005). The
Compromise of 1790 managed to carefully balance increased centralized power with assur-
ances that checks would prevent the abuse of such centralized power.
When the charter for the Bank of the United States came up for renewal in 1811, the political
climate in the United States was markedly different. Democratic-Republicans outnumbered
the Federalists roughly two to one in both the House and Senate and the executive office had
recently gone from President Thomas Jefferson (1801-1809) to President James Madison
(1809-1817). In a political environment of skepticism towards centralized power in Washing-
ton, especially power over money, and in a climate where war debt was paid off, there were
few economic or political incentives to renew the Bank's charter and it subsequently expired.
Opposition came mostly from southern, especially rural areas who held an association
between central banking and expanded manufacturing and trade that could threaten their way
of life and infringe on their liberty, and from Americans residing in the west, who liked credit,
but not creditors (Wood, 2005: 124).
The War of 1812 and new debt that accompanied it changed the minds of Madison and other
Republican-Democrats and on April 10th, 1816 the Second Bank of the United States was
established (McCulley, 1992: 6). House author of the bill to re-establish the central bank,
John Calhoun, argued that the Constitution necessitated a central bank (Wood, 2005: 129).
The powers delegated to Congress in the Constitution to "coin money, [and] regulate the
value thereof" (Article I, Section 8) meant that a central bank was, in fact, constitutional and
meant to be placed solely under the control of Congress (not the states). States at the time
were prohibited from issuing currency notes themselves, however they did regulate banks
within their borders. This was a sort of de facto currency regulation that then Speaker of the
House Henry Clay said was incumbent upon Congress to recover through the restraining
influence of a national bank (Wood, 2005: 130). Thus, the economic benefits of a central bank
had once again won over majorities in the government but only to a point: the Second Bank of
the United States also had a twenty-year charter, which failed to be renewed.
At the end of the BUS's charter, the political environment in the United States had once again
shifted back to skepticism at the concentration of economic power in a central bank. War
debts were paid off and those interests that could benefit from disaggregated monetary policy
voiced their opposition louder than those who saw the economic benefits of a central bank
(Wood, 2005: 134). Although a renewal did make it through Congress, President Andrew
Jackson vetoed the bill (McCulley, 1992: 8). From that point onward through the Civil War
and the turn of the 20th century, some states operated their own centralized banks or prohibit-
ed some banking activities entirely, leading to a very disaggregated and patchwork network of
banks, banking regulations, and various currencies throughout the United States.
The Civil War and economically turbulent years thereafter slowly laid the foundation for
another centralized banking system. Despite post-Civil War debt and monetary concerns, no
serious consideration was given to establishing another central bank, as concerns over
concentrated financial power in the hands of government reigned supreme again over a
majority of Americans (McCulley, 1992: 11). It would take repeated economic tumult and
dissatisfaction with the status quo to renew calls for a central bank.
An intriguing tripartite division in America emerged at the turn of the 20th century, following
an economic depression and general tumult in the 1890's. In New York, Wall Street sought
Hamiltonian arrangements with government that would stabilize financial markets and make
banking more lucrative. Further inland, the financial heart of the interior of the United States
in Chicago (La Salle Street) wanted government to take a laissez-faire approach to banking,
only maintaining minimal sanctions that met the needs of the interior of the country. The
average person on "Main Street" America viewed banking somewhat skeptically, and stressed
a need for government to restrict the speculative powers of urban bankers (McCulley, 1992:
97). Balancing these concerns, President Roosevelt in 1904 noted that, "...under present
conditions it would be unwise and unnecessary to attempt a reconstruction of our entire
monetary system" (McCulley, 1992: 110).
1.5 Economic Turbulence and the Establishment of the Federal Reserve
The 1900's, while more prosperous than the 1890's, had numerically more (but smaller)
banking crises. In addition, yearly strains on credit and currency during the harvest season,
when demand for currency rose dramatically in the interior of the country, pointed out how
inelastic money was in the United States at the time (Wood, 2005: 153). Representative
Carter Glass (Democrat- VA, 6th District) believed the system of national banks (7,300 in
1913) lacked adequate cooperation and coordination in providing for the nation's monetary
needs (Wood, 2005: 155). In September of 1913 he introduced the Federal Reserve Bill that
would establish the central banking system still in place in the United States today.
Consensus in the United States had finally congealed around the need for something that
could manage the nation's money better than what was occurring at that time. The US
economy in 1913 was heavily based on agriculture, and politicians had a distinct electoral
incentive to fix the seasonal strains on credit and currency that had been plaguing farmers
year after year (Meltzer, 2003: 8). New York City at the time was a de facto central bank, as
nearly all banks elsewhere in the country had accounts there. Thus, New York served as a hub
for gold and silver specie and the various currencies in circulation at that time to transfer
between surplus and deficit areas in the country, and when farmers in western states needed
funds, New York was where those funds had to pass through to get where they were needed
(Wood, 2005: 135). One thing the banks in New York could not do, however, was expand and
contract credit and serve as a bank for banks. By 1913 citizens, politicians and bankers alike
realized that this system was not equipped to alleviate banking panics and that a new institu-
tion was needed to ensure more consistent banking conditions in the US.
Federalist/Anti-Federalist debates again served to define the structure of how the new banking
institution would achieve these improved banking conditions. Secretary of the Treasury
George Cortelyou (1907-1909) had foreseen the federation structure that would eventually be
implemented with the Federal Reserve, "Cannot the principle of federation be applied, under
which the banks as individual units, preserving their independence of action in local relation-
ships, may yet be united in a great central institution?" (Quoted in Wood, 2005: 153) Here the
reality of needing improved coordination and cooperation in the nation's banking system was
solved while still preventing complete central authority. The Federal Reserve System and
Board were designed to prevent too great a concentration of power (both from politicians as
well as from "greedy" bankers in New York) by establishing regional banks based on similar
industrial characteristics in the states at that time but with pooled reserves and forums for
cooperation and coordination (Wood, 2005: 164-165). Fears over leaving the control over the
nation's currency and money in general in the hands of commercial bankers with potential
conflicts of interest were weighed against fears of placing control entirely in the hands of
government officials who may have had very little actual banking experience (Meltzer, 2003:
2). Compromise was found on a system that would balance these concerns, where a politically
appointed Federal Reserve Board in the capital would work with the regional banks run by
bankers (Meltzer, 2003: 67). Once again, a 20-year charter added another layer of insurance
that a future Congress would be able to reshape the Fed if any parts were abusing their powers
or not functioning as intended.
This third attempt at a central bank in the United States, unlike its predecessors, has perse-
vered. The first two Banks of the United States could not provide enough arguments to merit
the renewal of their charters against persistent fears of abuses of power when placed in a
central authority, stemming from the very founding of the country itself. By the 1930's
however, the US had experienced the First World War and was in the midst of the Great
Depression. The necessity of a permanent central bank and its monopoly over a single
currency (the Dollar) was widely accepted.
1.6 Conclusions
The history of the United States of America is filled with examples of the struggle between
stronger centralized authority attempting to more efficiently provide public goods and efforts
to ensure that decision-making and power remain as close to the people as possible, ensuring
their sovereignty, liberty and independence. This essay has focused on particular economic
challenges present during the Revolution, the push for a constitution after the Articles of
Confederation, and the three efforts to establish a central bank in the United States. The spirit
of the Revolution has seemingly been at odds with economic realities since that time; namely
that centralized economic and monetary powers could better achieve the goals of a strong,
prosperous and united nation.
The former thirteen colonies that had declared their independence from Great Britain recog-
nized the need for unity against the colonial master, but were wary of empowering a central-
ized government that looked anything like that distanced monarchy and parliament. The
Articles of Confederation sought that unity with minimal powers given to Congress, however
collective action problems plagued the new confederation. States rarely paid their requisitions
and the national defense and international financial standing suffered as a result. Peacetime
following the cessation of hostilities did not improve the situation, and in 1789 the new
Constitution of the United States of America went into effect. This Constitution protected the
liberty and sovereignty of the individual, and made direct taxation democratically legitimate
through the House of Representatives while maintaining a body attune to voices of states both
big and small: the US Senate. Federalists fought for a central government empowered to deal
with the economic concerns of being able to pay back international debt during the war,
defend the vital trading ports from attack and resolving any interstate disputes within the US.
Although not all in America were convinced by this rationale for a stronger federal govern-
ment, the powers to tax, regulate commerce and provide for the common defense and welfare
of the country were entrusted to the federal government.
The battles over federal assumption of debt as well as for a central bank continued the debate
as to which powers should belong in the hands of the federal government, and which should
remain in the hands of states themselves. Two attempts to establish and sustain a Bank of the
United States failed. The economic advantages to having a central bank that sparked the
creation of the banks were overshadowed 20 years later when the banks' charters came up for
renewal. Concerns over debt and centralized management of money no longer outweighed
fears of power-hungry politicians and greedy bankers. The system of various forms of money
and locally-issued currencies persisted into the 20th century. The Federal Reserve Bank and
Board system still operating today came about as a result of frustrations with turbulent
economic conditions and cycles tied to waxing and waning needs for credit in the agricultural
interior of the country. Politicians listened to calls from constituents to make banking more
stable and won approval from New York bankers who were happy to have someone else
responsible for ensuring the cooperation and coordination of banking in the US; the Dollar as
the single currency of the US came about as a result of both this central bank and the gradual
phasing-out of other currencies This system also balanced the 150 year-old Federalist/Anti-
Federalist debates by establishing a system balanced and checked by regional banks run by
bankers with know-how and a centralized Federal Reserve Board without banking conflicts of
interest.
These examples, taken from American history, point out the economic underpinnings of
select decisions to transfer power from the state-level to the federal-level. Economic concerns
were certainly not the only forces at play in these decisions, however it is interesting and
important to note that they did influence the public and politicians to accept greater central-
ized power despite the inherent skepticism toward it and authority in the US. Those united
states that declared their independence from Great Britain required time and a lot of inner
struggle and debate to become the powerful United States of America, and recognition that
some public goods were better managed at the federal level was one of the main driving
forces of centralized authority that has defended and unlocked the vast potential of the
country.
2. Loonie for Your Thoughts? - An introduction to the Co-Evolution of
Canada and Its Monetary System
- by Shaun Hislop
2.1 Introduction
Any analysis of the history of Canada is inherently also an analysis of the relationship
between Canada and Great Britain on the one hand, and Canada and the United States on the
other. As a former colony of Great Britain and neighbor to the United States of America,
Canada's history has always been a balancing act of interests and loyalties, from the colonial
period until the present day. That both great powers played a decisive role in the course of
Canada's development from colonial trading post to modern democracy in indisputable. To
this end, historian John Bartlet Brebner coined the term North Atlantic Triangle in his seminal
1945 work of the same name to describe the social, political and cultural interplay between
the three countries, and highlighted "the unparalleled interlocking of the American, British
and Canadian economies" in the period between 1880 and 1940 (Brebner, 1945: p. xi). The
inclusion of Canada in our analysis stems from the historically significant developments in
that country that help us to answer some of our foundational questions, such as: What makes a
single currency attractive? What makes it feasible? What are the economic prerequisites and
what are the political repercussions of monetary union? Furthermore, as Professor of Eco-
nomics at the University of British Columbia Angela Redish has noted, "Canadian monetary
history affords monetary economists an opportunity to observe numerous experiments in
banking and exchange institutions in providing currency" (Redish, 1985: 1020).
In Canada, debates about monetary union can be divided into two parts; first, there are the
decisive events of the 1840s and 1850s namely, the abolishment of the British Corn Laws in
1846 and the establishment of the Canadian-American Reciprocity Treaty from 1854-1866
and the strategies employed to overcome the collective action problems associated with
Canadian dependence on foreign specie, which led to the creation of the Canadian dollar in
1858. Also significant is the economic integration within the Canadian colonies and the
effects that the emergent domestic banking and financial system had for Canadian Confedera-
tion in 1867.
3
Equally noteworthy, however, are contemporary arguments for and against the
creation of monetary union with the United States and the position of Canada within debates
3
For the sake of simplicity, the term "Canadian colonies" will be used in this paper to denote a variety of terms
ranging from British North America, Upper and Lower Canada, Canada West and East (the two parts of the
united Province of Canada modern day Ontario and Quebec, respectively that existed from 1841 to 1867),
and the Dominion of Canada, and the Maritime provinces of New Brunswick and Nova Scotia. Special mention
of other terminology will be employed to illuminate or elaborate upon important historical developments where
appropriate.
around the creation of a North American Monetary Union (NAMU), either through "dollari-
zation" or through the creation of a pan-North American currency, such as the "Amero"
(Grubel, 2003: 318). First, however, let us trace the development of Canadian currency from
its humble beginnings through to the establishment of the Canadian dollar shortly before
Canadian Confederation in 1867.
2.2 Specifically a Problem of Specie
Going back to the late eighteenth century, we find that the conditions which led to the hodge-
podge currency situation throughout British North America stemmed from the trade between
the Canadian colonies and the original thirteen Atlantic colonies, the monetary system of
which, in 1763, revolved around the Spanish dollar (McIvor, 1958: 13). To complicate
matters, the Spanish dollar had a different exchange rate depending on where it was being
traded. So, for example, one Spanish dollar, which under the proclamation of Queen Anne in
1704 had a Sterling value of 4s. 6d. was valued at 6s. in Upper and Lower Canada, but 5s. in
Halifax and Massachusetts, and 8s. in New York (McIvor, 1958: 13). New ratings established
in 1777 took the "Halifax currency" rating of 5s. and became the standard throughout British
North America. The various acts of Parliament that were passed in the following years one
in 1796 recognized "a wide variety of coins...gold and silver from England, France, Spain
Portugal and the United States... as legal tender in the Canadas," for example had the
objective of establishing rates of exchange for the wide array of foreign coins but did little to
rectify the situation in terms of providing a reliable and readily available currency for com-
merce and trade, both domestic and foreign (Redish, 1984: 715). Furthermore, while Sterling
was the legal standard of the Canadian colonies, and therefore the currency in which all coins
were rated, there existed very little British coins in circulation; the various coins that were
available were continually in short supply.
4
As there was no centralized banking system at
this point, the British government took to overvaluing specie in domestic trade in the hopes of
keeping it within the Canadian territories (Neufeld, 1964: 1), a policy that had already been
attempted by the French before them, but ultimately failed (McIvor, 1958: 13).
The 1808 attempt to establish a commercial bank in Canada sought to remedy the situation of
increasingly limited coinage by providing "some safe substitute [that] would be greatly
desirable and tend to facilitate the trade of the province, particularly the export trade" (McIv-
4
UBC Economics Professor Angela Redish makes the case that the constant complaints within the Canadian
colonies about the scarcity of specie was not simply due to a " chronic external drain" as is often suggested by
Canadian monetary historians, but was more precisely a shortage of "good specie," that is heavy, or full-weight
coins (Redish, 1984: 723).
or, 1958: 18)
5
.
6
While the bill of 1808 failed to materialize, the influence of the American
banking system as envisioned by Alexander Hamilton is clear in its construction; this "master
document" clearly shows the extent to which the U.S. system shaped the younger Canadian
system, with "significant passages, exactly in the letter of Alexander Hamilton's provisions
for a national bank" (Breckenridge, 1910: 7). The War of 1812 provided enough distraction
over the course of the next decade that the establishment of a chartered bank system was
delayed until the 1820s, a phenomenon which we shall look at in section 2.5. Importantly,
however, the much-needed use of paper money, or so-called "Army Bills," before, during,
and after the War of 1812 helped to familiarize the public with notes. This raised confidence
in banking and paved the way for chartered banks to become established (Neufeld, 1964: 2).
2.3 A Question of Dollars and Sense
The aforementioned Halifax rating which measured value in pounds, shillings, and pence
was used throughout the Canadian colonies prior to the adoption of the decimal system. This
was simply a unit of account, as there was no mint in the Canadian colonies at that time
(Redish, 1984: 715) and thus there never existed a Halifax coin (McCullough, 1984: 18). An
1838 creed to the directors of the Bank of British North America on the state of banking in
the colonies by George Renny Young, a Scottish-born journalist, lawyer, author and political
figure in Nova Scotia, bemoaned the state of affairs and placed the blame for a lack of trade
between the Canadian colonies squarely on the lack of a single currency. Moreover, there was
speculation that the uncertainty produced by the differing Halifax values depressed economic
growth and productivity; to this end, Young wrote the following:
"It is clear that the condition of our currency this conflict in the nominal val-
ues of the different coins must embarrass both the convenience and the fre-
quency of inter-colonial exchange. I press it as a practical evil, that I have fre-
quently known sums lying unproductive for months in the hands of parties, both
in the Provinces of Nova Scotia and New Brunswick, who were anxious to trans-
fer them, and who felt an insuperable difficulty in procuring any available mode
of remittance." (Young, 1838: 36)
5
Journal of the House of Assembly of Lower Canada, January 29 April 14, 1808, Minutes of February 22 (as
quoted in McIvor, 1958: 18)
6
It has been highlighted by Canadian economics professor Craig McIvor, that erroneous assumptions were made
in this era about the new banking system; it was "apparently based on a `commodity' theory of the value of
money," which failed to take into account the effect of the quantity of money in circulation upon its value
(McIvor, 1958: 19).
Despite such calls for a more organized monetary system, the diverse coins that were in
circulation continued to be valued according to the Halifax rating, ostensibly in order to
facilitate trade with the colonial master, Great Britain.
One such proponent of a Canadian monetary policy free from British interference was Francis
Hincks, inspector general
7
of the Province of Canada
8
from 1848-1951, and Prime Minister
from 1851-1854. In his lauded study of Canada's monetary history, Professor of Political
Science Eric Helleiner blatantly links Hincks' "commitment to monetary reform... to his
political principles" (Helleiner, 2006: 21). Although a staunch loyalist to the British Crown
and an opponent of annexationist sentiments in the Canadian colonies, Hincks had been
influential in the creation of the first elected Legislative Assembly in 1841; for him, it was
obvious that responsible, democratic government was an indicator that the Province of
Canada was ready to take an increasingly autonomous role in shaping its own destiny, not
only politically in the parliamentary arena but also economically with regard to monetary and
trade policy. Hincks thought that the new Canadian-made currency would not only be "a
source of gratification and pride to Canadians" but would also "reduce the colony's depend-
ence on heterogeneous foreign coin," thus creating a public good for Canadians and providing
the government with the means to "manage the supply of coin more effectively" (Helleiner,
2006: 22).
In the hopes of encouraging trade and increasing exports to the United States, Hincks wanted
the Canadian colonies to adopt the decimal-based system of dollars and cents, which had been
established south of the border. At first, the British were reluctant to allow for such a move,
fearing its Americanizing tendencies. In the face of growing public pressure from the most
populous British North American colony,
9
however, they eventually relented. The choice was
practically made without British consent, as the merchants and bookkeepers that were brought
into daily contact with American trading partners had already de facto switched to the dollar
standard. Nova Scotia initially continued to link its currency to sterling, as their main eco-
nomic activity centered on maritime trade with the colonies of the British West Indies. After
Confederation in 1867, however, public sentiment changed and the province adopted the
decimalization of its currency. The adoption of a single currency with the rest of Canada was
such a powerful symbolic act that Members of Parliament from the province even gushed that
7
Finance Minister
8
The amalgamated provinces of Canada East and Canada West; present day Ontario and Quebec
9
English-speaking Canada West had by the mid nineteenth century established important trade relationships
with the United States, making that country the colony's most important trading partner. The American market
was less important for the Maritime Provinces on the Atlantic coast.
the move was "nothing less than one of the first steps to making us one people" (Helleiner,
2006: 28).
Thus we see in the 1840s and 1850s that the emergence of a Canadian dollar was an essential
aspect of the nation-building project before the Legislative Assembly of the Province of
Canada. This would suggest that control over the coinage and monetary policy was more than
a symbolic act; for Canada, the move towards a domestic currency had real consequences for
the political make-up and economic trajectory of the country. Moreover, throughout the mid-
nineteenth century, as the Canadian colonies grew in population and the construction of
railroads increased economic output, broader trade and integration with the United States
became more important than ever (Pentland, 1950: 469). Contrary to the British, who saw
decimalization as a prelude to annexation by the United States, Canadian policy-makers
cleverly foresaw the creation of a Canadian currency as a bulwark against precisely that
threat. In fact, a national currency oriented towards trade south of the border, enabling
merchants and exporters to enjoy the spoils of the comparatively massive U.S. market while
retaining their unique cultural and national identity, left Canadians more than content to
maintain their conditional sovereignty within the British Empire.
2.4 Reciprocity
Trade figures from the 1860s show the extent to which Great Britain and the United States
influenced and dominated the economic activity and planning of the Canadian colonies,
which conducted comparatively little trade amongst themselves as late at 1861. In that year,
for example, Canada sent "51 per cent of its exports by value to Britain [...] and 44 per cent
to the United States. The rest of British North America accounted for under three percent of
Canadian export trade" (Martin, 1995: 10), for reasons we have already touched on above,
and which can be summarily attributed to the lack of a profit motive, relatively small markets,
and an overly decentralized currency regime.
With the repeal of Britain's Corn Laws in 1846, which ended the period of protected export
markets and preferential treatment for Britain's colonies, merchants in the Canadian colonies
were forced to look south for new import markets to sustain trade and continued economic
growth. The Canadian-American Reciprocity Treaty of 1854-1866 was one way in which
Canadian authorities were able to enact a free-trade agreement with the U.S. and thus keep
annexationist sentiments at bay (Helleiner, 2006: 22). With a lack of coordinated monetary
systems, however, this measure alone was not enough to satisfy the increasingly important
trade between the Canadian colonies and the U.S.
The American Civil War, which ranged from 1860-1866, created a unique circumstance
where the U.S. was plagued by not only labor shortages but also experienced a diversion of
resources. For this reason, the numbers from the second half of the Reciprocity Treaty's
lifespan have been called unreliable by some authors, notably Economics Professors Law-
rence H. Officer and Lawrence B. Smith (Officer; Smith, 1968: 603). These two scholars have
pointed out that, in hindsight, while there was a slight increase in trade with the U.S., espe-
cially in Canada West, the Reciprocity Treaty did little to stimulate the economies of the
Canadian colonies as a whole. Furthermore, the Treaty encouraged the Canadians to special-
ize more in wheat and flour, and this lack of diversification might have actually been harmful
for the economy in the long run, had the Treaty not ended and brought about an increased
demand for other crops, such as Barley (Officer; Smith, 1968: 615). In this respect, the
Reciprocity Treaty may have provided more symbolic value than economic stimulus.
Regardless, with the end of the American Civil War in 1866 the Americans did abrogate the
Treaty, bringing to an end the first experiment with free trade on the North American conti-
nent. Ankli shows that the objective of the Canadian colonies was to increase exports while
decreasing imports, or keeping growth flat, an objective that foreign trade data from 1851 till
1860 suggests did indeed occur. Perhaps this was another reason for the Americans to cancel
the Treaty; the "Republican `protectionist' majority in Congress" felt that the Canadian
colonies were benefitting more from the arrangement. Certainly the Americans felt double-
crossed when in 1858 tariffs on manufactured goods were introduced, despite the unwritten
promise made by then Canadian Finance Minister Francis Hincks that this would not happen.
Moreover, the Americans resented perceived British (and, by extension, Canadian) support
for the Confederate States (Ankli, 1971: 2).
Thus the Canadian colonies once again lost privileged access to a much larger market. For
this reason, Confederation in 1867 seemed to be an antidote by which trade within the newly
formed Dominion of Canada could be increased and economic growth encouraged domesti-
cally. The political realities of the day forced the Canadian colonies to look first from Britain
to the United States, and then from the United States at themselves, in order to secure their
own domestic market and prevent economic stagnation.
2.5 Think Banks
A 1910 report to Congress relayed the development of the nineteenth century Canadian
banking system, stating: "during the first half of the nineteenth century the commercial and
financial interests of Canada and the United States were comparatively intimate and the
Details
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