Italy will Kill the Euro - Not Spain or Portugal

The American constitution, for instance, did not provide for a central bank. Many of the Founding Fathers (e.g., Madison and Jefferson) refused to countenance one. It took the nascent USA two decades to come up with a semblance of a central monetary institution in 1791. It was modeled after the successful Bank of England. When Madison became President, he purposefully let its concession expire in 1811. In the forthcoming half century, it revived (for instance, in 1816) and expired a few times.

The United States became a monetary union only following its traumatic Civil War. Similarly, Europe's monetary union is a belated outcome of two European civil wars (the two World Wars). America instituted bank regulation and supervision only in 1863 and, for the first time, banks were classified as either national or state-level.

This classification was necessary because by the end of the Civil War, notes - legal and illegal tender - were being issued by no less than 1562 private banks - up from only 25 in 1800. A similar process occurred in the principalities which were later to constitute Germany. In the decade between 1847 and 1857, twenty five private banks were established there for the express purpose of printing banknotes to circulate as legal tender. Seventy (!) different types of currency (mostly foreign) were being used in the Rhineland alone in 1816.

The Federal Reserve System was founded only following a tidal wave of banking crises in 1908. Not until 1960 did it gain a full monopoly of nation-wide money printing. The monetary union in the USA - the US dollar as a single legal tender printed exclusively by a central monetary authority - is, therefore, a fairly recent thing, not much older than the euro.

It is common to confuse the logistics of a monetary union with its underpinnings. European bigwigs gloated over the smooth introduction of the physical notes and coins of their new currency. But having a single currency with free and guaranteed convertibility is only the manifestation of a monetary union - not one of its economic pillars.

History teaches us that for a monetary union to succeed, the exchange rate of the single currency must be realistic (for instance, reflect the purchasing power parity) and, thus, not susceptible to speculative attacks. Additionally, the members of the union must adhere to one monetary policy.

Surprisingly, history demonstrates that a monetary union is not necessarily predicated on the existence of a single currency. A monetary union could incorporate "several currencies, fully and permanently convertible into one another at irrevocably fixed exchange rates". This would be like having a single currency with various denominations, each printed by another member of the Union.

What really matters are the economic inter-relationships and power plays among union members and between the union and other currency zones and currencies (as expressed through the exchange rate).

Usually the single currency of the Union is convertible at given (though floating) exchange rates subject to a uniform exchange rate policy. This applies to all the territory of the single currency. It is intended to prevent arbitrage (buying the single currency in one place and selling it in another). Rampant arbitrage - ask anyone in Asia - often leads to the need to impose exchange controls, thus eliminating convertibility and inducing panic.

Monetary unions in the past failed because they allowed variable exchange rates, (often depending on where - in which part of the monetary union - the conversion took place).

A uniform exchange rate policy is only one of the concessions members of a monetary union must make. Joining always means giving up independent monetary policy and, with it, a sizeable slice of national sovereignty. Members relegate the regulation of their money supply, inflation, interest rates, and foreign exchange rates to a central monetary authority (e.g., the European Central Bank in the eurozone).

The need for central monetary management arises because, in economic theory, a currency is never just a currency. It is thought of as a transmission mechanism of economic signals (information) and expectations (often through monetary policy and its outcomes).