The Full Monte

Adopting the euro gave Montenegro independence

Market place in Dubrovnik, Yugoslavia (1969) (edited, source: World Bank Archives)

It’s rare for a country to fully abandon its domestic currency and adopt another’s as sole legal tender. According to IMF classifications, only about 14 jurisdictions have done so: roughly seven use the U.S. dollar, four the euro (including the two unilateral cases of Montenegro and Kosovo), and three small Pacific nations use the Australian dollar. Rest assured there will be a Hegemoney piece on Oceanic currencies eventually but not today. Today we examine Montenegro’s idiosyncratic adoption of the currency of a political bloc to which it doesn’t belong — the euro.

Montenegro, a small Balkan country (pop. equivalent of Vermont), has been trying to join the European Union for some time now. In April, an EU working party began drafting Montenegro’s accession treaty, marking two firsts: the first potential new EU member since Croatia joined in 2013, and the first time a candidate arrived already using the euro.

Montenegro has been in “put me in, coach” mode for decades. The country unilaterally adopted the euro as legal tender 24 years ago — a move that some might say was a little too eager. Like the time I really wanted to dance Aurora at my ballet school’s performance of Sleeping Beauty, so I dyed my hair blonde and kept talking about spindles but alas. No dice. Jess Hoversen will be dancing the role of Fairy #5 this evening and forever.

Anyway, I hope it works out for Montenegro, but the EU is characteristically unsure how to handle a country that did things out of order. Every accession treaty commits a new member to adopt the euro by a fixed sequence: join with your own national currency, spend at least two years at a stable rate against the euro, pass tests on inflation, deficits, debt, and rates, then get a Council decision admitting you to the euro area. Montenegro cannot perform step one. It has no national currency to stabilize. The European Central Bank has been clear about its discomfort, noting in 2004 that the bank “does not welcome unilateral euroization,” because it undermines the process and circumvents the multilateral assessment of new members.

Now, with Montenegro targeting membership by 2028, the EU is charting a way forward. Though details will likely be worked out during the treaty drafting process, Bloomberg reports that EU officials will treat Montenegro’s use of the euro as an unorthodox, fixed-rate currency regime, suggesting they will not have to return to a national currency before accession. Montenegro will create a new precedent and that journey, along with its lessons for the next wave of dollar-, euro-, or stable-ization, is worth studying.

Montenegro(w)

A quick primer for those who were not born in the 80s. The Socialist Federal Republic of Yugoslavia was a federation of six republics — Slovenia, Croatia, Bosnia and Herzegovina, Serbia, Montenegro, and Macedonia — assembled after WWII by dictator Josip Broz Tito, the partisan leader turned president for life. When Tito died in 1980, the federation began to decay. Between 1991 and 1992, four of the six republics declared independence, triggering the Yugoslav Wars. Montenegro and Serbia formed the Federal Republic of Yugoslavia in April 1992.

As part of the integration process, the National Bank of Montenegro became a regional office of the National Bank of Yugoslavia, putting the monetary fate of Montenegro into the hands of central bank officials in the Serbian capital. Even prior to unification, inflation was already bad in Montenegro, hitting 50 percent in early 1992. However, the situation only deteriorated and inflation reached 3,508,091,786,746 percent (no, that is not π) by the end of 1993. In 1994 the central bank introduced the “super dinar,” which was initially pegged 1:1 to the German Deutsche Mark but then devalued twice. By 1999 the dinar traded on the black market at two and a half times weaker than its official rate.

This economic deterioration drove households and firms into Deutsche Marks because it was Europe’s most stable currency and Montenegro has a natural supply of them through remittances and tourism. By 1996, as much as 70 percent of all cash Deutsche Marks were estimated to sit outside Germany.

In economics, a country adopting a foreign currency is typically equated with that country surrendering monetary sovereignty. But for Montenegro, adopting marks and abandoning the dinar was not only a path to currency stability, but also an act of political secession from Serbia. While it was a part of the Federal Republic of Yugoslavia (its union with Serbia), Montenegro had a national currency but no monetary sovereignty, because every decision about the dinar was made at the central bank in the Serbian capital, leaving Montenegro’s economy at the whims of Slobodan Milošević — the Serbian strongman whose wars and money-printing were dismantling what remained of Yugoslavia.

On November 2, 1999, Montenegro’s acting monetary authority made the Deutsche mark legal tender alongside the dinar. On January 1, 2001, that same authority declared that the Deutsche Mark was the sole legal tender. Steve Hanke, then state counselor and adviser to President Đukanović, described the decision to formally adopt marks as “the first step in the march towards secession… the dinar was ‘Milošević’s Achilles’ heel.’”

A few months later, the Central Bank of Montenegro was established. Then, as euro notes and coins replaced participating national currencies in early 2002, Montenegro likewise converted to euros that same year. Four years later, in 2006, the people of Montenegro declared independence in a referendum. Currency independence in 1999 preceded political independence by seven years.

Monte-absolutely-no

The Central Bank of Montenegro — because it uses the euro — does not set interest rates nor does it control the money supply. Montenegro imports its monetary policy from the European Central Bank. The Central Bank of Montenegro will raise or lower reserve requirements or make collateralized loans to high-quality financial institutions to manage liquidity in the banking sector.

Euros enter the Montenegrin economy through the balance of payments: tourism receipts, remittances, foreign direct investment, and external borrowing deliver the cash and deposits. Several decades ago, Deutsche Marks arrived the same way, in such quantities that the Bundesbank found the 1999 adoption had no measurable effect on Deutsche Mark demand because so much of the cash “was already in circulation.”

Although euro-ization brought currency stability, domestic economic crises hit harder without a full central bank backstop. Without the ability to prop up the economy through monetary policy, Montenegro’s labor market was hit hard: unemployment peaked at 20 percent in 2012, and remittances doubled as a share of GDP.

The country has had to improvise safety nets during the global financial crisis and the pandemic — emergency deposit guarantees, reliance on the Vienna Initiative (Western parent banks supporting subsidiaries), and ad-hoc liquidity lines. A large share of the banking sector in Montenegro is foreign-owned, which has provided some voluntary lifelines but no guarantees.

As researcher Lara Merling has noted, after decades of entrenchment, returning to a national currency is unrealistic. Unilateral adoption of the euro gave Montenegro the drawbacks of surrendering monetary autonomy without the full benefits (or voting power) of actual Euro-zone membership. EU accession is the only realistic path to more permanent stability for Montenegro’s economy.

The Full Monte

Montenegro pulled off a successful (if messy) unilateral currency substitution as a small, open, tourism- and remittance-heavy economy. But nothing is easy, and here is what stands out for any country considering some flavor of “-ization”:

Adoption provided sovereignty: Abandoning the dinar brought monetary independence from Serbia and Milošević’s policies, serving as a key step toward eventual political secession.

The balance of payments is the central bank: The monetary authority cannot create euros to inject liquidity into the economy or respond to a crisis. Montenegro must therefore rely on tourism, remittances, and foreign direct investment to obtain the euros it needs. Similarly, dollarized countries such as Ecuador must earn dollars through exports in order to sustain their dollarized systems.

Currency substitution works best when it is bottom-up: Households and firms had already shifted to Deutsche Marks before the government made it official. When the state tries to force the switch (El Salvador’s Bitcoin experiment is a recent example), adoption is usually much slower and more contested.

There is no guaranteed lender of last resort: Without a central bank to provide emergency assistance, crises require patchwork solutions such as government guarantees, foreign parent banks, multilateral deals, or emergency credit lines. This is arguably the biggest drawback of any “-ization” project.

There’s no easy off-ramp: Once entrenched, reintroducing a national currency is politically and economically painful.

A seat at the table matters: Montenegro at least has a realistic path to influence monetary policy through eventual EU membership. A full stablecoin adoption would leave an economy without a route for influence. I don’t think Tether has membership meetings, but if they did I bet it would be lit! This leaves users at the whims of the issuers.

In the end, Montenegro ran the Full Monte: all-in on someone else’s currency, scars included, and now has a realistic shot at making it permanent with EU accession. A potential parallel adoption of stablecoins (in whatever denomination) throughout an economy would carry the same (or higher) costs, fewer improvised backstops, and no path to the best-case ending that Montenegro is about to get.