Europe’s Doomed Euro

Few people predicted the global financial crisis. Everybody predicted the crisis of the eurozone.
Read almost any critique of the euro from just a few years ago and you’ll be struck by their foresight. The euro will encourage government profligacy – tick. The euro will be extremely vulnerable to a housing bubble – tick. It will rely on the willingness of stronger economies to bail out weak ones – tick. And it will do nothing to buffer Europe from an American downturn – tick.
These objections were raised by everyone from Paul Krugman to Milton Friedman.
So how on Earth did Europe get its doomed euro – an idea which was viewed with deep scepticism if not outright hostility by some of the finest economic minds of the age?
As Romano Prodi, the European president said in 2002, “The introduction of the euro is not economic at all. It is a completely political step”.
Europe switched its currency for geopolitical purposes and got burned.
In his Euro On Trial (written well before the financial crisis) the economic historian Brendan Brown argues that the European monetary union was a power play between French policymakers and German monetary authorities. Germany is Europe’s largest economy and the Deutschmark was its strongest currency. The influence of the Deutschmark was seen as a threat to both France’s strategic interests and its moral leadership of Europe. French politicians worried that bolstered by monetary strength Germany could act independently of Europe, forging a unique relationship with the United States and even the Soviet Union.
So for the French, a common currency offered glue with which Germany could be stuck in Europe. German foreign policy interests could be overcome by French ones.
Of course, the Germans knew this. French politicians actively raised the spectre of German nationalism when campaigning for the common currency. But these days the only country which fears German power more than France is Germany. For historical reasons, Berlin wanted a deeper European Union. If that meant sacrificing the Deutschmark for French support, so be it.
In adopting the euro, both France and Germany were subordinating economic policy to foreign policy, each trying to bind future German politicians.
The economist Philipp Bagus also argues that prudence of the Bundesbank, the German central bank which dominated Europe, restrained other European countries from excessive spending. This discipline was, needless to say, unwanted. Get rid of the Bundesbank, and the spigots of government largess could open freely.
No wonder that in 2004 the Czech president Vaclav Klaus argued that the euro creates a perfect environment for fiscal irresponsibility.
Certainly, there was an intellectual case presented for monetary union. The theory of optimal currency areas suggests that, at the very least, the size of some currency jurisdictions are better than others.
Then there are the intuitive benefits of currency consolidation. Single currencies reduce the costs of trade, at least a little bit. One currency makes it easy to compare prices across the continent.
But there was no reason to suggest that Europe was such an optimal currency area. (Europe’s economies are, obviously, different.) Even if it was, which countries opted in and opted out of the monetary union was, again, dictated by political considerations, not economic theory.
And the mild convenience of being able to compare prices between Barcelona and Berlin without using a currency converter seems to be a very mild benefit considering the costs of monetary union.
One of the more reasonable polemics in support of the European project was by the British author Mark Leonard – Why Europe Will Run The 21st Century. Social democratic Europe would retake world leadership from liberal democratic United States. And in Leonard’s view, a common currency would be a core foundation in Europe’s revitalisation – luring the centre of global finance back across the Atlantic.
Leonard’s book was published in 2005. How times have changed.
In 2011, we can read in the Guardian that “the monetary union, unlike the EU itself, is an unambiguously right-wing project”.
It’s hard to see why. The European ideal is a long way from its classical liberal origins in a free trade and migration alliance. The 1957 Treaty of Rome set up a simple union of free movement in goods, services, capital, and people.
That early classical liberal vision is very different from the vision of Europe which informed the euro – one in which not only borders are being eliminated but policy differences as well. The monetary union sought to eliminate inter-state competition for the most stable currency. In the Europe of the 21st century, taxes are being harmonised. Regulations are being increased.
The Spanish prime minister said in 1998 that “The single currency is a decision of an essentially political character… We need a united Europe.”
Unfortunately, the only people who have been surprised by the euro’s failure have been the politicians who thought monetary policy should be a weapon for international diplomacy.