Europeans can’t say they weren’t warned. For a decade before the euro was launched, critics -- and many economists -- argued that one currency wouldn’t fit all, or even most, of the nations of the European Union.
The unfolding euro-area crisis is proof that the critics were right. Now it’s up to the strongest member countries to put an end to this failed experiment.
Nobody denies that the introduction of the euro had some economic benefits. The cost of currency conversion at national borders disappeared, and exchange-rate risks no longer had to be weighed when making transactions within the countries of the zone.
But it was never clear that Europe formed what economists call an “optimal currency area.” The countries had different business cycles and levels of wage flexibility, which suggested that the right interest rates for one part of the zone might be wrong for another. This problem might have been overcome if the euro area had a powerful central government capable of cushioning the blow for nations that experienced shocks as a result of inappropriate monetary policy. But, of course, it didn’t.
Proponents of the euro adopted the optimistic theory that its introduction would eventually make the region an optimal currency area. The euro would facilitate tighter economic integration, thus causing the business cycles of European economies to converge. It would also give rise to stronger European political institutions.
For a while, it seemed to be working. A September 2010 report from Barclays Capital found that the euro did indeed promote convergence. The EU did gradually gain power at the expense of its member states, though there was always plenty of popular resistance.
But these effects were outweighed by two others. The euro allowed profligate countries, notably Greece, to borrow money at low interest rates made possible by German thrift. And when trouble came, weak economies were unable to resort to the traditional expedient of devaluing their currencies to adjust. Thus, both boom and bust were accentuated.
The economies of France and Germany are so large that a policy designed for the euro zone as a whole would inevitably be a better fit for their needs than for those of the countries on the zone’s periphery. But the European Central Bank has given Germany’s economy even more weight than its size alone would suggest. The Barclays Capital report found that European monetary policy since 1999 “has tended to correspond more closely with German economic conditions than for the euro area as a whole.” Interest rates were thus much lower than they should have been in Greece, Spain and Ireland during the boom, and since then have been higher than they should have been.
If the ECB were now to loosen its monetary policy considerably, one would expect inflation to hit disproportionately in the countries with the fewest idle resources, such as Germany and France. Thus the troubled peripheral countries could benefit from a kind of internal devaluation while staying in the euro. Devaluation would lower real wages in the periphery to sustainable levels. If the weaker members stick with the euro and the ECB balks at inflation in the core, however, then the only way for the periphery to adjust is through nominal wage cuts.
As Allan H. Meltzer, a professor of political economy at Carnegie Mellon University, put it last week, Greece could “remain with the euro and deflate prices and wages 2% or 3% a year for six to 10 years.” The American political system wouldn’t be able to tolerate such a policy, and there is no reason to think the much-more-socialist Greek one can.
Poland, having not met the criteria to join the euro, was able to devalue its currency and has weathered the economic storms of the last few years fairly well. Switzerland is pegging its franc to the euro to prevent deflation. The Greeks -- as well as the Irish, Spaniards and Portuguese -- would be far better off if they, too, could have devalued their currencies. And so would the rest of the euro area, where taxpayers wouldn’t be facing pleas for bailouts.
A Reckless Gamble
Over the past 20 years, European elites have treated expressions of popular opposition to regional integration as spasms of irrationality. But the euro itself was a reckless gamble by those elites -- a bet motivated more by an enticing political vision of European unity than by any economic objectives.
Even as the euro wreaks fearsome damage on European economies, its defenders remain committed to this political project. Jose Manuel Barroso, the president of the European Commission, said this month that the euro “embodies the will of Europeans to share their future. This oath is not in question; we will come out stronger from this crisis.”
In this view, what Europe needs now is to deepen its political integration in the midst of crisis. Yet the crisis is itself making this scenario less likely: Nationalistic sentiment is rising, with Germans balking at bailouts and Greeks at the conditions they would involve.
The wiser course is to ditch the euro. The countries in the most trouble can’t leave it because their first whisper would trigger widespread bank runs. If Germany and like-minded nations want to avoid either inflation or bailouts, they themselves should leave en masse -- creating a new northern European currency covering a more economically cohesive area. The remaining euro countries could then adopt a realistic exchange rate in relation to this new currency.
Otherwise the shared European future that Barroso invoked is likely to be a grim one.
(Ramesh Ponnuru is a Bloomberg View columnist and a senior editor at National Review. The opinions expressed are his own.)
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