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Euro Trashed

Europe’s rendezvous with monetary destiny

Dec 20, 2010, Vol. 16, No. 14 • By CHRISTOPHER CALDWELL
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It has been easy to snicker in recent weeks at the politicians who designed the euro, which appears on the verge of collapse after a decade as the common currency of a dozen countries in the European Union. Last May, the continent’s finance ministers put together a $145-billion package to bail out the corrupt Greek state. When that failed to calm markets, a new trillion-dollar European Financial Stability Facility was set up with money from the EU and the International Monetary Fund. It was meant to awe any speculators away from betting against the euro. It didn’t work. 

Euro Trashed

Hal Mayforth

Since October, the yields on Irish, Portuguese, Spanish, and even Italian and Belgian bonds have risen dangerously. While Americans were celebrating Thanksgiving, European finance ministers tapped the EFSF to buy Irish bonds and set up a fresh $113-billion rescue plan. The numbers surrounding the plan sound like a joke. It comes to about $25,000 for every man, woman, and child in Ireland. Ireland’s budget deficit is 32 percent of GDP. 

When you look at the debts that other countries have to roll over very soon—Italy, for instance, reportedly needs to raise well over $150 billion in the first quarter of next year alone—the sufficiency of the EFSF looks dubious, and the political landscape across Europe looks apocalyptic. The Irish government will fall when the Green party leaves it in a month. Silvio Berlusconi faces a confidence vote in Italy on December 14. Demonstrations against austerity programs have degenerated into riots not just in Greece but also in France. 

The euro deserves a lot of the blame. By tethering dynamic Ireland to interest rates more suitable to the sluggish economies of Central Europe, it sparked a housing boom more excessive than even that of the United States. Today, Ireland’s marriage to the euro deprives it of the main instrument—devaluation—that countries have traditionally used to export their way out of such financial messes. The economists who said that you cannot unite countries in a single currency unless you unite them under a single central government have been proved right. 

As we contemplate the macroeconomic storm that is now passing through Europe, we must bear in mind that this is a storm that the EU’s promoters knew would come. The euro’s designers understood Rahm Emanuel’s philosophy about not letting a crisis go to waste. “Europe will be forged in crises,” the European Community’s founding father Jean Monnet wrote in his memoirs, “and it will be the sum of the solutions brought to these crises.” When the French statesman Jacques Delors laid out his plan for the euro in the late 1980s, he drew a clear trajectory: A common market had made possible a common currency. A common currency would make possible a common government. 

But how would that happen? After all, if a currency worked well within the existing political arrangements, there would be no reason for those arrangements ever to change. New institutions could result only from the currency’s blowing up. Economic crisis would be the accidentally-on-purpose pretext for replacing a system based on parliamentary accountability with a system based on the whims of a handful of experts in Brussels. Europe’s countries now face the choice of giving up either their newfangled money or their ancient national sovereignties. It is unclear which they will choose.


How the euro started

The ideals behind the euro have a lot in common with the ideals behind the European Union. The single currency is the monetary expression of Europeans’ hurt pride, desire to cut a figure on the world stage, and impatience with that unique combination of sunny overconfidence and mismanagement that has often been the trademark of the American hegemon. Since World War II, the United States has supplied the world’s reserve currency. To borrow and to trade, European countries had no choice but to buy and hold dollars. This gave the United States what French president Valéry Giscard d’Estaing described as the “exorbitant privilege” of “issuing depreciating dollars as a means of funding massive foreign investment from which it derived a large surplus.” When the United States was profligate, Europe had to tighten money to avoid importing American inflation. According to the British journalist David Marsh’s authoritative history of the euro, John Connally, as Treasury secretary, once described the dollar to a European counterpart as “our currency, but your problem.” 

(Lest anyone think the American privilege has disappeared, consider that the world’s speculators are now circling vulturelike over the weakening Eurozone economy because its deficits average 6 percent, and its total debts just over 80 percent, of GDP. Meanwhile, U.S. deficits are 11 percent of GDP and its total debt approaches 95 percent.)

Americans’ cynical deployment of the dollar ticked Europeans off. For the short term, Charles de Gaulle sought to undermine U.S. predominance by converting France’s dollar reserves into bullion, which helped accelerate the eventual American abandonment of the gold standard under Nixon. For the long term, the Western European countries began designing a currency that could vie with the dollar.

The euro, a product of the 1970s, ’80s, and ’90s, probably could not have been implemented today. It was developed on the watch of two politicians gifted with a deep understanding of macroeconomics, Giscard and German chancellor Helmut Schmidt. It was, however, brought into being by two politicians, François Mitterrand and Helmut Kohl, who, although wise on other matters, were economic bumpkins. The strongest instrument for countering U.S. monetary hegemony—the Deutsche mark—lay in the hands of a country that had been deprived of most of its sovereignty by its historical misdeeds and could not, therefore, assert its interests. Most observers consider the abandonment of the Deutsche mark for the euro as the price Germany paid for European acceptance of German reunification and, more generally, for German readmission, on equal terms, to the civilized world. But the Germany that dominates the euro today is not the Germany the euro was designed for. 

Theoretical problems

of a currency union

The first draft for a euro-style currency, the so-called Werner report of 1970, called for a transfer of economic policy to a centralized European authority. Naturally. A common currency implies a common fiscal and budgetary policy. Otherwise, all sorts of moral hazards result. If, say, a dozen countries participate in a currency, all will be tempted to run deficits, since each will draw 100 percent of the benefit from it and suffer only 8 percent of the monetary costs. If such behavior weakens the debtor country, others will have to bail it out. 

European national governments wanted a common currency, but they were not ready to give up their sovereignty. So they came up with a compromise. They figured that if European governments could converge sufficiently in their style of budgeting, they could do without a central budgetary authority. Their plan for common-currency membership rested on an independent central bank and three regulatory pillars: First, no bailouts (as stipulated in article 125 of the Maastricht Treaty). Second, no “monetization of debts”—that is, printing money to pay off creditors (article 123). Third, no crazy budget deficits (as laid out in the so-called Stability and Growth Pact, which limited them to 3 percent). There was a logical problem with this structure. As the French economist Charles Wyplosz pointed out recently, if the no-bailout clause were really credible, then there would be no need for the Stability Pact, since countries that ran excessive deficits would be disciplined by markets. But Europeans lacked the discipline even for the Stability Pact. Greece cooked its books to conform with it. Italy was given a waiver on its total-debt provisions, and Prime Minister Romano Prodi called it a “Stupidity Pact.” France and Germany flouted it. And last spring, European authorities both bailed out Greece and (despite some accounting trickery to disguise the fact) monetized its debt.

The architecture of the euro had other elements. Most monetary unions—consider our dollar—have automatic transfers that smooth imbalances when one region of a currency area is booming and another is slumping. If California is stagnant, its residents collect more in unemployment benefits and pay less in taxes. If Texas is getting rich, tax revenues go up and welfare expenditures go down. But as the Harvard economists Alberto Alesina and Edward Glaeser have shown, people are reluctant to pay taxes to help out those with whom they don’t feel they have much in common. Just as a lot of suburban Americans saw the black, inner-city poor as “welfare queens” in the 1970s and 1980s, frugal Germans fear that their savings will be shipped to Greece to fund retirement-at-50 for a bunch of mafiosi.

That is why virtually every mainstream German politician, from Chancellor Angela Merkel on down, has promised German voters that the European Union must never be understood as a “transfer union”—a promise that is growing more and more detached from reality. Merkel has lately insisted that, in the future, bondholders, not taxpayers, must take the hit when governments go bankrupt. Guidelines to that effect have just been agreed on by Europe’s finance ministers and will go into effect in 2013. This naturally angers many Irish and Spanish politicians, who would rather tap the public than alienate the bond markets. 

The euro, whatever else it may have done for good or ill, should have spelled the end of a lot of European welfare protections. Without the instrument of devaluation and revaluation, a country can fiddle with its exchange rate only by making internal adjustments. In practice, this means cutting public spending, trimming labor costs, and making it easier to fire people. The so-called Lisbon agenda of deregulation, meant to make Europe more competitive by 2010, was not just a sideshow, or the hobbyhorse of free-marketers, as such agendas tend to be in the United States. As long as Europeans were not willing to have a strong, Europe-wide government, the Lisbon agenda was a sine qua non of monetary union. Trotskyists and other leftists tried to rally the French electorate to vote against the European constitutional referendum in 2005 by arguing that somewhere in this European project there lurked an iron capitalist logic. They were essentially right. The French voted against the EU in a landslide. The Dutch vote was nearly 2-to-1 against. At that point, other countries cancelled their referenda.

Next to nothing was ever done to enact the Lisbon agenda. In fact, the countries with the most sclerotic labor markets—Spain, most glaringly—were the slowest in reforming them, and macroeconomic instability was a result. 

We’ve now listed about a half-dozen conditions that are indispensable to maintaining the euro as it stands, and Europe has fulfilled none of them. There is only a series of ad hoc improvisations—the responses to crises that Monnet said would create the rules of Europe. This is not “bold, persistent experimentation” of the sort that Franklin Roosevelt claimed an overwhelming electoral mandate for. It is a displacement of the democracies that people think they’re living under. So we should ask whether it is intentional or incidental.


Democracy against economics

The euro is an end-of-history currency. The late Dutch central banker Wim Duisenberg called it “the first currency that has not only severed its link to gold, but also its link to the nation state,” and other economists have been just as forthright. The very capable economist Tommaso Padoa-Schioppa, probably the leading Italian champion of the euro, wrote a column last spring entitled, ominously, “The euro remains on the right side of history.” Padoa-Schioppa complained about the way both defenders and detractors of the euro believe that the traditional nation state “is and will continue to be the absolute sovereign within its borders.” He himself believes no such thing. “The advent of the euro is just an episode—a most significant one—in the building of a post-Westphalian order,” he writes. “At stake in this struggle, ultimately, is the ideology of the omnipotent nation-state.” 

Fans of the euro used to sell this post-national vision as a matter of hope. But today they are just as happy to sell it with fear. France’s finance minister, Christine Lagarde, told a German newspaper recently that any wavering from European unity would be a “disaster.” She said, “We need to go further towards a convergence of our economic policies.” One need not be particularly ideological to feel this way. One need only assume that, when economics speaks, politics must fall into line. 

Last summer, at the height of the Greek debt crisis, economists looked ahead to other problem countries and came to the uncomfortable conclusion that most of them had not been badly, incompetently, or corruptly run. There were exceptions, of course. Greece was corrupt by any historical or geographical standard. It would today be a basket case whether it had been using the euro, the drachma, or wampum. Ireland’s ruling Fianna Fáil party certainly retained elements of the traditional cronyism that is Irish political culture’s besetting sin, and which no one who has observed Boston politics for even a week will fail to recognize. 

But these are not the main problems the euro has wrought. The big damage has been in the private, not the public, sector. Politicians in Ireland may have got the occasional backhander from an unscrupulous property developer, but in the quantitative terms of balancing the budget, the Irish were model fiscal stewards until the property market collapsed. Greece itself proved contagious partly because of the private-sector trade imbalances the euro created, which left French and German banks searching for debt to invest in. It was the Western private sector, as much as the Greek public sector, that rendered Greece too big to fail and put an end to the EU’s no-bailouts rule. And then there is Spain, the other country whose rescue appears to be coming as inevitably as Christmas. Spain not only balanced its budget—it took precautions to keep its home lending sector from overheating. Unfortunately, even that was not enough to keep the artificially low real interest rates that the euro gave it from doing their damage. According to the Spanish macroeconomist Angel Ubide, Spain “probably should have been running fiscal surpluses of the order of 5-6 percent of GDP to offset the negative real interest rate its borrowers enjoyed.”

Well, as an economic matter, yes. Just as, as an economic matter, the United States should probably have been running surpluses to prepare for the wave of Baby Boom retirements that are fast approaching. But how would you have explained that to the Spanish people? Money burns a hole in the pocket of a democratic electorate. Voters hate reserves, surpluses, or any kind of money lying around. What do they call a 5-6 percent surplus? They call it “my money.” This, incidentally, is why Keynesianism, while logical in theory, is impractical in an open democracy. Demand cannot be “managed”—it can be stimulated, but voters will not tolerate seeing it dampened. “In a democracy at least,” as the wise economist Wyplosz writes, “fiscal profligacy is not a story of ‘politicians gone crazy.’ It is the rational outcome of the interplay between elections and pressure groups.” (Last week’s mad bipartisan tax giveaway in Washington provides further evidence that Wyplosz is right.)

The euro created a situation under which the democratically logical thing to do is economically destructive, and the economically logical thing is opaque to even the most well-meaning and well-informed elected representatives. When Ireland promised to stand behind its domestic banks in the immediate aftermath of the Lehman Brothers collapse, what was a member of the Dáil supposed to think? Was this a “bold” and “generous” way of protecting “the little guy” against the ravages of the global economy? Or was it a way of assuring that the two-dozen sybaritic Fianna Fáil cronies who drove the country into the ground would get bailed out by the taxpayer? The answer is the same as the one that any independent-minded U.S. congressman voting on the bailout package in 2008 could have honestly given: It would take weeks of study to come to a decision, and even that might be falsified if the markets turned fickle. 

It may be that the better an economist one is—certainly, the more focused an economist one is—the more one underestimates the complexity of this political problem. Last spring, one suggestion frequently advanced for reforming the euro was the establishment of “independent fiscal councils” at the European level, with veto power over budgetary decisions made in national parliaments. Representatives could still decide what they would spend money on, but only within parameters set by expert macroeconomists. Not surprisingly, economists thought this was a terrific idea. The Trinity College (Dublin) economist Philip Lane opined, “The establishment of a fiscal framework does not constrain the fundamentally political nature of decisions over public spending and taxation.” The Berkeley economist Barry Eichengreen agreed with Lane. “Europe will need fiscal rules with teeth,” he wrote. “The [European] Commission will have to be strengthened to where it has veto power over those pre-legislative submissions.” 

It is hard to quarrel with Eichengreen on the economics of the European finance crisis. He has written classic books on currencies and on crashes and on European economic history. Lane is as good an economist as any in Ireland. But the issues they are addressing are not primarily economic. In a democracy, the size of the budget is a political decision. Empowering a body of economists to overturn that decision would be an antidemocratic constraint. So a question of proportion arises: You’re going to rob a dozen ancient democracies of a large part of their sovereignty in order to salvage a ten-year-old accounting convention? That is what is at stake with the euro. Europe must now choose between its traditions of self-rule and promises of a radiant economic future that may not include self-rule. 

Christopher Caldwell is a senior editor at The Weekly Standard and the author of Reflections on the Revolution in Europe: Immigration, Islam and the West.

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