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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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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. 

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