By now, it's obvious that adopting the euro was a colossal
blunder. It may rank as Europe's worst policy mistake since World War II. The
virtues of the common currency -- it reduced transaction costs and the
uncertainty of fluctuating exchange rates among national monies -- were
temporary. Its vices seem permanent or, at least, semi-permanent: the mounting
economic costs of saving the euro; the growing nationalism from arguing over
who's to blame.
Do not expect some magical "solution." Europe has entered an
economic and political purgatory from which there is no early escape. On paper,
the crisis countries (so far: Greece, Portugal, Ireland, Italy and Spain) might
benefit from abandoning the euro and resurrecting national currencies. They
could then devalue these currencies, spurring exports and tourism. But in
practice, this choice is dangerous and maybe impossible.
Any hint that a country might dump the euro would trigger runs on banks, as
depositors sought to withdraw their euros. Banks would collapse. Deprived of
buyers for their debt, countries would default. This would impose further
losses on banks inside and outside the defaulting country. Without viable
banks, borrowers would be starved for credit. There would be capital controls
restricting the shift of funds abroad. If one country (say, Greece) left the
euro, it might precipitate runs and capital flights elsewhere. Writing in The
Financial Times, Citigroup chief economist Willem Buiter sketched this grim
outlook:
"Disorderly sovereign defaults and eurozone exits ... would drag down
not just the European banking system but also the North Atlantic financial
system. ... The resulting financial crisis would trigger a global depression
that would last for years, with GDP likely falling by more than 10 percent and
unemployment in the West reaching 20 percent or more. Emerging markets would be
dragged down too."
Given these terrifying possibilities, hardly anyone is eager to tempt fate
and see whether they might actually occur. Buiter himself rates the probability
of this doomsday outcome at no more than 5 percent; the assumption is that
European governments -- or someone -- will avoid it by continued bailouts
(loans to weak governments). But this creates other problems. It imposes
austerity on countries and removes control of their budgets to third parties:
the European Union or the International Monetary Fund (IMF).
The logic is plain. If debtors need rescuing, then the rescuers ought to
have some say over the policies that might cause trouble. Under the latest
agreement among European leaders, member countries have to submit their budgets
to Brussels to certify that any deficit does not breach a ceiling of 0.5
percent of national income. There would be some unspecified transition, because
most budgets are now in violation.
The potential for intrusiveness -- and resentment -- is obvious. Brussels
might order tax increases or spending cuts. National sovereignty over basic
political choices is being outsourced. Too much power is being centralized away
from nation states. A backlash against the idea of Europe is possible and
probable.
So Europe is trapped in purgatory. What's economically sensible is
politically treacherous, and what's politically sensible is economically
treacherous. Moreover, the euro's promise has been turned on its head.
When introduced in 1999, its overriding goal was clear. As an engine of
shared prosperity, it would strengthen a common European consciousness.
Germany's power would be subordinated to the larger project of a united Europe.
Now, everything is reversed: The euro is undermining Europe's economy, sowing
conflict (Britain has rejected the latest package) and elevating Germany -- as
the economically strongest state -- to set terms for dealing with the crisis.
Much of this was predictable and, indeed, was predicted. Here's a
commentary of mine from 1997: "A single currency (the dollar) works in the
United States because wages are flexible and workers are mobile. Workers move
to find jobs. ... Europe lacks these advantages. ... One way countries can offset
differences in competitiveness is through flexible exchange rates. ... A single
currency would eliminate this possibility." Others, more eminent, issued
similar warnings.
Because the euro's economic advantages were oversold, it was also doomed
politically. "The great potential tragedy here is that ... (it) would
spawn disunity." Europeans "would quarrel over who's to blame for the
single currency's failing to meet its inflated (and unrealistic) expectations.
There would be disillusion with the larger idea of Europe."
Perhaps Europe will overcome the present crisis through some combination of
loans from the European Central Bank and the IMF along with policies to improve
economic growth. This is the best imaginable outcome, and many others -- much
worse -- are possible. But even the best result would not be very good for
Europeans or for us. It would leave, as I noted back then, "a weakened,
resentful Europe (that) would not make the partner America needs in the 21st
century."
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