The ECB is now a lender of last resort not only to the commercial banks in its club but to governments in its area
Almost from the start, the single currency was seen as a necessary
ingredient of a unified Europe. The Treaty of Rome that launched the Common
Market was signed in 1957; the Werner Report outlining the path towards full
economic and monetary union was commissioned in 1969 and made official in 1970.
Despite this relatively early start, the creation of a solid euro is taking
time; from the beginning it was beset with incident. It was not finally
launched until the year 2000. The honeymoon lasted until 2007. Since then,
progress has become less than smooth, to say the least.
The original euro
The intention was to make the euro a special kind of currency, a sort of
European Deutschemark with no need for a government to back it. Monetary
sovereignty would reside in a fully independent European Central Bank. Its
remit according to the Maastricht Treaty (1992) was strictly reduced to issuing
the euro, to managing an area-wide interest rate, and to leading the old
national central banks in the oversight of the Eurozone banks. The ECB was to
be a rule-bound institution. Its only obligation was to maintain the purchasing
power of its currency. Knowing that repeated budget deficits and continuous
accumulation of sovereign debt sooner or later lead the issuer of the currency
to print excessive amounts of money, a parallel document, the Stability and
Growth Pact (1998) put a limit to member states' deficits and debt. This
transfer of monetary sovereignty to the ECB and the limiting rules accompanying
it meant that neither member states nor the European Union could use the euro
as an instrument of discretionary economic management. In practice, no
devaluation and no inflation imposed a harsh discipline on the Ministers of
Finance of the Euro area—a welcome brake on democratic profligacy.
This well-meaning project had its failings, as experience has shown. Some
small instrumental changes, especially regarding the over-lenient interest rate
policy, would have given the new currency greater stability. But nobody made
clear from the start its possible costs in terms of budgetary discipline,
structural reform and reduction of entitlements. A pampered electorate should
have been told the price to be paid for the great advantage of a stable
currency. In sum, the euro could have been a sort of pale replica of the gold
standard, aspiring to the solidity of gold but free of gold's automatic
rigidity. Better that than nothing.
An 'American' euro
The current crisis has led the European authorities and the Bank to throw
away the monetary ideal of rule-bound action, independence from politics and
attention to the long run. The ECB is now a lender of last resort not only to
the commercial banks in its club but to governments in its area. Far from being
independent of politics, it is in continuous consultation and collaboration
with European and national authorities. The current president of the ECB has
gone so far as to says that the Bank will "do whatever it takes" to
save the euro, which markets have understood as creating all the liquidity necessary
to stop speculators. Thus, the ECB is now turning itself into a traditional
government banker, ready to aid and abet in counter-cyclical monetary
management, protectionist exchange rate policy, and 'controlled' inflationism.
Euro-enthusiasts would like the euro to be another dollar, not only for the
privilege of cashing in the seignorage income of a world currency but also
because it would help Europe on the way to becoming a federal country. Whenever
the Eurozone authorities show lack of decision in facing some euro crisis, as
in the case of Cyprus, the cry goes up that "We need more Europe!",
meaning 'we need a more federal Europe'. Why not issue Eurobonds along the
lines of the American Treasury to replace of so many different euro-denominated
national bonds? Many would like the ECB to be turned into another Fed with full
capacity for indefinite Quantitative Easing. They sigh for the likes of the
United States President, Federal Reserve Chair, and Treasury Secretary to
appear together before the media to issue a common policy statement when a
crisis arises.
Mundell, the sorcerer's apprentice
Robert Mundell (1961) is the main author of the theory of monetary unions,
on which the blueprint of the euro was based. He made two points: He criticized
the reliance on flexible exchange rates to solve a country's balance of
payments difficulties, and he outlined the conditions for successful monetary
unions, an arrangement he much preferred to dispersed monetary sovereignties.
His first point is well taken if one wants a world of stable currencies and
solid forward contracts. The classical gold standard of the second half of the
19th century was precisely an arrangement of this kind. This was not Mundell's
idea. For him, a single currency was an instrument of political power.
His list of conditions for a well functioning monetary union is really a
list of impossibilities in the case of the euro. A single currency could only
function optimally in single market, where workers would be ready and able to
relocate. If this was not so, it was enough if in places of low productivity,
wages and prices were fully flexible downwards. If the EU had made real
progress towards becoming a single market, the euro would not find itself in
such straits as now.
In a recent lecture, Mundell (2011)1 wants Europe to imitate the beginnings of the monetary and financial
union in America after independence. The creation of the dollar as a legal
tender currency posed no problems of its own; the states' debt was the problem.
For Mundell, the crisis of the euro is one of fiscal insolvency, to be remedied
by a measure of fiscal consolidation, but mainly by merging all European sovereign
debt into a single Eurodebt and placing it on the world's capital markets. This
was Alexander Hamilton's idea in 1792, to issue federal debt for all the states
of the Union. The result, notes Mundell, is that the United States has over $5
trillion in debt outstanding around the world today. EU bonds would permit
Europe to place perhaps €4 trillion worth of debt and so attend to the needs of
Greece, Ireland, Portugal, Spain, Italy and even Cyprus without turning a hair.
But Mundell undermines his own argument by quoting Thomas Jefferson in 1810,
who said, thinking of Hamilton, "And we were told that the public debt
would be a blessing". Just ask the Americans of 2013.
The political aim of "an ever closer union" led the framers of
the euro to impose a single currency. John Major, then
Chancellor of the Exchequer in Lady Thatcher's Government, proposed launching a common currency
to run in competition with national currencies. He called it the "hard
ecu", offering people a choice currency they could freely adopt. It was to
be an electronic money to be used in business and tourism. Its value would
initially have been equal to a basket of European currencies, but would not
depreciate subsequently relative to any member currency, even if one of them
lost value. This would have made the ecu as hard as the hardest currency in the
basket. Jacques Delors, then President of the Commission, rejected Major's plan
out of hand because he was more interested in the politics of union than in the
economics of competition. (Schwartz 2013) The euro would have fared much better
as a choice rather than as an imposition.
The euro is the product of men of system, whom Adam
Smith so memorably portrayed
in his Theory of Moral Sentiments (1759): "The man of
system [...] seems to imagine that he can arrange the different members of a
great society with as much ease as the hand arranges the different pieces upon
a chess-board. [...] In the great chess-board of human society, every single
piece has a principle of its own, altogether different from that which the
legislature might chuse to impose upon it."2
References
Mundell, Robert A. (1961): "A Theory of Optimum Currency Areas", American
Economic Review, vol. 51, pgs. 657-665.
Mundell, Robert A. (2012): "Making Europe Work", Lecture at
Columbia University, May 24th, 2012. Forthcoming in the Proceedings of the
"Global Conference on European Economic Governance in a Global
Context".
Schwartz, Pedro (2013): "Why the Euro Failed and How it Will
Survive". Forthcoming, Cato Journal.
Smith, Adam. The Theory of Moral Sentiments. Indianapolis (Liberty
Fund, Inc.), 1984.
Footnotes
1. Robert Mundell. "Making Europe Work." Paper for Global Jean Monnet Conference on "European Economic
Governance in an International Context." November 24-25, 2011. PDF file.
2. Adam Smith. paragraph
VI.II.42, The
Theory of Moral Sentiments. 1790. Library of
Economics and Liberty.
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