Published May 10, 2012
Europe’s single currency is a bust. With unemployment reaching depression levels in the Mediterranean states, time has long passed to negotiate an orderly return to national currencies.
Euro advocates argue a single currency is essential for creating a unified continental economy, and the euro is falling short of expectations, because monetary union was initiated without fiscal union—namely, sovereign taxing and spending authority for Brussels. Those arguments are little more than polemics from politicians, public servants and pundits who have staked their reputations and careers on a failed economic idea.
Prior to the euro, Europe already enjoyed tariff free trade, common product standards, and reasonably free migration of labor and capital. By Treaty of Rome, Brussels has constitutional primacy in antitrust enforcement, called competition policy across the pond. That permits the EU bureaucracy and courts to nix business practices and national government policies than may frustrate cross-border trade, much as the Commerce Clause empowers federal anti-trust authorities and courts in the United States.
Prior to the euro, a European Currency Unit, defined by a basket of major currencies that could adjust in value to accommodate changing competitive conditions, provided multinational businesses with a single monetary unit. Businesses could obtain checking accounts in the ECU, as well as dollars, to conduct pan European commerce.
After the introduction of the euro in 1999, productivity growth was slower and prices rose faster in southern Europe than in Germany and other northern states. Consequently, the more competitive north enjoyed growing trade surpluses and the Mediterranean states endured deficits. Trade deficits can instigate unemployment, and to create jobs and finance social programs, many Eurozone governments borrowed too much.
The absence of Euro Zone federal government, which could tax strong economies to subsidize pensions, health care and other services in Greece and elsewhere, made matters worse, but it was not determinative.
Without the ability to devalue a national currency to make their economies again competitive, Spain, Greece, Italy and Portugal must either endure, for many years, depression level unemployment to adequately push down wages and prices, or receive, for many years, huge transfers of cash from Germany and other northern states. Popular support could never be sustained for governments to remain faithful to either path.
Government overspending did not create the mess in every troubled EU state. In Ireland and Spain, overextended banks that collapsed in the wake of the U.S. financial crisis brought down national finances.
During the 2000s, Spain enjoyed a boom in tourism and home construction, as richer northern Europeans sought vacations and second homes in its warm climate. Robust construction and property values provided Madrid with taxes revenues, and unlike Rome and Athens, it enjoyed persistent budget surpluses.
Foreigners invested in Spanish bank securities, and the latter financed a hotel and housing boom. In the wake of the global financial crisis, loans defaulted and Spain’s banks nearly failed. Unlike the Federal Reserve, Spain’s central bank could not print money to mop up the bad loans. Hence, Spain’s national government had to borrow euro in international bond markets to save its banks.
With property values collapsing and tourism flagging, international investors lost confidence in Spain’s sovereign debt, and now Madrid must impose wrenching austerity and endure 25 percent unemployment to placate creditors.
European fiscal union won’t have helped Spain. Madrid would still have had to borrow and cut other spending to bail out its banks, and a similar story can be told for Ireland.
Iceland, which suffered a similar fate, has its own currency and is recovering much better than Spain or Ireland.
In the United States, fiscal union does not solve all problems either—unemployment is much higher and fiscal challenges more difficult in some states than others. However, workers are much more mobile than in Europe, because the United States has a common language and more a homogeneous educational system across the states.
A common culture and language is not something a Eurocrat can design or treaty divine. Either a common currency makes sense at first sight, or all the stitching in time won’t make it right.
Peter Morici is an economist and professor at the Smith School of Business, University of Maryland. Follow him on Twitter@pmorici1.