The fundamental problem with the euro is that you cannot have monetary integration without fiscal integration – especially in a region with spending and thrift habits as diverse as those of Germany and Greece.
The incongruity would break the system down eventually. For this reason, the euro was destined to flounder, with its demise written into its DNA.
Its difficulties over the last few years should not be seen as stemming from either the failure of one or two governments to spend within their means or the failure of others to warn them of the dangers of not doing so.
That is to say, the euro’s troubles are not the result of a historical accident that could have been prevented if a few actors involved had made different decisions – more responsible ones – in the course of its implementation.
Instead, it was a historical inevitability that was waiting to happen. If things had not come to a head in 2010 or 2011, they would have come to a head in another year, with another set of circumstances.
I am not convinced, therefore, that the euro can be saved, at least not in its present form, with all 17 countries remaining in the fold.
From the inception of the euro project, clear-eyed and well-respected economists, including the likes of Harvard Professor Martin Feldstein, had been sounding alarm bells about its inherent paradoxes.
The British did not join because they did not see it working. They were not convinced about the benefits and were fully cognisant of the dangers.
However, the governments which joined the euro zone in 1999, as well as the populations that elected them, while eager to move on the single currency, were not prepared to accept fiscal integration because of the loss of sovereignty that it obviously implied.
In the end, their choice to go ahead with the euro anyway reflected a misplaced belief that Europe was somehow special enough to overcome the contradictions. It was a political decision.
In the United States, one currency can work for 50 states because you have one Federal Reserve and one Treasurer.
When one state runs into economic hardship, it receives generous transfers from the centre in the form of social spending on individuals living in that state and government projects.
The federal taxes raised in that state will not be sufficient to pay for the federal spending disbursed to that state.
If one were to keep accounts, that state might be running deficits for years – but it is a sustainable situation precisely because nobody is keeping accounts.
The people living in that state are considered fellow Americans and the people living elsewhere do not actually expect the money to be repaid. It is effectively a gift.
The other extreme works too, of course – that is, Europe under a pre-euro system, with each country having its own finance minister and managing its own currency.
Under that system, when one country experiences a slowdown, it can roll out remedial monetary policies because it is free from the shackles of a common currency.
These include expanding the supply of money – what the Americans call “quantitative easing” – and devaluing the currency to make the country’s exports more attractive.
But these were tools that the euro zone countries gave up as a result of their entry into a common monetary community.
They did so, furthermore, without ensuring that there would be budgetary transfers similar in type and magnitude to those that depressed states in the US receive.
What do you get, then, when a motley crowd tries to march to a single drummer? You get the euro zone.
Some countries surged ahead while others struggled to keep pace.
In countries that fell behind economically, governments were under electoral pressure to maintain or even increase public spending, even though tax receipts decreased.
Budget deficits had to be financed through loans from the money markets. That these loans could be obtained at relatively low rates – since they were made in euros, not, say, drachmas – did nothing to discourage the profligacy.
The Greeks eventually became the most extreme example of this decline, going further and further into the red.
To be fair, the community as a whole also has to bear some responsibility, since there were rules under the Stability and Growth Pact that allowed for sanctions on governments that ran repeated deficits. But these sanctions were never imposed on any country.
For some time, experts with boundless optimism hoped that these governments could close the competitive gap with stronger nations like Germany by cutting welfare programmes, reforming tax collection, liberalising labour market rules or making their people work longer. But it did not happen.
The situation finally began to unravel with the global financial crisis of 2008.
Easy credit dried up and the markets’ falling confidence in the credit-worthiness of governments like Greece’s caused their borrowing rates to soar.
Germany and the European Central Bank were forced to intervene with bailouts to stop the debt crisis from spreading throughout the already crestfallen euro zone.
As at June 2013, the euro community has avoided catastrophe by throwing enough money at the problem.
But the 17 governments need to face up to the more difficult question of what to do to address the fundamental contradiction in the euro project – monetary integration without fiscal integration.
They might try to postpone this for some time, but they know they cannot do so indefinitely or history will repeat itself and another crisis will come along, requiring bigger bailouts, which, if push comes to shove, the Germans will probably have to underwrite.
Prompt action is far better than procrastination, especially since further down the road, as memory of the pain and panic of the debt crisis fades in the minds of voters, the political will to act decisively is also likely to wilt.
By The Straits Times Published on Aug 11, 2013