The euro: how to make it great.
“With all thy getting, get understanding”
THIS YEAR MARKS the 20th anniversary of the euro’s introduction, and not many champagne bottles have been uncorked in celebration. Since 2008, the EU has been beset by economic crises that have dulled any luster the new currency had.
Too bad. Had Europeans understood the proper principles of monetary policy, the euro would be a resounding success, doing for participating EU countries just what the dollar has done for the U.S.— a common currency that enormously facilitates prosperity-creating investment and commerce. But this extraordinary creation has been bedeviled by profound misunderstandings that could ultimately threaten its very existence.
Many critics moan that the euro has prevented Greece, Portugal, Spain, Ireland and others from using devaluations to help their economies recover from terrible contractions. Still others carp that the euro enabled Germany to rack up big trade surpluses without fear of having to revalue its currency, as previously would have happened. The biggest condemnation has been that the euro is doomed unless the EU has a united financial and banking regulatory system as well as a united fiscal/budgetary system.
These and other negative assessments are off base:
• Prosperity. The euro did make it easier for capital to flow across borders, thereby reducing costs of exchanging individual currencies and hedging against the risks of the currencies’ fluctuating against each other. However, the Continent’s chronic subpar economic performance didn’t improve as much as had been expected because the problems are structural: excessive taxation and regulation, particularly with regard to inflexible labor practices. When Germany made some labor and pension-rule reforms in the early 2000s, the country’s economy markedly improved.
• The euro is a straitjacket. One of the most pernicious myths afflicting current economic policymaking is that devaluations are a great way to boost a troubled economy. Exports suddenly become cheaper, goes this happy talk, thereby ginning up overseas sales. An artificially enlarged money supply will stimulate activity. But the reality is this: No state in history ever devalued its way to strength and prosperity. An unstable currency hurts productive investment and, worse, misdirects capital. Have we forgotten the housing bubble, whose root cause was a cheapening dollar?
Nonetheless, a host of economists lament that countries such as Greece and Italy can’t devalue their currencies since they’re tied to the euro. Everyone should rejoice that this is the case. Otherwise, Greece would have become the EU’s version of Venezuela, and Italy’s lira would resemble Argentina’s chronically shrinking peso. (The state of Illinois is in severe financial straits, but no one talks about it leaving the “U.S. dollar zone” to cope with its woes.)
• The euro can’t work without a single, Europe-wide regulatory and tax/budget arrangement. Nonsense. A country can use any currency it wants. Panama, Ecuador, El Salvador and Timor-Leste (East Timor) directly use the U.S. dollar. Countries such as Costa Rica allow the dollar to be used alongside their own national currencies. The euro is legal tender in Monaco and Vatican City. Numerous nations employ currency boards to rigidly link their money to a hard currency, such as the dollar or the euro. (Under a currency board, the local currency is backed 100% by, say, the dollar.) Hong Kong has done this with the greenback since the early 1980s. Bulgaria has done the same thing with the euro for more than 20 years. Several countries in Africa are pegged to the euro.
Needless to say, in none of these cases are budgets, taxes, government spending and financial regulations coordinated with the U.S. or the EU.
• The euro will eventually fail because it obliges Germany to bail out profligate countries like Greece. No, it won’t, and no, it doesn’t. Back in the 1970s Washington refused to bail out New York City when it was on the verge of bankruptcy, even though they share a common currency.
The euro would do just fine if authorities took to heart the following fundamental but out-of-fashion truths:
• Money is not an instrument for guiding an economy. It isn’t similar to the steering wheel of a car. Attempts to misuse it in this way retard economic progress. Countries with stable,
trustworthy money always do better than those with weak currencies. Always.
Too many times American and European central banks have tried to use monetary policy to overcome structural barriers to growth.
• Money measures value the way a clock measures time. Money works best when it has a fixed value, just as markets work best with fixed weights and measures.
• The best way to achieve a stable, trustworthy currency is to tie it to a fixed weight of gold. Contrary to myth, this no more restricts the size of an economy than the 12 inches in a foot restricts the size of a building a contractor may wish to construct. Four thousand years of experience have proven that a gold standard works better than anything else.
Robert Mundell, the Nobel Prize-winning economist regarded as the euro’s godfather, believed that his conception would lead to a stronger, more prosperous Europe and would become a global alternative to the dollar that would force the authorities of both currencies to pursue sound monetary policies. He never imagined that both would remain in the thrall of funnymoney theorems.