The euro turns twenty this year. The anniversary is not a happy one. Europe’s common currency has turned out to be a source of both political disruption and economic misery. Indeed, it has the distinction of being one of Europe’s most costly mistakes. In recounting in detail its trajectory over fifty years, from the first serious proposals for a common currency in the late 1960s through its operation through the end of 2017, the aptly-titled, clearly written, and highly informative EuroTragedy: A Drama in Nine Acts by Ashoka Mody, a former official of the International Monetary fund, illuminates the euro’s flawed origins, the counterproductive way that Europe’s political and economic leaders have managed it, and its dismal prospects for the future.
A geographic entity of any size will have economic differences within it. Some sections will prosper while others falter. With its own currency, a government has two instruments for helping the laggards: an interest rate that it can lower to stimulate economic activity; and an exchange rate with other currencies that it can reduce to promote exports. Of course, the 50 American states lack their own separate currencies, but the United States qualifies as what economists call an “optimal currency area” because the federal government has other ways of assisting economically distressed states and regions. It can redistribute money from booming to lagging places through unemployment insurance and other programs; and Americans can and do move from parts of the country where jobs are scarce and wages low to other, economically more promising areas.
These compensatory mechanisms operate because the United States is a sovereign state, with the power to collect taxes and distribute benefits. From this a clear lesson follows: In order to work smoothly, in order to moderate politically toxic economic inequality between and among different regions within it, a currency union requires a political union. An effective currency, that is, requires a state, and the Werner Report of 1970, an early, serious, official study of currency union in Europe, said so explicitly.
The euro, however, conspicuously lacks a state. There is no United States of Europe. Without a state to operate it, the euro was doomed from the start. The troubles it created were predictable, and indeed prominent economists did predict them. Moreover, history as well as logic argued against it. In the course of the twentieth century, various efforts to fix exchange rates, beginning with the gold standard inherited from the nineteenth century, had ended in failure. The world had increasingly moved toward making exchange rates flexible. Yet the governments of Europe went ahead with an inflexible common currency nonetheless.
In response to the criticisms the idea of a common currency attracted, its proponents put forward two scenarios that they said would solve its inherent problems. Both turned out to be examples of wishful thinking.
The euro would, they said, serve as an “anchor,” compelling its poorer members to adopt economic policies that would raise them to the economic levels of the rich. Differences in regional and national economic conditions would disappear as economic performances across what became known as the eurozone converged. In fact, the precisely the opposite took place: The differences became greater rather than smaller.
The euro’s champions also foresaw a process of “falling forward” in Europe, whereby the operation of the common currency, especially as it encountered divergent economic conditions, would inspire increasing political cooperation and solidarity, forging an ever-closer political union to assure its effective working. This, too, failed to occur. As economic difficulties mounted, the countries of the European continent became less inclined to fulfill the requirement for a successful currency: sharing sovereignty.
While the proponents’ rosy scenarios could conceivably have come to pass, such outcomes were never certain. At best, therefore, the euro was a risky experiment. Why were Europe’s political leaders determined to take such a chance?
They were in the grip of a powerful idea. The process of European integration, which had begun after World War II and proceeded for the next four decades, had achieved an almost sacred status with them. The continent had left behind its awful history in the first half of the twentieth century, with its two world wars and Great Depression, and become peaceful and prosperous. To retain and build on those achievements the governments of Europe had to push integration ever farther, or so the continent’s political elites believed. A common currency had become, by the late 1990s, the next logical step in the process. Still, even that conviction, deeply and widely held though it was, could not have established the euro without the active support of the EU’s two most important countries, France and Germany.
The French embraced the idea of a common currency as part of their perpetual quest for parity with their enemy-turned-partner and more prosperous neighbor Germany. French leaders experienced devaluations of the French franc against the German deutschmark as national humiliations and believed, wrongly, that submerging the two currencies into a single one would restore economic and political parity between the two countries that issued them. They also assumed, or at least hoped—again wrongly as it turned out—that they would control the management of the new currency and would be able to manipulate it to France’s advantage.
The Germans had little enthusiasm for a common currency—with one exception, which, however, proved decisive. Helmut Kohl, the country’s chancellor from 1982 to 1998, developed a personal passion for the project and managed to make the political momentum for the euro irreversible by the time he left office, shortly before it was launched. (Mody disputes the notion that Kohl agreed to it as a quid pro quo for French and European acceptance of German unification.)
To overcome the skepticism of his countrymen Kohl pledged that German taxpayers would never have to contribute any of their own money to the operation of the common currency. This was perhaps a politically necessary promise but also a foolish one, since a certain measure of economic redistribution from the affluent to the impoverished, as occurs in the United States, is a basic condition for the smooth functioning of any currency.
Germany also insisted on rigid rules to govern the economic policies of the euro’s members, notably a three percent limit on annual budget deficits. These rules, which were not what the French had had in mind, further restricted the leeway of governments of the eurozone to cope with economic downturns. As a vehicle for expanding political harmony and economic prosperity in Europe, therefore, the euro was set up to fail; and fail it did.
The Greek Crisis
The most conspicuous failure came in response to the Greek financial crisis that started in late 2009 and has still not ended. Greece should not have joined the euro in the first place. Its government obfuscated its economic statistics in order to gain entry and the other European governments, wanting as large a eurozone as possible, chose to accept them at face value.
Greek membership in the euro helped to create a bubble in its own government-issued bonds. Investors at first considered them perfectly safe by virtue of this membership and bought them in large volume. Then, as happens with financial bubbles, the market changed its mind and Greece’s borrowing costs rose sharply, threatening its financial system. Had Greece not joined the euro the other countries in it might have been content to leave the Greeks to their financial fate, or to turn the problem over to the International Monetary Fund. Without the euro, that is, there might have been no Greek crisis, or at least not as serious a crisis nor one in which the other Europeans became so deeply involved. Since it did share their currency, however, the other members of the eurozone concluded that they had to take responsibility for rescuing Greece.
The history of financial crises has yielded a formula for addressing them: the restructuring of the debt of essentially insolvent countries such as Greece; financial assistance in the form of loans; and some changes in the distressed country’s economic policies and institutions that bring economic losses in the short run but position it for recovery over the longer term. Above all, the lessons of history teach, the rescue must be launched at the first sign of serious trouble in order to minimize the economic damage that such crises inevitably cause. The Japanese government’s dithering in addressing its financial problems in the 1990s had, it was clear in retrospect, only served to increase Japan’s economic losses.
The European response to the Greek crisis was led by the German chancellor at the time, Angela Merkel—not because she sought the role or because Germans were comfortable with it, but because, since it has the largest economy in the eurozone, no initiative could proceed without Germany’s participation. In their response, Merkel, the European Central Bank (ECB) that had been established to manage the euro, and the other European leaders got everything wrong.
Instead of acting promptly, they delayed, hoping that Greece’s problems would somehow resolve themselves. When they did act they preemptively ruled out debt restructuring. Mrs. Merkel, in particular, seemed to fear that effectively forgiving any of the Greek debt would enrage German voters by violating Helmut Kohl’s promise that they would have to pay nothing for the euro; and indeed, throughout the crisis the German public evinced little or no sympathy for the travails of their Greek fellow Europeans. Instead, Europe’s political leaders and economic authorities insisted that Greece incur more debt in order to avoid default; and in order to receive the new loans the Greeks had to undertake harsh economic measures at home, which caused their incomes to fall and unemployment to rise.
Rather than reviving the Greek economy, the austerity program that Europe prescribed made matters worse. The new loans, combined with falling national income, worsened the ratio between the country’s debt and its GDP. Total debt ballooned to the point that no serious analyst believed Greece could ever fully repay it.
Outraged at its increasingly harsh economic circumstances, the Greek public on several occasions voted for a change of direction in economic policy; but the authorities in Brussels and Berlin, who, because they controlled the flow of funds to Athens, had effective control over the Greek economy, refused to countenance such a thing. The Greek crisis thus marked not only a low point in European economic policymaking but also an unhappy chapter in the history of European democracy.
The Italian Danger
While Greece experienced the worst losses as a result of membership in the eurozone, other countries fared poorly as well. Between 2007 and 2013 Europe was mired in an economic slump dramatically worsened by the near-collapse of the American financial system in the fall of 2008. The American central bank, the Federal Reserve, adopted swift, decisive measures to fight the recession. It sharply lowered interest rates and even went so far as to buy bonds directly, through a program known as Quantitative Easing, which further encouraged the borrowing and spending necessary to revive economic activity. The European Central Bank at first declined to take such measures, then implemented them in a far more modest way than had the Federal Reserve. As a result, a recession of American origins did more economic damage to Europe than to the United States.
The countries of southern Europe incurred the greatest damage. Not only Greece but also Portugal, Spain, and Italy suffered from their membership in the single currency because their economic fortunes required lower interest rates than the ECB was willing to provide. Of the four, Italy posed the most serious threat to European prosperity.
To be sure, its economic problems did not begin with the establishment of the euro. Well before then the country was experiencing economic stagnation, the result of a lack of growth in productivity, substandard educational achievement, underinvestment in research and development, and its own particular culture of political corruption. (Readers interested in the peculiar, economically stifling nexus between Italian government and business can find a compelling description of it in the mystery novels of Michael Dibdin, whose protagonist, the Rome-based Venetian policeman Aurelio Zen, encounters it all over the country.) Before joining the euro Italian governments were able to bolster the country’s exports by periodic devaluations of the national currency, the lira. After entering the eurozone this became, of course, impossible.
Its combination of low growth, a very high public debt in relation to GDP, a large and precarious banking sector, and, since 2018, a populist government strongly inclined to ignore the strictures of economic orthodoxy, make Italy vulnerable to the kind of financial crisis that struck Greece. Since it has, after Germany and France, the third largest economy in the eurozone, the rest of Europe could not afford to ignore an Italian crisis. Because of Italy’s size, however, the Europeans might also not be able to supply the resources necessary to ward off disaster. In a crisis Italy might prove to be too big to save, with adverse consequences for Europe, and indeed the whole world, that would dwarf the damage that Greece’s problems have caused.
Europe would be better off today if it had never established a common currency. Having established it, however, the members of the eurozone are stuck with it, with all its flaws. They can neither fix it nor abandon it: Neither option is politically feasible.
They could in theory fix it by moving forward to what a currency requires—a political union. If the countries of Europe were unwilling to surrender important sovereign prerogatives when the euro was launched, however, they are even less willing to do so now. The Northerners will resist incurring an obligation to spend money to support what they consider the economically feckless countries of the South. The Southerners want less not more Northern control over their economic policies. Far from “falling forward” toward political integration, during the life of the euro the members of the eurozone have fallen—or fled—backward.
Or, the weak economies of Europe’s south could give up the euro, either voluntarily or by being thrown out. In that case, however, their new national currencies would plummet in value, making it difficult in the extreme to repay their largely euro-denominated debts. Their financial systems would be vulnerable to collapse and if one country defaulted on its debts, global markets would attack others encumbered with similar economic problems. The result could be the kind of economic damage that an Italian financial crisis has the potential to inflict, something that all the countries of the euro, no matter how unhappy they are with it, will seek to avoid.
Mody suggests, in passing, a possible solution to the problems that the twenty-year-old common currency has brought to Europe: Germany could abandon the euro, and perhaps create another multinational currency, but this one including only countries with strong economies—Finland and the Netherlands, for example—in addition to Germany. The remaining, Southern-dominated euro would be weak, which would help its member countries. The fugitives from the euro would form a strong new currency and would have no difficulty in settling euro-denominated obligations.
If for no other reason than that the euro has worked well for the countries that would leave under this scenario, no such exodus is imminent. Perhaps it will come to pass one day but, in early 2019, Europe’s common currency, with its malign economic consequences, remains a tragedy that has yet to reach its final act.