How the Euro is Destroying the EU

Europe is currently in the throes its most recent crisis, that of the inundation of refugees. This has caused the EU economic crises to quickly fade from view. With another ephemeral deal agreed to in Greece this year, some might even think that the problem is solved. Unfortunately the problem is not solved. It will not be solved in fact, until there is a radical shift in the institutional underpinnings of the EU Monetary Union (EMU, or the Euro currency). There are two options, either the EU is going to emerge into a mega-state with a fiscal union, or the Euro will need to disappear.

The first question to address is why is there a Euro? Where did it come from? It would make sense for there to be an economic rationale behind the introduction of the single currency. In fact, economics had almost nothing to do with it. The idea was to begin the process of establishing a federal states of Europe by creating greater convergence within the EU. Along with creating a Schengen area of free movement, and allowing EU citizens to work anywhere in the EU, sharing a common currency was meant to pave the way for a common European identity that would lead to greater political integration. There are of course some economic arguments for a monetary union. Primary among them is that it decreases transaction costs between countries, which should boost trade and prosperity. Joining a monetary union however eliminates the ability for flexible exchange rates to adjust to external shocks. To rephrase the above, due to the economic jargon: it is a lot easier to trade things and invest in other EU countries when everyone is using the same currency. This is good. However, if a negative economic event effects some countries and not others, the ability to devalue a currency and pursue monetary policy which ameliorates employment is lost. This is bad.

On balance however the argument for the EU is clear, a monetary union does not make sense. A monetary union is good when there is a strong central state which can increase spending to areas effected by economic malaise, and there are few impediments to capital and labour flow. The European Commission in Brussels spends a fraction of what member-state governments do. Labour and capital though supposedly freely moving within the EU face onerous restrictions, such as differing languages among EU countries and divergent industrial and employment laws. I am far from the first to notice the unsuitability of the EU for a common monetary union. Milton Friedman, on the eve of the adoption of the Euro, wrote a prescient article on the devastating impact of a common monetary union. As Mr. Friedman said in words that I would not dare try to improve on “The aim has been to link Germany and France so closely as to make a future European war impossible, and to set the stage for a federal United States of Europe. I believe that adoption of the Euro would have the opposite effect. It would exacerbate political tensions by converting divergent shocks that could have been readily accommodated by exchange rate changes into divisive political issues. Political unity can pave the way for monetary unity. Monetary unity imposed under unfavorable conditions will prove a barrier to the achievement of political unity.”

This is not simply a pedantic argument on the benefits of monetary union in the EU, there are real consequences to this policy. Discussions about the Euro-zone’s current economic turmoil mischaracterize it as simply a debt crisis. This is an obscenely myopic view of the situation. One problem is that the EU has a severe internal trade balance. Germany in particular exports far more to the EU than EU countries export to it. This has happened at least partially because Germany has actively engaged in a policy of wage suppression. In a normal situation, the benefits of keeping wages low would be short lived, as the currency would adjust due to those aforementioned exchange rates. In the absence of this, the Euro is advantaging the German policy of excessive exports, while weak demand at home is preventing struggling Euro-zone countries from selling their products in Germany. Without rectifying this situation, the Euro-zone periphery will never recover. Once again, this is an oft overlooked institutional problem that would not exist without a Euro. With no Euro, Germany’s wage suppression policy would not hurt other Euro-zone members. There is meant to be a mechanism in Brussels for addressing excessive macroeconomic imbalances, of which this is an acute case. If the concern was largely economic and technocratic, as is usually portrayed, this imbalance would be a top priority. It isn’t however, and Germany’s political clout make any action on this inconceivable. This once again shows the relative irrelevance of the European Commission in Brussels compared to certain member states, and yet another reason why the Euro is not working.

The remedy that has largely been chosen for Europe’s crisis economies is to slash spending and supress wages (called structural reforms) in order to increase competitiveness. Increasing labour competitiveness would be much more effective with the ability to devalue a currency however. This is the beauty of exchange rates, they compensate for differing economic realities across countries. Unfortunately, with the current situation of a single currency and Germany’s low-wage labour competitiveness, it is almost impossible for structural reforms to work in Europe's periphery. In addition, without the Euro, national central banks would be able to set the interest rate appropriate for their respective countries. Greece desperately needs to get out of a deflationary spiral. Deflation is probably the worst macroeconomic outcome, it increases debt burdens (including of Greece’s sovereign debt), and makes people less likely to spend (because prices will be lower in the future). This would be the perfect time to lower interest rates, and spur inflation. However, in the usual refrain, with a monetary union this is impossible. The EU as a whole is less in need of a rate cut, without the deflationary pressures Greece is facing, and thus Greece will suffer.

Fundamentally the structure that undergirds the entire Euro-zone is unsustainable. Few would say that the monetary union has been successful. In fact, it has been an abject failure. Growth is anemic, unemployment is at stunning levels, and perhaps more tragically, the political project it was meant to propel seems destined to collapse. One of the main arguments for staying in the Euro now is the catastrophic consequences of leaving it, this is not exactly a ringing endorsement of the single currency’s success. In the most extreme case of Greece, this argument does not even hold. Greece has already faced the effects of a financial crisis and bank runs. With these costs already paid, it would at least be worth reaping the benefits of leaving the monetary union.

Friedman, and so many others were right. The Euro has created schisms in the EU that have endangered the entire European project, all because of the erroneous assumptions some European elites made. They knew that the EU was not ready for a deep political union and in its stead a monetary one was created. Now, much less than catalyzing a stronger and closer union, the Euro has simply led to political acrimony. This is the underlying and important story of the Euro-zone economic crisis. Debt, competitiveness, and bailouts are all elements of this story. But ultimately, the EMU structure belies much of the grief that has been endured in Europe. The only long-term solution is an end to the euro-zone, or the transition to what would essentially be one country. With neither of these options on the horizon, all that remains is more despair.