Was Europe's common currency doomed from the start?
The question nips at the back of the minds of its advocates, both economists and politicians, as they reckon with the crisis of Greece. In the wake of Sunday's rejection of bailout terms, European creditors must decide their next move. Stiff-necked insistence on financial discipline alternates with anguished leanings toward making concessions in this test of the euro's integrity and sustainability.
Was it ever a workable idea to believe that the benefits of a common currency could be shared among independent countries in the absence of fiscal integration? Does a nation's ability to depreciate its own money figure more importantly in its economic performance than the gains from adopting a credible and widely used currency?
Euro critics point out the presumed inherent flaw of the European model versus the monetary union that reigns in the United States by offering an analogy: If Florida's economy were to succumb to a collapsed housing bubble, its seniors would still receive entitlement payments from the federal government. Since the funds for social spending programs are mostly channeled through our federal government budget, Floridians would not have to absorb the entire impact of a devastating economic event through drastic reductions in their income.
It doesn't work the same way in Europe; sovereign nations are expected to take care of their own citizens. Greece's creditors have grown tired of extending loans to finance that nation's budget deficit to provide ongoing pensions to its population. But they would have worked with Greece to resolve its fiscal predicament if its leaders had shown a willingness to cooperate; instead, they were confrontational. So now it appears the nation may be forced to exit the eurozone — and some are encouraging that outcome. Why? Greece would be liberated to reap the advantages of reinstating its own national currency and then promptly devaluing it.
Paul Krugman and Joseph Stiglitz, both Nobel laureates in economics, were urging Greece in recent weeks to shun the demands of those calling for government cost-cutting in Athens. The euro has "trapped Greece in an economic straitjacket" from which it should now be ready to escape, Krugman argued in his New York Times column. In an interview in TIME magazine last month, Stiglitz accused the institutions that bailed out the Greek economy in 2010 — the International Monetary Fund (IMF) the European Commission and the European Central Bank — of having "criminal responsibility" for Greece's economic predicament. They should not only forgive Greece's debt, he argued; they should offer more stimulus money.
Of course, one person's "stimulus" is another person's wasted, out-of-control government spending. And it's not clear why other eurozone members (not to mention non-European IMF member countries) should incur the cost of funding Greece's envisioned comeback when that nation's own government seems so ill-prepared to launch pro-growth structural reforms.
So does that leave Greece with devaluation as its best option? Will it set an example for other weak sisters in the eurozone to abandon the common currency?
To unpack the monetary question from matters of fiscal malfeasance, it's helpful to invoke the views of yet another Nobel laureate in economics, Robert Mundell, who is widely credited with providing the intellectual rationale some five decades ago for the creation of Europe's single currency. In an email interview with Terence Corcoran of Canada's Financial Post in June 2012, Mundell expounded on the challenges it faces:
"The euro is not the problem. The problem within the European Union and the European monetary union is government deficits and the debts of a few countries, mostly in Southern Europe. It is a failure of fiscal discipline that has threatened the solvency of the debt-ridden countries whose high deficits are due in large part to the current recession in Europe and more generally the slowdown of the world economy."
Does the lack of fiscal integration among eurozone participants doom a common currency? "A fiscal union is not a prerequisite for a monetary union," according to Mundell.
The argument that monetary unions require fiscal unions is a recent idea based on new functions of government to give assistance to specific economic groups hit by asymmetric shocks. This kind of specific relief to hard-hit segments would be better carried out at the federal government level, as in the U.S. or Canada, rather than the local level. But it does not require fiscal union in any comprehensive sense."
Drawing lessons from historical monetary unions, Mundell made the observation: "Even after the U.S. consolidated state debts into a national debt in 1792, states were sovereign with respect to debts and deficits. When several defaulted in the 1840s they were not bailed out and nobody imagined that the problem had anything to do with the U.S. monetary union." Bringing the issue into modern times, he asked: "If California is on the verge of insolvency would that be a U.S. dollar problem or a debt-default problem for California?"
Applying these insights to the example cited earlier of a collapsed housing bubble in Florida, one begins to discern a difference between an unanticipated financial calamity — a "shock" — and the steady erosion of creditworthiness through government fiscal irresponsibility, whether at the state or national level. While a certain amount of short-term assistance might be appropriate for financial exigencies, it makes no sense to permanently underwrite bad behavior.
Mundell's comments from that interview three years ago help to clarify, too, the futility of seeking economic salvation through monetary debasement. Expressing dismay at the prospect of Greece exiting the euro — "in my opinion a great disaster for the people of Greece" — in order to devalue a resurrected national currency, Mundell pulled no punches. "Yes, Greece can't devalue without its own currency. But Greece's problem is not an overvalued currency. The problem is an excess of debt and budget deficits. Greek debts are now denominated in euros. If Greece created a new currency in order to devalue, its debts would still be in euros and devaluation would not change that fact."
It is telling, perhaps, that Mundell's renown in the field of political economy also stems from his role as primary architect of the Reagan revolution — the hard-money, low-tax policy mix that broke stagflation in the early 1980s. Europeans would do well to remember the supply-side prescription that did so much to spur economic growth.
Meanwhile, let's hope that California or Florida or Puerto Rico never resorts to issuing its own currency in an attempt to rectify budgetary folly through the false promise of competitive depreciation. If the very notion seems laughable, take a sobering moment to ponder Europe's internal dilemma. And be grateful to our own nation's founders for deciding early on that a common currency would encourage mutually beneficial trade among the independent states and strengthen America's economic future.
Shelton, author of Money Meltdown, is a senior fellow at the Atlas Network and co-director of the Sound Money Project.