How I was wrong about the euro

This Transitions Online piece is fascinating – as south-eastern Europe has changed, the location of “Europe” or “the West” has swung around all over the place. Once upon a time, Bulgarians and Romanians looked at Yugoslavia as the future, a better version of their own society, and both a reasonable substitute for Germany or Italy and a transit route on the way there. People watched Yugoslav TV illegally. Then, the earthquake, the nightmare. Nobody wanted to be anything like it. People in what had been Yugoslavia looked east, both because there was peace, because that was where the smuggled fuel came from, and also for political support.

Meanwhile, people in the rest of the Balkans looked north at Hungary or south at Greece. Of course, that was because the European Union came to them. Now, well, not so much. If there was ever a time to be eurosceptic, this is the moment. Greeks are quite possibly looking north and wishing they weren’t in the eurozone.

I remember that in the mid-1990s, I was quite sceptical about the single currency for the usual reasons from the left – basically, Keynesian concerns. Having grown up in a succession of recessions, the prospect of joining the Stability & Growth Pact and signing up to the monetarist second pillar of what wasn’t then the ECB didn’t seem great. However, I was (still am) very pro-European on all other issues and eventually I came round to it for not much of a better reason than that it offended the right people. Also, this was the early 2000s and economic policy based on rules seemed to be a pretty good idea. As it happened, of course, when a dose of stimulus was wanted this didn’t keep anyone’s hands out of the medicine chest. Neither did the austerity hold back anyone who was determined to have a monster property boom.

The other big concern was the optimal currency-area problem – could the interest rate be right for the whole eurozone? This is about the most conventional critique of the euro there is. In the UK, it used to be quite a commonplace that the country itself wasn’t an optimal currency area, with the corollary that it therefore didn’t matter so much about the euro. I never quite grasped the logic here, although I admit I may have used the argument. Perhaps the underlying thinking was that there is really no such thing as an optimal currency area – a currency system that was sufficiently decentralised to offer an optimal credit environment in its whole territory would have such high transactions costs it wouldn’t be worthwhile, and therefore we would always have to tolerate some inefficiency due to this effect.

So I was very pro-euro and pro-European while it was a live issue in the UK (about 2003, IIRC – I wonder what happened then?).

What I don’t remember anyone discussing much was the Eurosystem as opposed to the Euro or the ECB – the transactional, flow-of-funds financial workings between the member central banks and the ECB. Nor do I remember anyone talking very much about the fact that the ECB doesn’t have an explicit lender-of-last-resort function. And even discussing whether member states should do anything to manage their trade balances with one another – that was so far out of fashion, of course, that even I didn’t give it any thought.

Of course, this was the bit that bit us.

To put it another way, we argued enormously about the fiscal aspects of the Euro, which turned out to be absurdly easy to fudge when it became necessary to do so. We argued quite a bit about interest rate policy. We hardly even mentioned banking or the issue of money. This is quite a cock-up when you remember we were talking about setting up a new central bank. No wonder west is north and east south.

Is this just my fault? Was there serious discussion of how the Eurosystem might work or not in a financial crisis back in the 90s? Working on my own private black swan theory – apparently unlikely events are both predictable and usually predicted, but they tend to be ones it was unrespectable to predict – somebody must have been.

Also, has anyone else in Britain changed their mind, or is it only me?

13 thoughts on “How I was wrong about the euro

  1. There are a few “I was for the Euro, but how could I have been so foolish” pieces like this knocking around, and they all ignore a couple of big points:

    1. The critical flaw is the *design* of the eurosystem, not the concept of the single currency per se. A single Eurobond would help Greece more than having the Euro has hurt it.

    2. The design flaw has been exposed by an international financial crisis that would have smashed Greece no matter what – perhaps it would have devalued to regain competitiveness, but these days of globalised markets and supply chains that’s nowhere near as good a strategy as it used to be.

  2. It seems to me that many of the problems faced by the euro were entirely predictable from looking at the effects of the earlier currency union that took place on German re-unification.

    The problem was that in the time frame you mention, euro-skepticism of any sort in the UK placed you alongside the likes of John Redwood.

  3. FWIW, I remember some discussion of the Lender of Last Resort issue – I think it must have been at Eurotrib, so probably not until 2004 or so – and I must admit I’m having trouble finding it using Google.

    However, the overall view was that the ECB had all the tools needed to be lender of last resort if needed. Further, that the Franco-German axis might not love southern Europe but leaders understood that in an emergency lending would have to occur.

    What we all missed was:

    1) How completely the European policy apparatus (at both national government level, national bank level, ECB and European Commission) has been captured by neo-liberal, Austrian and neo-classical economics to the point that Keynesian approaches are not even considered worthy of discussion.

    2) How the European spirit would disappear from the leadership of major countries. Or to put another way that we’d end up with pygmies in charge…

  4. Maybe I haven’t the faintest idea what I’m talking about but surely the biggest problem with the Euro is the fact that for a currency to function effectively it requires a single Economic zone – usually a Nation State, and a viable politically accountable management mechanism, called a government?

    Clearly, the Eurozone does not operate in this manner – there is no unified political mechanism in sight and whenever the first sign of stress hoves into view the underlying fracture points, ie. the frontier lines drawn on the map indicating the constituent elements in this bogus quasi political structure, become all too apparent.

    In short the entire European project has been constructed using a fatally flawed geo-political template; the “Europe des Patries” or Europe of Nations model that simply cannot work in the long term – fine when everything in the economic garden is rosy (unemployment stable or slightly falling, fiscal deficits/surpluses in balance, inflation in the one to two percent range etc., etc.) but at the first hint of trouble all the players in the game (sovereign nation states represented by their respective political leaderships) point the finger of blame at their peers and run for the hills!

    So – how to solve the problem (some may ask) and this is where it really gets tricky because the only sustainable solution is summed by one word: FEDERALISM!

    Firstly, unless and until the European Union is founded on something called citizens, rather than Nations, it can never fully succeed or realise its almost limitless potential. Secondly, those very same citizens must be fully engaged in a long overdue process of radical political realignment, whereby certain broad areas of government activity (policy portfolios if you like) are ceded upwards and others are devolved downwards.

    Which areas travel in which direction is for citizens to decide, not politicians but eventually you end up with a Federal central administration, direcly elected directly by and accountable to a European electorate, managing certain tasks (the Euro being a blindingly obvious candidate) and a more localised (Regional?) and immediate administration doing more or less all the rest. You then write all of this important stuff down so everyone knows who does what, why, when and crucially how, ie. funding wise. You call this document; A CONSTITUTION!

    If you don’t like what they’re doing (at either level), vote ‘em out next time round – sounds simple really but there is something rather awkward standing in the way of this rather bleedin’ obvious solution – it’s called Nationalism, and right now it’s raising its ugly head just in time for a bunch of shady political opportunists to exploit for their own short term gain?

  5. You’re basically right, Alex, as far as I can see. There was a recent Irish Times article that phrased it something like “we had a prudent central bank for the entire existence of the state, and no-one anticipated that joining the euro would put an end to that.”

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  7. About the optimal currency area … the UK argument can be used both ways I guess, as can the argument about German reunification as made by chris above. Though especially to the reunification argument: Weak. This was not really a currency union in any way, it was more like annexation and then obviously new currency. If you would spin this further you could also ask why all the US states have the same currency, after all great differences in all kinds of matters exist between them.

  8. Yes – it’s weak. Though on the other hand it was the only other analogue we have of something similar that happened in the European Union.

    To the extent that France and Germany drove the industrial and financial policies around the euro, it is significant that the one time Germany tried to make this work on it’s own it wasn’t able to get it to work.

    ALl the same elements were there – a state going into a union at too high an exchange rate – radical disparities in relative economic development, etc.

    That this didn’t work even with a common language and a political union, should have been a danger sign.

  9. Yes, I know what you mean but I precisely don’t think some of the (economic?) elements being there makes it comparable enough. Because of the same language, political union/ethnicity. Also maybe it would help if you explained what you mean with ‘didn’t work’ after all it’s not like east Germany switched back to another currency or ‘got out’.

  10. Though especially to the reunification argument: Weak. This was not really a currency union in any way, it was more like annexation and then obviously new currency.

    You may notice that Germany made enormous transfer payments to the new states.

    If you would spin this further you could also ask why all the US states have the same currency, after all great differences in all kinds of matters exist between them.

    1. The US federal government’s budget is an order of magnitude larger than the EU budget.

    2. All US states have a common language.
    I have the legal right to move to and work in Budapest. Unfortunately I cannot learn Hungarian by legislative act. A common labor market needs a common language.

  11. By ‘didn’t work’, I meant that despite massive fiscal transfers, large parts of East Germany ended up in long term depression.

    And the East Germans did indeed get out – anyone who could migrated to the West.

    In the case of the euro, the fiscal transfers just weren’t there – and in any case it wasn’t like the Greeks could all move north when their economy collapsed.

  12. I discussed half of that -the lender of last resort issue- with friends of mine and with my brother at the end of the 90s. I also argued that there is no such thing as Germany, virtually alone, pulling half of Europe towards stable money. If you combine many countries with unstable finances and two or three with stable finances and unless the minority that managed to have financial stability gets to have authority over the majority, you’ll get: unstable finances. But I hedged my fortunes. If the Euro goes bust between 2010 and 2030 following any financial crisis, I’ll at least get some crates of beer.