?End the Euro?

Conclusion

The institutional setup of the EMU has been an economic disaster. The Euro is a political project; political interests have brought the European currency forward on its grievous way and have been clashing over it as a result. And economic arguments launched to disguise the true agenda behind the Euro have failed to convince the general population of its advantages.

The Euro has succeeded in serving as a vehicle for centralization in Europe and for the French government's goal of establishing a European Empire under its control—curbing the influence of the German state. Monetary policy was the political means toward political union. Proponents of a socialist Europe saw the Euro as their trump against the defense of a classical liberal Europe that had been expanding in power and influence ever since the Berlin Wall came down. The single currency was seen as a step toward political integration and centralization. The logic of interventions propelled the Eurosystem toward a political unification under a central state in Brussels. As national states are abolished, the market place of Europe becomes a new soviet union.

Could the central state save political elites all over Europe? By merging monetarily with financially stronger governments, they were able to retain their power and the confidence of the markets. Financially stronger governments opposed to abrupt changes and recessions were forced help out. The alternative was too grim.

Mediterranean countries and particular the French government had another interest in the introduction of the Euro. The Bundesbank had traditionally pursued a sounder monetary policy than other central banks, and had served as an embarrassing standard of comparison and indirectly-dictated monetary policy in Europe. If a central bank did not follow the Bundesbank’s restrictive policy, its currency would have to devalue and realign. Some French politicians regarded the influence of the Bundesbank as an unjustified and unacceptable power in the control of the militarily defeated Germany.

French politicians wanted to create a common central bank to control the German influence They envisioned a central bank that would cooperate in the political goals. The purchase of Greek government bonds from French banks by an ECB led by Trichet is the outcome—and a sign of the strategy's victory.

The German government gave in for several reasons. The single currency was seen by many as the price for reunification The German ruling class benefited from the stabilization of the financial and sovereign system. The harmonization of technological and social standards that came with European integration was a benefit to technologically advanced German companies and their socially cared-for workers. German exporters benefited from a currency that was weaker than the Deutschemark would have been. But German consumers lost out. Before the introduction of the Euro, a less inflationary Deutschemark, increases in productivity, and exports had caused the Deutschemark to appreciate against other countries aer WWII. Imports and vacations became less expensive, raising the standard of living of most Germans.

Sometimes it is argued that a single currency cannot work across countries with different institutions and ways. It is true that the fiscal and industrial structures of EMU countries vary greatly. They have experienced different rates of price inflation in the past. Productivity, competitiveness, standards of living, and market flexibility differ. But these differences must not hinder the functioning of a single currency. In fact, there are very different structures within countries such as Germany, as well. Rural Bavaria is quite different in its structure from coastal Bremen. Even within cities or households, individuals are quite heterogeneous in their use of the same currency.

Moreover, under the gold standard, countries worldwide enjoyed a single currency. Goods traded internationally between rich and poor countries. The gold standard did not break down because participating countries had different structures. It was destroyed by governments who wanted to get rid of binding, golden chains and increase their own spending.

The Euro is not a failure because participating countries have different structures, but rather because it allows for redistribution in favor of countries whose banking systems and governments inflate the money supply faster than others. By deficit spending and printing government bonds, governments can indirectly create money. Government bonds are bought by the banking system. The ECB accepts the bonds as collateral for new loans. Governments convert bonds into new money. Countries that have higher deficits than others can maintain trade deficits and buy goods from exporting states with more balanced budgets.

The process resembles a tragedy of the commons. A country benefits from the redistribution process if it inflates faster than other countries do, i.e., if it has higher deficits than others. The incentives create a race to the printing press. The SGP has been found impotent to completely eliminate this race; the Euro system tends toward self explosion.

Government deficits cause a continuous loss in competitiveness of the deficit countries. Countries such as Greece can afford a welfare state, public employees, and unemployment at a higher standard of living than would have been possible without such high deficits The deficit countries can import more goods than it exports, paying the difference partly with newly printed government bonds. Before the introduction of the Euro, these countries devalued their currencies from time to time in order to regain competitiveness. Now they do not need to devalue because government spending takes care of resulting problems. Overconsumption spurred by reduced interest rates and nominal wage increases pushed for by labor unions increases the competitive disadvantage.

The system ran into trouble when the financial crisis accelerated deficit spending. The resulting sovereign debt crisis in Europe brings with it a centralization of power. The European commission assumes more control over government spending and the ECB assumes powers such as the purchase of government bonds.

We have reached what may be called transfer union III. Transfer union I is direct redistribution via monetary payments managed by Brussels. Transfer union II is monetary redistribution channeled through the ECB lending operations. Transfer union III brings out direct purchases of government bonds and bailout guarantees for over-indebted governments.

What will the future bring for a system whose incentives destine it for self-destruction?

The system may break up. A country might exit the EMU because it becomes advantageous to devalue its currency and default on its obligations. The government may simply not be willing to reduce government spending and remain in the EMU. Other countries may levy sanctions on a deficit country or stop to support it.

Alternatively, a sounder government such as Germany may decide to exit the EMU and return to the Deutschemark German trade surpluses and less inflationary policy would likely lead to an appreciation of the new Deutschemark The appreciation would allow for cheaper imports, vacations and investments abroad, and increased standard of living. The Euro might lose credibility and collapse. While this option is imaginable, the political will—for now—is still to stick by the Euro project.

The SGP will be reformed and finally enforced. Harsh and automatic penalties are enacted if the three percent limit is infringed upon. Penalties may consist in a suspension of voting rights and EU subsidies, or in outright payments. But there are incentives for politicians to exceed the limit, making this scenario quite unlikely. The members of the EMU are still sovereign states, and the political class may not want to impose such harsh limits that limit their power.

Incentives toward having higher deficits than the other countries will lead to a pronounced transfer union. Richer states pay to the poorer to cover deficits, and the ECB monetizes government debts. This development may lead to protests of richer countries and ultimately to their exit, as mentioned above. Another possible end of the transfer union is hyperinflation caused by a run on the printing press. In the current crisis, governments seem to be hovering between options two and three. Which scenario will play out in the end is anyone's guess.