A Single European Currency: High Risk, Low Returns
May 7, 1998 – published in St. Paul Pioneer Press
“A man is wise with the wisdom of his time only and ignorant with its ignorance”, Henry David Thoreau wrote. “Observe how the greatest minds yield in some degree to the superstition of their age.”
What is the superstition of our age? Globalization. In its name we are willing to take any risk, no matter how great, to achieve benefits no matter how small.
Consider what happened last weekend. Eleven nations, in an unprecedented political and economic leap of faith, formally adopted a single European currency. A New York Times headline accurately describes the experiment, “The euro: High Wire Without a Net”.
On January 1, 1999, the euro will come into existence. National currencies will begin to disappear. New government bonds will be issued in euros; old ones will be redenominated. Stocks and other financial assets will be redenominated as well. European businesses will keep their books in eros. On January 1, 2002, euro notes and coins will enter general circulation. On July 1, 2002, national currencies will cease to be legal tender within participating countries.
The transition to a single currency is expected to cost as much as half a trillion dollars.
The agreement creates a new European Central Bank(ECB) that is virtually independent of political control by the member states. Its charge is much narrower than the one we give to our own central bank, the Federal Reserve. The Fed is required by law to make policy that promotes multiple goals: “maximum employment, stable prices and moderate long-term interst rates”. The ECB, however, will have only one objective: “to maintain price stability” which Europeans translate into a remarkably low inflation rate of 2 percent or less.
Not only are countries giving up their right to exercise monetary policy. They are also largely renouncing their right to exercise fiscal authority. According to the stabilization pact, countries must keep their annual and cumulative deficits at very low historical levels. If an economic downturn occurs, countries will not be able to increase spending to ameliorate its effects.
The euro locks countries into a one-size-fits-all monetary policy. And there is no escape hatch. Once in, no country is allowed to withdraw. Martin Feldstein, President of the National Bureau of Economic Research, calls it “a marriage made in heaven that must last forever.”
Floyd Norris of the New York Times observes, “In effect, Europe has traded a saucepan for a pressure cooker. The pressure cooker won’t boil over as easily as the old pan. But if pressures ever get too great, the resulting explosion could be catastrophic.”
Such pressures are not hard to envision. It is not unusual for some European countries to experience economic dislocation while others are doing quite well. In the United States when this occurs, people relatively easily relocate. We speak the same language and have a history of nationhood and mutual aid. But Europeans speak different languages and have a long history of mutual suspicion and conflict.
What happens if Italy suffers an economic downturn but the European Central Bank maintains a tight money policy and Italy’s voters elect a government that promises to help right the economy only to discover that it no longer has the tools to do so? Will discontent boil over?
Given the enormity of the outcome, remarkably little public debate has occurred. Indeed, parliaments in Germany, France and Austria have refused to hold referendums on the euro. England, Denmark and Sweden, more responsive to the popular will, are staying out of the new financial setup for the time being.
The euro offers modest benefits. Tourists will no longer have to exchange currencies. However, a European electronic cash card already exists that automatically takes account of the different exchange rates. Cross-border comparison shopping will be easier. But the internet is already effecting that consumer revolution.
No, consumers won’t be the major beneficiaries of the euro. Big business will. The euro will demand more mergers and acquisitions, generating enormous profits for investment bankers. The scale of business will become continental.
On the other side of the ledger looms the prospect of violence. Feldstein worries about the possibility of war if the citizens of one country vote to secede and the European Union tries to stop their exit. Remember, the bloodiest war ever fought by Americans was against each other. The Civil War occurred when member states tried to secede in a dispute about economic policy, and the nation refused to allow them to.
In keeping with the superstitution of our age, most of Europe has voted to leap off a cliff. Now we can only hope that the global economy will allow them to fly.