The Euro: one of the biggest economic catastrophes in monetary history?

The euro promised a brighter future. That hasn't happened.



For the Nobel Prize winning economist, Paul Krugman, the euro is one of the greatest catastrophes of economic history (New York Times, August 2014).



In 1997, Nobel economics prize-winner Milton Friedman had  predicted that the absence of political unity would be exacerbated by a single currency. Sadly, he was probably near the truth.



At the risk of shocking a number of readers, I believe that Krugman is partly correct despite the fact that we will stay in the Eurozone because our currency simply cannot remove itself. The euro will survive, unless major political shocks occur. But there are undeniable flaws in the currency's design and they will make things worse. There may be bad times ahead.



The euro does not qualify as a so-called “optimal currency area” characterised by the mobility of factors of production, industrial specialisation and adequate services.



It is strictly the outcome of a political decision spurred by German reunification. Germany ended up footing the bill for a reunification that cost it its monetary sovereignty. The argument that the euro guaranteed peace in Europe was a deliberate ploy. An ageing Europe was at peace and equipped with nuclear weapons. Germany was and still is demilitarised. Any wars were on the periphery of Europe. The euro was not built on the foundation of any fiscal or budgetary union as each country kept its own sovereignty.



Worse still, the euro produced a windfall gain that meant Germany no longer had to revalue the Deutschmark, while the Southern European countries saw their interest rates nosedive giving them the impression of borrowing in Deutschmarks.

The sole political response to the crisis was austerity. This led to a spiralling recession in Southern Europe before deflation set in due to the ill-timed monetary policy pursued by the European Central Bank.



Policy errors have been heaped on policy errors, despite condemnations by reputable economists. Those errors have been similar to the mistake made by Churchill when he tied Sterling to gold again in the intolerable conditions of 1925, the mistake of the austerity programmes following the 1929 crisis, and the mistake of the gold standard bloc's creation, reminiscent of the euro zone, in 1933, etc.



What's more, the facts are unavoidable:  Eurozone GDP since the start of the crisis is lower than it was, for a similar number of years, during Japan's deflation and the revaluations of the pound sterling and the gold bloc.



Two risks appear underestimated in my view.



The first is monetary. The single currency was adopted without first preparing the Eurozone to become an optimal currency area characterised by harmonised fiscal policies and labour market mobility.



The second is political. The euro is no longer a socially unifying project, even becoming a source of profound social resentment in the Southern European countries. In the past, social risks of this kind were minimised through devaluation. This policy instrument is no longer available. Setting fixed limits on a currency means accepting movements in other parameters. It is therefore theoretically possible for the euro to become a destabilising factor. Public debt rescheduling is thus bound to happen in weaker countries unable to repay their debts with too strong a currency.



In 1998, 150 leading German economists penned a well-publicised open letter requesting the postponement of the euro due to the currency's inadequate budgetary and fiscal underpinning.



They highlighted a prior need for more flexible national economies and the consolidation of government budgets. They even surmised that the euro should be restricted to a smaller number of countries.



The faultfinders were, of course, right. But their objections were dismissed out of hand, particularly by our own Minister of Finance, Philippe Maystadt. Nevertheless, it is absolutely essential that we acknowledge that afterwards he constantly warned that the political coordination needed to support the euro was lacking.



Although still legal tender and a single currency, the euro is no longer a force for social good or a common currency. It has become a genetically deflationist currency. We are perhaps falling into the Japanese-style trap of a strong currency combined with insufficient inflation or growth.



Some will conclude that the euro is a generation-long project and that it is too early to make an assessment. Be that is it may, the question is which generation will be its beneficiary and which will be its loser. Only the future will tell.