The fate of the Euro will be determined not in Brussels, Frankfurt or Berlin, but in households and firms across Europe. In effect, the countries of the Eurozone have returned to the Gold Standard. The social costs, in terms of the unemployment and political change, of readjustment to the Gold Standard could prove to be too high to be sustainable.
The creation of the Euro conflated two distinct goals into a single event. One was to replace national currencies with a common currency. The other was to replace politicized monetary policy with a technocratic decision process tasked with price stability. Either of these would have been ambitious; in combination they were truly daunting.
A common currency across distinct societies with different economic histories could potentially have worked had the new currency been fitted to the political economy of the country with the weakest domestic economic institutions. In effect, the Euro would have been the Drachma with an inflation rate to match. By design this would have enabled the Greek economy to continue unchanged but would have inflicted higher-than-desired inflation on other countries to varying degrees. The French government of the time may have intended something along these lines. The impetus for the Euro came from growing French discomfort at the cost of maintaining the policy of shadowing the Deutschmark – the franc fort policy. The Euro, as conceived by the French, was to be a politicized currency, in effect with a higher inflation rate than that set by the Bundesbank. In the event, the German government won the struggle for a technocratic Euro: instead of becoming the Franc, let alone the Drachma, the Euro became the Deutschmark. In the short run this created a bonanza for governments in proportion to their previous inflation: the higher was inherited inflation the greater was the fall in borrowing costs, hence the borrowing spree in Greece.
The switch from a politicized to an independent central bank tasked with price stability is a harrowing one even within a single national polity. Coincidentally, while the Eurozone was going through the dual adjustment, Britain was going through this latter adjustment at the national level: in 1997 the Bank of England was given operational independence and told to achieve price stability. As in Greece, this delivered a one-off reduction in nominal interest rates which helped to induce a borrowing spree by the government. But even with a labour market that by European standards was only lightly regulated, and with the active and substantial depreciation of the currency, once the economy went into recession the Bank of England chose to abandon the inflation target rather than further deflate: inflation in Britain is currently above 5 percent whereas the target is the same as that of the European Central Bank, namely 2 percent. This was a wise decision: in effect, the myriad of local institutions that determine the relationship between inflation and unemployment have not, after 14 years, adjusted sufficiently for price stability to be a reasonable goal. This was, indeed, the second time in a century that Britain had tried to depoliticize the currency: in the 1920s Britain had returned to the Gold Standard. The policy proved to be a catastrophe, resulting in conflict and mass unemployment. It was abandoned only once political egos cracked.
If the experience of Britain has shown the limits to the adoption of a technocratic currency in a society unprepared for it, Greece and others that were unaccustomed to living with the Deutschmark were inevitably worse-placed. The Euro was sold to citizens in terms of its first characteristic, of being common across Europe, rather than its second, of technocratic delivery of price stability. As a result, citizens unfamiliar with German inflation rates continued to demand high nominal wage increases, and governments, instead of reducing their indebtedness, increased it.
The result is a situation familiar to any economist who worked on Africa. Greece has demonstrated beyond reasonable doubt that its politicians cannot address the crisis. That is what the IMF is for: in return for concessional finance it imposes a standard policy adjustment of devaluation, debt restructuring, bank recapitalization and orderly fiscal retrenchment (the latter being less severe than the disorderly retrenchment that would be inevitable in the absence of the concessional finance). The achievement of the Europe’s politicians has been to veto this outcome as unacceptable, while also blocking the politicization of the Euro. In effect, the Euro has returned Europe to the Gold Standard. The social costs are likely to mount until either this forces radical change on myriads of local institutions, or political egos crack. I expect both: neither institutions nor egos are likely to change at the same rate across so many different societies.
This article first appeared on Social Europe Journal