Why the euro is working

It’s just misunderstood

The euro is a disaster. The single currency is falling apart because it does not have a central fiscal authority or a central bank capable of acting as lender of last resort standing behind it. Because of this it was doomed from the start and everybody knew it.

This line of thinking, stretching from the pages of the Telegraph to the New York Times, is so widespread that it might seem ridiculous to challenge it. Indeed, I subscribed to it myself. But lately I’ve been having second thoughts. Is it, in fact, possible that the euro is working in exactly the way it ought to be?

Let’s go back to basics and look at what we want our money to do. As I wrote recently

“The textbook functions of ‘money’ are familiar to anyone with a smattering of economics; a medium of exchange, a store of value, and a unit of account. But each of these functions is entirely dependent upon money maintaining its value. If the value of the pound fluctuates it is no more useful as a unit of account or measure than a twelve inch ruler which kept changing length. Money which declines in value is a poor store of value.

Historically, when its value declines beyond a certain point people stop storing their wealth in money and trade it for commodities as quickly as possible. This acceleration in velocity of circulation exacerbates the decline in value and can trigger hyperinflation. And money which is rapidly losing value can cease to fulfil the function of medium of exchange if people refuse to accept it, legal tender laws or not.

So the value of money must be maintained for it to serve its functions and value is determined by supply and demand. Money is demanded for transactions, buying and selling. A few coin collectors aside, people do not demand money for its own sake but because they wish, at some point in the future, to exchange it for goods or services.”

So what is the greatest threat to this maintenance of purchasing power which we desire from our money? Historically it has come from currency issuers, almost always governments, who have issued excess amounts of currency to pay their bills and caused a decline in the purchasing power of everyone else’s money in the process.

In the last century this was taken to lamentable extremes. John Maynard Keynes wrote in 1931 that “A preference for a gold currency (which could not be produced at will by monetary authorities) is no longer more than a relic of a time when governments were less trustworthy in these matters than they are now”

The following decades proved Keynes’s faith in politicians to be grossly misplaced. We’ve all heard of the Weimar inflation but over the twentieth century the dollar and the pound lost about 90 percent of their value. This didn’t happen smoothly. As D R Myddelton writes, during the Keynesian golden age “The pound’s purchasing power halved between 1945 and 1965; it halved again between 1965 and 1975; and it halved again between 1975 and 1980. Thus the historical ‘half-life’ of the pound was twenty years in 1965, ten years in 1975 and a mere five years in 1980”

As a result of such monetary mismanagement many countries sought a way to get their politicians’ hands off the printing press. No one was willing to go the whole hog and reintroduce the gold standard (which had tied the issue of currency to the amount of gold the issuer held) but the German model, with the Bundesbank independent from the government, was widely copied.

The whole point, to repeat, was to remove from government the power to print excessive amounts of money to cover their own expenses and, in doing so, ruin everyone else’s money. That considered, the euro is actually performing well.

Given the dire state of several eurozone economies, this may seem a bizarre thing to say. But can Spain’s horrific unemployment really be blamed on the euro when it hasn’t been under 8 percent since 1979? Is it really the fault of the euro that the Greeks chose to pay their pastry chefs, radio announcers, hairdressers, and steam bath masseurs (among 600 other “arduous and perilous” professions) a state pension of 95 percent of their final salary when they retire at 50?

Spain’s unemployment predates the euro and won’t be solved until a labour market which makes it practically impossible to hire and fire is reformed. Greece’s politicians have to stop promising Greeks that they can spend one third of their life retired, living on money borrowed from the Germans. ‘Reforming’ the euro can’t help with either of these. Indeed, by forcing governments to address these structural issues the euro could be seen to be doing them a service.

But these steps will have to be taken against the backdrop of a debt crisis. This is where calls for the European Central Bank to act as lender of last resort or for fiscal union to match monetary union are heard. The fatal flaw of the euro, these people say, is that it cannot be produced at will by governments to pay their bills.

But then, that is, and always was, the whole point. If a given country cannot pay its bills, is the solution for it to run the printing press and devalue everyone’s money or is it for that government to stop making spending commitments it can’t keep?

Countries like Greece are faced with massive borrowings in a currency which they cannot produce at will. Those who argue that this represents a fatal cleavage between monetary and fiscal policy and that a single fiscal policy must stand behind a single currency to bridge it are arguing that the solution is to put the power to make spending commitments in the same hands as the power to print money. The lessons of history are that this does not end well.

This article originally appeared at The Commentator

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