Conventional wisdom holds that the eurozone problem is the adoption of a common monetary policy without a common fiscal policy. But a common fiscal policy is not necessary for a successful monetary union. No such agreement existed under the gold standard. Nor does one exist now between the US and the several countries – including China – which have pegged their exchange rate to the dollar.
Nor is a common fiscal policy sufficient for a successful monetary union. Neither the European Commission nor the German government can put tanks on the streets of Athens. The only mechanism the European Union has, or can have, for imposing fiscal discipline in any country or region is to refuse further payments to that country or region. This is precisely the mechanism that has been deployed, with limited success.
Monetary union implies that areas with different economic conditions, growth rates and price expectations are no longer forced by markets to make compensating adjustments through currency devaluation. They must instead impose appropriate local policies towards wage growth, taxation and public spending. Differences in incomes, growth and price movements are inevitable in a union that stretches from Aran to Athens and from Lapland to Lisbon. No institutional arrangements can change these facts.
A Franco-German monetary union was an ambitious project. But the half dozen potential members of such a union mostly had political and economic institutions sufficiently robust to handle the consequences. The success of such a project over the past decade might have provided a springboard for expansion.
But an excess of ambition extended membership of the eurozone to states that were neither willing nor able to accept the economic disciplines that replaced those imposed by the currency market. These states were enabled to escape serious consequences by funding budget and trade deficits through public and private borrowing. They will continue to be able to do so until creditors believe they will not be repaid – which would, if the new stability fund were to succeed in its objectives, mean that they could continue these policies for ever. The eurozone’s difficulties have been created by member states not markets, giving members more resources to fight markets makes things worse, not better.
The eurozone’s difficulties result not from the absence of strong central institutions but the absence of strong local institutions. A miscellany of domestic problems – rampant property speculation in Ireland and Spain, hopeless governance in Italy, lack of economic development in Portugal, Greece’s bloated public sector – have become problems for the EU as a whole. The solutions to these problems in every case can only be found locally.
But many interests converge in supporting the demand for collective action. An elite in Brussels and some other capitals takes the view that whatever the problem, the answer is more Europe. Another reason is the pleasure European leaders take in holding international crisis meetings. Nicolas Sarkozy will not forgo any opportunity for public grandstanding, while the representatives of smaller European states exploit the crisis to acquire a profile they would not otherwise achieve or, in most cases, deserve. Financial markets are desperate to be bailed out, with the support of Tim Geithner, in his capacity as ambassador for US investment banks. The decisive action they all seek is not really a European solution at all. It is that the German government should write very large cheques – or underwrite very large borrowings.
Whenever you assert responsibility for issues you do not have authority to tackle, you risk a crisis of credibility that undermines the authority you do have. Europe’s leaders see themselves as mustering resources for a war with the markets: a war which they will lose, not just because they will never find sufficient resources to defeat the markets, but because they are really fighting reality.