For Better or Worse, The Euro is Here to Stay [1/2]

For Better or Worse, the Euro is Here to Stay:

A Response to Eichengreen’s “Is Europe on a Cross of Gold?”

Since the introduction of the euro as a common currency on January 1^st 1999, it was apparent that the European monetary union is at the heart of the whole European Union project. The common currency is the foundation on which the European Union is built, not least because it improves the allocative efficiency of the price mechanism by reducing price uncertainty. After all, the reason to have a monetary union in the first place is to have a strong source of stability in Europe, not just economically but also politically, by establishing a fully integrated single goods, services, and financial market. However, since the advent of the Great Recession, the monetary union has produced disasters, particularly in the Iberian peninsula and southern Europe: Portugal, Ireland, Italy, Greece, and Spain (the so called PIIGS) have gone the way of the 1930s with cycles of deflation, massive banking crises, more sovereign debt, and social and political crises. Because European governments lack a national currency to depreciate, and lack the power to relax credit, they face an unbreakable constraint on reflationary action to counter the massive deflationary shock of the Great Recession. One popular argument in response to this constraint is to abandon the euro: just as the gold standard was abandoned after the Great Depression, so too should the euro be abandoned so that countries have the ability to depreciate their currencies, and loosen credit. This argument has both pros and cons, but, ultimately, will not hold: for better or worse, the euro is here to stay.

Four Key Differences Between the Arguments Against the Gold Standard and the Euro

In his article, “Is Europe on a Cross of Gold”, Eichengreen states four key differences between the arguments against the gold standard and the arguments against the euro that leads him to believe “that maybe—just maybe—the euro will survive” (Eichengreen, 2012).  First, the European Central Bank (ECB) has the capacity to quickly mount a monetary response. By contrast, when there were many central banks, it was difficult to get them all to move together because they

viewed economic prospects through different lenses. Though Eichengreen’s first difference that the ECB can adopt decisive matters quickly is supported by empirical evidence, it is not clear to what extent the ECB’s measures, such as its role in austerity, needs to be adjusted. If the euro were to survive over the long run, the ECB must be able to quickly identify the outcomes of its measures, and adjust them as quickly as they implement them. Eichengreen’s second difference is that the unemployed receive more extensive public support than in the 1930s (not withstanding recent cuts in social programs), making pressure to abandon the euro less severe (Eichengreen, 2012). The question that remains to be answered, however, is “how much less severe and whether the political center can hold” (Eichengreen, 2012).

Eichengreen’s third key difference is that political preconditions for a cooperative response are better today: though political tensions still do exist, particularly between France and Germany, it is almost certain that they will not begin to rise to the level they were at during the early 1930s. One important corollary to this argument is that European countries today are more interconnected—culturally and economically—and are prepared to work together to save the euro, “fearing that its collapse would jeopardize their single market” (Eichengreen, 2012).  Finally, Eichengreen’s fourth key difference highlights that abandoning the euro would be substantially more disruptive than abandoning the gold standard was: “reintroducing the national currency in order to depreciate it, but leaving the euro value of other financial instruments untouched, would destroy balance sheets and wreak financial havoc” (Eichengreen, 2012). In the 1930s, by contrast, bank deposits, along with most other public and private debt, were denominated in that national currency; when a European country abandoned the gold standard, all it had to do was, literally overnight, stop backing their national currency with gold. In short, though Eichengreen argues that the greater scope of cooperation that exists today bodes well for the euro, he is quick to highlight that it is the precise policies on which European governments cooperate that will tell the tale (Eichengreen, 2012).

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