The neo-Canutists who invented the European single currency are still blind to its irremediable design faults
When I was eight years old, I was given a book about the kings and queens of England. My favourite picture showed King Canute sitting on a throne at the beach holding his hands up to the incoming tide in a successful demonstration of his inability to turn it back. Canute’s courtiers had apparently believed that his majestic qualities enabled him to suspend the laws of nature.
I interpreted the story as a hilarious example of man’s hubris, of the absurd power people will ascribe to the mere will of their dear leaders (and in some cases, though not Canute’s, of the absurd hubris of the leaders themselves). For years, I thought everyone interpreted it thus. But many were laughing only at ancient regal hubris. Substitute a modern variety of dear leader — an elected president or an unelected European Commissioner — and they are happy to believe that reality will yield to his glorious intentions.
We are now watching the tide of economic reality lapping over the thrones of those dear leaders who took their countries into the euro. Hundreds of billions of euros are being confiscated from European taxpayers for the sake of saving the currency. This must disappoint the neo-Canutists because it was supposed to be the other way around. The euro was supposed to save the people of Europe.
Before the introduction of the euro, many warned that it was unlikely to work. Where there is a single currency, there is a single rate of interest (for any given term or maturity). Different borrowers pay different rates, but this reflects only their “risk premium” on the underlying “risk-free rate”.
Within any economy with a single currency the ideal rate of interest may vary from region to region. Roughly, rates should be higher in those regions where consumption is higher. So, inevitably, some regions will have the wrong rate of interest. Within the UK, the north would sometimes have benefited from lower rates than London. And, as everyone now knows, in the eurozone, interest rates have been too low in the so-called Pigs (Portugal, Ireland, Greece and Spain).
In an optimal currency zone this problem is ameliorated by three things. First, the regional economies are not overly divergent. They usually experience trends or shocks that require interest rate changes in the same direction at the same time. Second, there are low barriers to labour mobility between the regions. Third, there are automatic “fiscal transfers” between the regions. When the north of England suffers and London thrives, tax money flows out of London and into Newcastle as social welfare spending. None of these conditions is satisfied by the eurozone. Its states should not share a single currency. Consider Germany and Greece. Their economies are highly divergent. The law may allow Greeks to move to Germany but their different languages and education create high barriers. Nor do German taxes fund Greek social welfare or vice versa.
There was never any serious prospect of the eurozone quickly becoming an optimal currency zone. The Greeks will not soon start manufacturing high-tech machinery, speaking German or sitting the Abitur exam when they are 18. Germans are unlikely to develop sufficient fellow-feeling with Greeks to fund their featherbedded lives in government departments. But never mind all that. What concern is the dismal business of economics for those with a grand vision? The European Project must not be stalled by the forces of division. Like love, the goodwill of great men can conquer all.
Some will say I am being unfair to the euro’s creators. In recognition of the economic challenges, did they not insist on all eurozone countries signing up to the Growth and Stability Pact? This is like arguing that King Canute’s chance of turning back the tide was really not so small since, after all, he was wearing a golden crown.
Nothing better illustrates the preposterous economic power politicians imagine for their edicts than the Growth and Stability Pact. Among other things, it stipulates that no country will run a fiscal deficit in excess of three per cent of GDP. Here are some eurozone deficits: Greece 13 per cent, Spain 11 per cent, Portugal eight per cent.
The now standard view, expressed by The Times, is that the current crisis shows that monetary union requires fiscal union. To hold together the euro over the long run, national tax and spending policy will need to be centralised in Brussels. Since this is the kind of thing the European integrationists are imagined to have wanted all along, some see the absurdity of the current eurozone arrangement as part of a cunning plan.
Yet this is merely fantasy. European states will never give up control of their domestic government spending. The eurozone will remain a calamitously suboptimal currency zone costing Europeans hundreds of billions to hold together and keep alive a glorious delusion.
More than 1,000 years after Canute’s courtiers were disappointed by the tide, reality remains resolutely disobedient.