Alive, If Not Entirely Well
It has been 15 years since the euro was first introduced as an accounting currency for non-cash payments in 12 EU nations. Now it is time to examine the lessons from this bold experiment.
It is true that there has been a terrible crisis in the eurozone, and it is not over. However, the euro has been a tremendously successful experiment. Roughly 350 million people now routinely use this currency every day without giving it a second thought. They can, and do, travel in 18 countries (soon to be 19) without having to exchange money or worry about volatile exchange rates. The euro is alive, if not entirely well.
During the crisis, many economists forecasted the impending death of the euro. This never came to pass, so what made them get this so wrong? In short, because they did not understand a few simple things.
First, the euro is a deep political commitment. Among current and past government leaders, no one has wanted to be responsible for killing off the euro. That may change in the future, but for now, the euro remains the symbol of a peaceful and prosperous European integration.
Second, the eurozone is a robust union. Countries cannot be expelled, and there is no voluntary exit procedure either. This is an arrangement that is designed to last forever. Third, the euro is a relatively young invention. Its initial design was imperfect and incomplete, but it is easier to fix these flaws than to give up on the whole arrangement – the economic and political consequences of that would be disastrous for every member country. In fact, an element that was originally missing, a banking union, has since been instated. While the union is neither perfect nor complete, it is in place and it will be improved over time. Future historians will likely look back on the crisis and describe it as a classic growing pain.
Finally, there is no economic mechanism that will ruin the euro. The crisis has deeply hurt certain countries, largely due to short-sighted politicians and profound mismanagement, but the euro has persevered. The currency is still used daily, bank transfers continue flowing, and the exchange rate has not seriously declined.
The only danger is that suffering and disagreements have opened the door to opportunistic politicians committed to destroying the euro. One or two of them could come to power one day, and that could be the end of the experiment. At the end of the day, political will is what has sustained the euro so far, and it could be what eventually undoes it. We should never underestimate the power of politics.
A Model for Export
Before the crisis, the euro was sometimes seen as a model for other world regions to follow. A common currency was debated in Latin America and, more seriously, in Southeast Asia (outside of China and Japan). But now, people are reconsidering and it is not looking like as good of an idea. The experiment may not be easily exported, but that does not mean it should be ruled out entirely. Sharing a currency represents a sharing of sovereignty; each participating country must give up its own currency, exchange rate, and central bank. As the European crisis illustrates, it also requires much more than that. Banking supervision and occasional rescues cannot be conducted on the national level, as eurozone countries initially attempted before the adoption of a banking union. The benefits of this will likely extend beyond a monetary union; it will also help ordinary citizens, who are the true victims when bank failures are not appropriately dealt with. Breaking the link between the states and their banks was an important step, but there is still more to be done.
A single world currency may happen sometime in the distant future, but no time soon. Significantly more economic integration would need to occur for that to happen. Even then, countries would have to give up a certain degree of sovereignty. In this day and age, when nationalism is on the rise, the whole idea is quite outlandish. However, it will not go away entirely, because the exchange rate question has no easy answer
Each member country must also impose strict fiscal regulations. Contrary to popular belief, this does not mean a fiscal union – the bane of a federal government – or jointly guaranteed public debts – the so-called Eurobonds. It requires that governments not run budget deficits year in and year out, as many eurozone countries have been doing for so long. What is needed is for every country to adopt strict rules limiting their ability to freely run deficits whenever the government finds it convenient. This requirement is often seen as an encroachment upon sovereignty, even though many countries around the world – Chile, Brazil, Sweden, and Switzerland, to name a few – have freely come to recognize the benefits of enforceable budget rules.
Countries that decide to share a common currency must be ready to give up some elements of their national sovereignty. Thus, we come back to political will. It is difficult to imagine another region taking on a common currency, but does this mean it is a silly idea? Not at all. Every country faces the same difficult issue: what to do with the exchange rate.
The standard answer is to let it float more or less freely, which is what Russia just decided to do. However, floating exchange rates tend to be quite volatile. This volatility hurts businesses and consumers, and the government as well. The exchange rate question does not have a clear answer, or a standard one. Flexibility is troublesome and stability is hard to enforce. Exchange rate stability is more valuable among tightly integrated countries, and that is precisely the reason why the euro was adopted. This is also why Southeast Asia has become interested in the euro experiment.
A number of economists, including Nobel laureate Robert Mundell, argue that the whole world should be on one currency. Those who are nostalgic for the days when money was minted in gold and silver also yearn for a single world currency. The euro experiment suggests that a single world currency may happen sometime in the distant future, but no time soon. Significantly more economic integration would need to occur for that to happen. Even then, countries would have to give up a certain degree of sovereignty. In this day and age, when nationalism is on the rise, the whole idea seems quite outlandish. However, it will not go away entirely, because the exchange rate question has no easy answer.
So much has changed over the last 50 years that it is not impossible to rule out additional regional monetary unions. Perhaps eventually, these monetary unions would merge into a single world currency. The bitcoin experiment is deeply flawed, but has shown that there is a strong desire to break the one country-one currency shackles, and that technology constantly challenges familiar wisdom.