Sunday, July 15, 2012

Europe on Fire

It’s satisfying to be proved right, but there’s little joy in it when the call you got right was a prediction of disaster.

I don’t pretend to be an expert in economics. I’m a self-educated amateur who tries to keep up with the basic concepts and how they play out in the real world. Sometimes I think I understand why things happen the way they do; sometimes I have no idea what’s going on. Occasionally something like a conviction about proper policy solidifies.

Ten years ago when the euro usurped the national currencies of twelve European countries, I told the few people I happened to discuss it with, “It’s a bad idea.” Nobody seemed to be especially alarmed by my skepticism, and I didn’t really have an axe to grind. But I knew it was a bad idea, because a very lucid and instructive book had told me so.

In her 1984 book Cities and the Wealth of Nations, subtitled Principles of Economic Life, the urban theorist Jane Jacobs discussed the vital role a currency plays as a feedback mechanism for an economy. The book was an investigation of what makes some regions thrive and some stagnate, and one of its key ideas was that the fundamental unit for the care and nurturing of an economy was not the nation but rather the city. It is networks of cities and their surrounding regions, each specializing in what it does best and trading with others, that make up an advanced economy.

Jacobs discussed the feedback function of a currency at length, saying, “Today we take it for granted that the elimination of multitudinous currencies in favor of fewer national or imperial currencies represents economic progress and promotes the stability of economic life.” The European Commission couldn’t have put it better. But Jacobs dissented, pointing out the key function of a freely traded currency in regulating an economy. When a country exports too little and imports too much, the resulting decline in the value of its currency (because it is no longer in demand) ought to help correct the situation by making its exports cheaper and imports more expensive. It’s a feedback mechanism which Jacobs compared to the physiological mechanism of a rise in CO2 in the lungs triggering a contraction in the diaphragm.

The problem is that different regions of a country may have different economic needs. Jacobs cited the example of the rise in the British pound due to the demand for North Sea oil and how it killed the English pottery industry by making its exports too expensive. Having a national currency, Jacobs said, was like having a group of people engaged in diverse activities whose breathing was regulated by a central brain operating on consolidated CO2 data for the whole group. If you’re lying on the couch, the enforced breathing rate is probably OK; if you’re trying to swim or play tennis, you’re in trouble.

Of course, we’re not going back to having regional currencies in the United States. A big and culturally homogeneous country like the U.S. can get away with having a national currency because population mobility can compensate to some extent for the burdens imposed by a one-size-fits-all monetary policy. And it’s true that having a single currency over a large area lowers transaction costs and thus facilitates trade. But there are always trade-offs, and in Europe today the costs of the single currency imposed on the disparate collection of economies that makes up the EU have obliterated the benefits.

I wasn’t the only one who said this was a bad idea, of course; in 1998 the British Tory leader William Hague said the the euro would become “a burning building with no exits.” He was shouted down, and the imposition of the single currency proceeded. If ever a man was entitled to say, “I told you so,” it’s Hague.

How could the Europeans do this to themselves? Because politics always trumps economics. The people that wanted a federal Europe because they thought it would rival the United States as a world power knew that the single currency would force countries to surrender more and more sovereignty. A single currency can’t work without a single regulatory authority, lender of last resort, etc. And sure enough, in the face of the economic disaster that would be precipitated by a euro breakup, the measures being discussed are precisely those things: a banking union, jointly issued euro bonds and other measures that mean a further shift of power from Rome, Madrid, Paris, Athens and even Berlin to Brussels.

A lot of Europeans don’t like it, but it’s too late. They’re trapped in the burning building. The Greeks may have invented democracy, but their democracy is totally impotent in 2012. Both their choices in their recent election were bad: either excruciating austerity or a rebellious stance that would probably have led to their expulsion from the euro zone and precipitated a continent-wide collapse. Brussels has the whip hand because the Greeks like everybody else gave up their freedom of choice in exchange for the illusory prestige of a world class currency.

Jane Jacobs could have told them it was a bad idea.

Sam Reaves

No comments: