The Euro’s Coming Demise

The grand plan to create a united Europe, a land like the United States, is coming apart at the seams. Perhaps the statement that best exemplifies this view came ironically from Romano Prodi, president of the European Commission.

Prodi has rendered the pact unpoliceable; the penalties imposed on those nations that violate the common accord are a dead letter. He notes: “The Stability Pact is stupid, like all decisions that are rigid.”

The rules for the new Europe were designed by Germans to stop Latins from borrowing too much, breeding inflation, and forcing up interest rates. But what is now all too evident is that the rigid rules force overspent governments to retrench in mid-recession, thereby encouraging a deflationary spiral.

Even stolid Germany—the nation representing European backbone—has now breached the 3 percent deficit ceiling established with the Maastricht Accord. Prodi’s “courageous” comment was a welcome reflection on reality that simply brightened European spirit.

Of course, Prodi wasn’t exactly firm in his conviction. A week after his initial comment he said, “I defend the pact’s spirit, even if the letter is stupid.” Perhaps there is a European astrologer that can decipher his logic.

If the system is stupid, will a tweaking here or there restore it to sanity? Could the system be reborn with voluntary acceptance of the rules? If so, why have rules? Can European corpulence be excused away as “necessary borrowing” or as an “investment” strategy? Can the European Central Bank establish generally accepted medium-range inflation targets? Is there any way to guard against “free riding”?

Even if all of these questions could be answered affirmatively, the symptoms of the disease might be mitigated, but the disease would endure. Nationalism and the political mechanism that accompanies it cannot be wished away.

The money people use is a function of political power. And no matter how one considers it, power resides in the various nations, not in the European Union. The Euro’s introduction was a calculated step preceding political union, but it is obvious that the twelve disparate economies in the union cannot cope with a single interest rate and uniform fiscal constraints.

Any comparison with the United States is faulty. The U.S. had political union before monetary union. The U.S. can employ federal spending or restraints as an economic shock absorber. Most significantly, the U.S. has a representative government from which power for political action is derived.

The European Union doesn’t have integrated political power; it doesn’t have a lender of last resort and it doesn’t have a representative political assembly.

Francis Mer, Finance Minister of France, calls the European pact a Procrustean bed, “too small for some, too big for others, and torture for all.” If this description is accurate, as recent events suggest, the key issue is not cohabitation but divorce.

Yet how does one engage in divorce when the European banks have invested their future in the euro? No matter how “stupid” the euro may be, there are interests to be served.

Then again collapse of European economies may be just over the horizon. Either governments ignore the rules and adjust policies to the reality of individual circumstances or they abide by the rules and see their governments fall. The choices are equally unappealing.

History is an unyielding master. It is one thing for politicians to exhibit their hubris by defying the reality of separate states; it is quite another thing to maintain a position that is ruinous and ultimately unsustainable.

Only time will tell how this matter will evolve. As of this moment, it wouldn’t be wise to bet long on the euro. Stupid ideas have a way of failing.