In early November the governor of the Hungarian National Bank, Gyorgy Matolcsy, made a comment that the euro was mistake and argued that exit strategies should be in place for countries that aren’t faring well with it. In an article he wrote earlier this month in the Financial Times, Matolcsy refers to the euro as an “ill-advised decision” that has met none of its preconditions.
Since its introduction in 1999, the euro has been a highly debated currency regarding its ability to enhance the political integration and prosperity of Europe to bring the EU countries and their people together. Many economists hold that the euro has been flawed since its birth and has brought forth the opposite effects than originally intended. I would like to focus on the reasons for the wide rejection of this currency in certain circles of the eurozone and the ways it has impacted the economic stability of the European Union.
Why the Euro?
During the mid-20thcentury, European leaders sought to create a single currency - one that would save businesses and travelers the cost of exchanging currency and remove the currency risks associated with European trade. The idea was that with a European Central Bank (ECB), there would be a more uniform monetary policy that could not be manipulated by member nations in their favor. To avoid domestic inflation and foster domestic growth, the governments of all member countries would have to be equally fiscally responsible.
Fast forward to the near-end of the century. It’s post-Cold War with the wounds of the second World War still healing, and the European nations are looking for a way to unify. The idea of a single currency is substantiated on January 1, 1999 with the institution of the euro. Today, the euro is used in 19 out of the 28 EU countries which is also known as the eurozone.
Economic Effects from the Euro
Once established, the euro facilitated a way for citizens to identify the best price of a good without having to convert the currency. This ensures transparent prices and higher competition between members of the EU. Consequently, goods and services can flow more easily across borders to where they are needed, allowing the whole EU to operate more efficiently.
While these appear to be telltale signs of thriving countries headed towards political unification and prosperity, it’s important to read between the lines. The root of the problem lies within the fact that once the eurozone countries abandoned their national currency and adopted the euro, they essentially lost important policy levers. Suppose one of the member countries goes into a recession. If this occurs, then it wouldn’t have a currency that it could devalue so that its businesses could sell abroad at lower U.S. dollar prices to boost exports and unemployment. Also, they wouldn’t have a central bank to lower interest rates in order to encourage domestic spending and stimulate economic growth.
In The Role of Monetary Policy, world renowned economist Milton Friedman warrants that the primary function of monetary policy is to minimize the chances of macroeconomic dislocation. In other words, it is to prevent an economic boom from getting too big and to reduce the time that an economy spends in a recession. If monetary policy is badly implemented, the damage can be lasting. Taking the path of monetary union could further disrupt the economy and reduce long-term growth prospects.
When the economies of member nations sharing the euro diverge from one another, severe difficulties may arise. For example, let’s say that the French economy is struggling while the German economy is flourishing more than ever. The common interest rate set by the European Central Bank will be too high for France and too low for Germany and, in turn, will cause the economic troubles of France to persist while giving Germany’s economy a boost. This shows that once member economies begin to diverge from one another, the shared interest rate will result in the increase of divergence.
Further Thoughts from Economists
An insightful take on this topic comes from Gyorgy Matolcsy, whom I mentioned earlier in the introduction. He continues to be an avid critic of the euro calling it a “trap” and a “strategic error.” Matolcsy explains that many of the eurozone countries were far better off before adopting the single currency and that there should be exit strategies in place for those who wish to opt out. In an article earlier this month, he brings up some key points pertaining to the necessary pillars of a successful global currency, or lack thereof. They include a common state, a budget that covers at least 15-20 percent of the eurozone’s total GDP, a eurozone finance minister along with a ministry.
Matolcsy suggests that the origins of the euro lay in France's desire to prevent German dominance after the country’s unification following the fall of the Soviet Union. He refers to this as a “French snare.” French President, Francois Mitterrand, was able to persuade Germany’s Chancellor, Helmut Kohl, into giving up the Deutschemark and adopting the euro, convincing him that it was the price he would need to pay for a unified country. Matolcsy adds that “They were both wrong. We now have a European Germany, not a German Europe, and the euro was unable to prevent the emergence of another strong German power.”
When southern European economies were included in the eurozone, the exchange rate was weak enough to allow the Germans to become the global export powerhouse of the EU. In what Matolcsy calls a “windfall opportunity”, the Germans became complacent in that they ignored the need to upgrade infrastructure and invest in future industries. "They missed the digital revolution, miscalculated the emergence of China and failed to build pan-European global companies. At the same time, companies like Allianz, Deutsche Bank and Bayer launched fruitless efforts to conquer Wall Street and the US.”, he says. What Matolcsy wants us to understand here is that countries like Germany should’ve stayed away from the euro and that they were much better off before adopting it.
Proponents of the euro maintain that it was an economic project that sought to improve standards of living through more efficient resource allocation. It was a way to pursue the principles of comparative advantage, utilizing economies of scale, increasing competition and strengthening economic stability. Furthermore, it was a political project aimed to enhance the political integration of Europe, ensuring a peaceful coexistence among people and countries.
Like Matolcsy, economists argue that the euro has failed to achieve these goals and has caused more anger and distrust than peace and harmony. Europe has been widely known for its diversity, which is a good thing. The problem, though, is that for a single currency to be effective over a region with such broad economic and political diversity isn’t easy. As I mentioned earlier, a single currency consists of a fixed exchange rate and single interest rate. Even if these rates are set at a level that reflects the circumstances in the majority of eurozone member countries, considering the economic diversity, there should be institutions in place to assist those nations for which the policies are not well-adapted.
Some economists contend that the European leaders’ promises of political benefits are delusive. Despite the repeated motto of “political union”, these leaders knew that they wouldn’t forfeit their own tax revenues to provide help to other nations who needed it. They were aware of the economic conflicts of interest that were posed and understood that economic conflicts would turn into political conflicts. The risks of the euro were ultimately suppressed, and alternate viewpoints were averted.
This all begs the question as to why Europeans leaders would attempt such an endeavor that carried little benefits and big risks. While some continue to believe in the vision of the euro, many others believe that it has hampered its member countries, creating division among Europeans. It is apparent that the ideal goals of a single currency have not yet been reached in Europe and the question in certain member nations seems to be about how much longer the euro will stick around.