Today the IEA published a monograph, The Euro: the Beginning, the Middle and…the End? Given the meeting of EU finance ministers today, there is certainly some food for thought in the monograph. One day – though it is not obvious when – they might have to accept that governments that are not creditworthy cannot keep bailing out each other and cannot keep bailing out banks which themselves invest in large portfolios of bonds issued by the governments that stand behind them. There is political will to keep the euro zone going but, at some stage, the music must stop in the game of ‘pass the debt parcel’.
Most of the British authors of the book argue that the decision of the UK not to join the euro, which was supported by the vast majority of UK free-market economists, has been proven correct. The euro zone – even without the UK - clearly is not an ‘optimal currency area’. Furthermore, differences in financial systems between euro-zone members have meant that their economies responded very differently to global economic shocks and to the ECB’s monetary policy operations. This helped to create the financial imbalances that became unsustainable. In addition, product and labour markets in euro-zone members are far too rigid to respond adequately to economic shocks. The result has been high unemployment and prolonged recession in a number of euro-zone countries. Proponents of the euro thought that it would evolve into an optimal currency area through structural reform and economic convergence, but this has not happened in practice.
In this context, the EU should now face up to the fundamental structural problems of the euro project. There is, however, little indication that the EU elite support the kind of free-trade and supply-side reform agenda that can make the single currency viable. Current mechanisms being used to manage the euro crisis are inadequate at every level.
Accordingly, the authors of the book conclude that the status quo is unsustainable. Radical reform of monetary arrangements within the euro zone must be implemented. This could follow one of the following paths:
· A complete break-up of the euro and a return to national currencies. It is essential to plan carefully such a break-up so that it happens in an orderly way. A break up of the euro must go hand-in-hand with vigorous promotion of free trade in the difficult political environment that will then exist.
· Greece, and possibly other members, should be suspended from all the decision-taking mechanisms of the euro. Greece should establish its own parallel national currency whilst the euro remains a legal tender currency. Currency competition would complement a more general agenda for decentralisation in the EU.
· The euro should return to its founding principles. There should be very strict enforceable rules relating to fiscal policy that all member countries had to meet. Furthermore, the ECB should play no part in underpinning the government debt of member countries. Countries that did not abide by the rules would take no part in the economic and monetary policy decisions of the EU or would be suspended from membership of the euro.
· A system of liberalised free-banking should be established where businesses and individuals choose the currency they wish to use.
Unless the euro zone is very lucky (for example, there is a sudden spurt of growth in the world economy that reduces the volume of bad debts), the EU must face up to the contradictions within its own policy stance or face the consequences of complete social meltdown. There is no shortage of political determination in the EU. Unfortunately, the EU is determined to keep the current show on the road rather than investigate and implement lasting and sustainable reform. As our authors show, there are options out there. Some of them – such as parallel currency options – might not involve too much loss of face for the political elite. We live in hope, but not particularly in expectation of a positive outcome to the euro-zone crisis.