Why is the Euro a bad idea compared to other currencies?

Question

Many economists, including Nobel laureates Paul Krugman and Joseph Stiglitz, have said that the Euro was a bad idea from the beginning and is a major reason for all the current economic problems. My general understanding of this issue is that different countries with different monetary policies would have more control over how to control their debt and financial obligations instead of being tied to the same rules that all the other countries have to follow. This makes sense to me.

However why does the USA and China not have similar issues even though they are very large countries with a single currency as well? Should the US and China actually be using different currencies for different regions?

Answer 1

One of the key requirements for a currency area to be successful is that there must be a sustainable political mandate to support fiscal transfers between regions, to provide the balancing mechanism that would otherwise have been performed by fluctuating currency rates between those regions.

Another is that labour can move freely between regions.

The Eurozone, it turns out, met neither of those requirements:

Language barriers have impaired freedom of movement.

And although Northern Europe was happy to reap the benefits of currency union during the good times, it has proven to be unwilling to make the fiscal transfers to the South during the bad times.

Exacerbating this, Greek admission to the Euro zone was created on the back of some fraudulent accounting courtesy of Goldman Sachs. Based on the real numbers, Greece would never have been admitted.

Answer 2

The systemic problem with currency unions, and this is true of all historical currency unions, not just the current Eurozone, is that the banking systems that comprise them expand their money supplies (money in this answer is the total sum of bank deposits) at different rates. Banking systems can also contract their money supplies, this is rarer, but equally problematic.

Between different currencies this issue is reflected in the valuation of currencies relative to each other, and over time this shifts more or less in relation to the different expansion rates, and to economic changes which can also influence the price level.

Within a currency however, this can't happen, and the pricing issues created by different expansion rates have to be resolved within the economy, in so much as they can be.

This problem can and does occur within individual countries. Different banks also expand at different rates within a banking system, and because banking is structured geographically, unbalanced flows occur everywhere. The London problem is good example of this in the UK.

However, within a country, it is usually possible to politically intervene and direct tax spending by the government to the regions that are expanding at slower rates. Germany does this very well, the US increasingly not so well, as banking becomes more concentrated there, and political pressure is being put on the US Government to reduce spending, and since China has been reduced to building empty cities in an attempt to re-direct funds, I wouldn't describe that as exactly healthy.

A large part of the problem is that this effect is very slow. Monetary expansion rates in fiscally stable countries are typically of the order of 1.3 - 3 times per decade. The stresses on the systems build up very slowly, are generally misunderstood - the symptoms are economic and so people's behaviour can be blamed. In that borrowing is the trigger for the expansion, behaviour also influences the problem (and generally amplifies it).

Whether or not breaking currencies down further would be a solution to this is an open research question. Back in the 18th century in the USA there was a time when this was effectively occurring as each bank issued its own notes, and these notes traded at different rates to each other. It can be done, whether or not we would want to live in that world is another matter entirely. The Eurozone was created for a number of reasons, and one was that having a single currency significantly simplified commercial transactions. The idea at the time was that countries who joined it would have sufficiently similar economies and be fiscally responsible with respect to debt and government spending. The intrinsic monetary expansion issues inherent in fractional reserve banking appear to have never been explicitly acknowledged.

Answer 3

If I remember correctly reading Krugman's opinion, he stated that to be successful, a central bank has to be associated with a government. This is to harmonize fiscal and monetary policies. If you compare France and Germany in the 1960-1970s, France was playing with inflation-devaluation, whereas Germany (as is does the ECB today) tried to be more stable.

The euro created a union for monetary policies. But no union was achieved for fiscal policies. This created the problem that the ECB cannot know to which country it should adapt its policy. And the more countries, the more they diverge, and the harder it gets for the ECB. Ultimately, the Euro is too strong for exports of Southern countries, but it is too low for imports in Northern countries.

IIRC, for Krugman, the euro wasn't in itself wrong. But the failure to get a European constitution in 2005, or any fiscal hamonisation, lead to its downfall.

I can't find the article that I read some years ago, but for example, he asks

what would happen if countries couldn’t use monetary and fiscal policy to fight recessions.

-- Paul Krugman

But also concludes that the reason the euro was a failure a posteriori was that the EU had

• There is no fiscal union, no common taxes

• No banking union

• Not the degree of labour market mobility needed

-- Paul Krugman