Can American History Save the Euro?
Can the eurozone successfully model its monetary and fiscal community on the U.S. political regime of the 19th century?
- The only safe platform of EMU is a federation of sovereign states, with a common currency, but national responsibility and liability for government finances.
- That seems a more promising model for Europe than, for instance, having Germany play the role of the dominating power that enforces fiscal discipline through political pressure.
- One cannot expect sovereign states to abide by strict fiscal policy rules as long as there is no strong political force at the center to police the rules.
- The U.S. political regime of the 19th century combined sovereignty at the state level with fiscal responsibility in a community of equals.
The eurozone’s biggest long-term problem is how to run different regional economies across a fairly diverse economic area — without unduly relying on the help of a money printing press.
Achieving that goal may prove impossible, however, without the application of a rigorous amount of “tough love” to rein in the profligate and irresponsible spending tendencies among the various constituent parts.
It is precisely on this crucial issue that U.S. history offers today’s Europeans valuable insights into their future financial and economic path.
Chancellor Merkel wants to create a “fiscal union” consisting of binding rules for fiscal discipline. However, the experience of the first decade of Europe’s Economic and Monetary Union suggests that this is unrealistic.
One cannot expect sovereign states to abide by strict fiscal policy rules as long as there is no strong political force at the center to police the rules. This is true even when these rules are laid down in international treaties.
What is needed is a European public that is committed to sharing common principles and ideas that would be articulated in the European Parliament, executed by a European government — and trickle from there to lower levels of government at the national and regional level.
But in view of the considerable differences in culture and language barriers, how could political parties and candidates for political office formulate and present such programs?
After all, they would have to be formulated for the whole of Europe, form European government policy, and guide fiscal policy decisions at the lower levels of government. That is a very tall order.
The questions go on: How could such a common political discussion even be organized? Would a parliament with members elected mainly on the basis of their nationality have the democratic legitimacy to elect a European government and decide on legislation affecting people’s daily lives?
It is of course conceivable that, in the absence of commonly developed and shared principles to guide policy at all levels, one country could assume the role of the dominant power and impose common principles on the rest.
But if a European political union were to be created in such an authoritarian way, it would almost certainly be torn apart again by political movements for secession in the smaller countries. They would find that their national interests are oppressed by the dominating power.
If a leap forward to a much closer political union is against the wish of the peoples of Europe, the Economic and Monetary Union can only be stabilized by returning to its key building principles.
The common money needs to be shielded from any political influence and states need to take the full liability for their sovereign financial decisions.
This would require that the European Central Bank refrains from lending to banks and states that may be insolvent and that it returns to its main task of preserving the purchasing power of money.
It would also require that the principle of member states’ full financial liability is restored, even when this means allowing them to default on their debt. Of course, any external effects of such a default would have to be contained via Brady Plan-type debt swaps along the lines of the recent debt restructuring for Greece.
Above all, it would require that the economies of EMU member countries are made fit to live with a hard budget constraint.
For the deficit countries to restore their capital market borrowing capacity in the new environment of tight credit, it is essential for them to undertake comprehensive measures to reduce public debt levels, regain international competitiveness, and improve growth prospects.
Community of equals
The role model for these countries could be the United States of the 19th century, after the U.S. Senate rejected requests from the states for a financial bailout in 1842, thus establishing the principle of fiscal responsibility.
The U.S. political regime of that time combined sovereignty at the state level with fiscal responsibility in a community of equals. That seems a more promising model for Europe than, for instance, having Germany play the role of the dominating power that enforces fiscal discipline through political pressure.
The challenge is to move away from the current, unstable state of affairs where economies lack the flexibility to function smoothly in a monetary union and where governments are so heavily indebted that they represent a danger to the financial system of the entire euro area.
During the transition period to a more stable state, both pressure and help for adjustment would be required. Pressure for adjustment can be created through supervision of national economic and fiscal policies by community institutions and peers.
And it can be enhanced by the threat of sovereign bankruptcy, with the consequence of being stigmatized and cut off from capital market funding for an indefinite period of time.
Help for adjustment can be provided by an institution responsible for the monitoring of economic policies, identification of adjustment needs, and conditional financing of adjustment when imbalances have led to a sudden stop of market financing.
In the extreme case when a country has run up so much debt that repayment is beyond its capacity to generate the resources for debt service, this institution would also organize an orderly debt restructuring with as little external effects for other debtors as possible.
What this is, of course, is nothing but an International Monetary Fund for Europe — or a European Monetary Fund.
Since the beginning of the euro crisis in late 2009, many steps have been made to prevent a collapse of Europe’s monetary union. But these steps will amount to nothing if they are taken with the wrong destination in mind: a political union with a dominating center.
The only safe platform, then, is a federation of sovereign states, with a common currency but national responsibility and liability for government finances.
Editor’s note: This article is adapted from Europe’s Unfinished Currency: The Political Economics of the Euro (Anthem) by Thomas Mayer. Published by arrangement with the author. Copyright © 2012 by Thomas Mayer.