Why the Euro was doomed from the start and what to do about it

The crisis in the eurozone is a manufactured one. It isn't the result of there suddenly not being enough workers, social needs or a natural disaster. Worse, it was a predicable disaster. Put simply the currency union was based on political vision not economic fundamentals. The crisis brings out grinding debt-deflation that would make Irving Fisher bush. There is another crisis- one of government's inability to learn and adapt. There are good ideas out there but it requires listening to and evaluating ideas of those outside the mainstream who saw this coming. Here is Cambridge sociology professor Geoffrey Ingham on the euro (bold sentences are my emphasis):

As money is not a 'neutral vail', but rather a weapon in the 'economic battle of man with man' the legitimacy and effectiveness of any monetary system ultimately depend upon the enforcement and/or acceptability of a settlement between the major interests - that is to say creditors and rentiers, debtor classes of producers and consumers and the state itself. The potential weakness of the euro in the face of financial crisis is twofold. The first source of weakness as we have seen, stems from the absence of an overarching Europan political sovereignty that could speedily and unequivocally grant the European Central Bank the power to abandon the rules that might prove to be ineffective in a crisis. The second foreseeable source has the same basis. The Maastricht settlement, with its predominantly global creditors and money-capitalists, has been imposed on the other major nationally based interests - producers and consumers. Essentially the same regime is to be found across the capitalist world. But nowhere else are the constraints based on such inflexible stringent rules, and nowhere else do they exist in a sovereignty vacuum. In Goodhart's view, 'the defining moment for the eurozone will arrive when a (major) country is required by treaty to take deflationary fiscal action at a time when its economy is suffering the worse stagnation' (Goodhart 2003:194). Any individual state's non-compliance with the Maastricht conditions would effectively remove the credibility and political legitimacy of the euro. The response of the global money markets cannot be assessed with any confidence, but events in the euro's novel monetary space may well help to demystify the 'nature of money' more thoroughly.

As it is constituted by real social relations, money is an active element in social life- in Weber's terms, a weapon, as I have constantly stressed. The attribution of real force and efficiency to money does not entail a metaphysical nominalism, or, more prosaically in orthodox economics' terms, a 'money illusion'. This appears to be the case only if the economy system is taken to comprise nothing of importance other than the 'real' exchange ratios of commodities produced by individual optimizing strategies of economic agents. But this weapon, as we noted in the Introduction, is not only used despotically by the different interests in the constant economic struggle; it is also a collective resource - that is, infrastuctural power. The advance of human society's organizational capacity has been accelerated by changes in the social production of money - most notably by the balance of power between money-capitalists and the state in early modern Europe. As Weber also concluded, capitalism thrives on a delicate balance of its economic interests that prevents one group from achieving monopoly dominance. He believed that too great a concentration of power in the hands of one class -labour, producers, rentiers, etc - would inhibit the dynamism of the struggle. Following the conception of money as a neutral medium in a frictionless system of economic exchange, the Maastricht Treaty attempted to de-commission the weapon. By doing so, the European Union has temporarily enfeebled itself. The logic of the situation suggests - but of course can never determine - that it regains the power by placing its money in the hands of a sovereign body.

Source: Ingham, GI. (2004). The nature of money. Malden, MA: Polity Press.

There are many economists, even mainstream ones who saw the crisis coming. Lars Jonung and Eoin Drea's set out to find them for their paper Can’t Happen, It’s a Bad Idea, It Won’t Last: U.S. Economists on the EMU and the Euro, 1989-2002 What they discovered is that academic economists thought the euro didn't conform to to the optimum currency area and no mechanisms to deal with that problem were created. Economists at the Federal Reserve were even more skeptical because they took political considerations into account. Add to it the Maastricht treaty's caps on debt and deficits were set too low to allow automatic stabilizers to do their job in a severe recession.

There are ways to return to prosperity.

Option 1: Warren Mosler and I have long suggested the ECB distribute funds on a per capita basis to all member nation's governments. This will have the effect of bringing down interest rates on sovereign debt. It will not be inflationary for the same reason its not when American or Japanese or even Signapore's central bank buys government bonds. It is an asset swap. Savers will exchange government bonds for central bank reserves. If anything it is potentially less inflationary because reserves pay less interest as Scott Fullwiler points out. For there to be inflation a transaction must occur. The amount of transactions government is allowed to perform will still be limited by the Maastricht Treaty's deficit limits plus tax revenues. The debt limits can be adjusted to achieve economic goals. Enforcement can be handled by ECB witholding payments to nations which violate deficit limits. With the ECB being an active part of the solution, Eurozone governments can focus on serving the public purpose instead trying to pay for the budget by depressing wages, selling off valuable resources and cutting services to avoid high interest rates or default. In my view economic policy's success should be judged based on how it improves the lives of the least well off.

There should be some mechanism to balance trade because savings rates differ from country to country. Over time euros spent on imports leak out of trade deficit countries into trade surplus countries (more accurately current account deficit/surplus) and never come back causing the problems of insufficient aggregate demand over the entire euro zone, particularly in the trade deficit nations. If injections (Investment, Exports, Government Spending) are less than leakages (Saving, Imports, Taxes) the the country will enter a recession or depression.

Source: Europe's Web Of Debt Bill Marsh/NY Times

Option 2: Abandon the euro, restore old currencies and allow them to float. This will empower countries to be able to use their own labor and resources as they see fit. The government can spend on whatever is for sale in the domestic currency. They could implement a
job guarantee program, a tried and true powerful automatic stabilizer. The euro as it exists has many of the same flaws as the gold standard. It forces wages to fluctuate rather than the currency's exchange rate. It starves nations with a trade deficit of the funds it needs to sustain itself. In short, it deprives a nation of the ability to stabilize an unstable economy. If Ireland had its own floating currency, it won't need the permission of other euro governments to pay for Irish teachers, Irish police and whatever else they can produce internally. They won't need to cut wages or become more productive than the Germans in order to have competitive exports in order to acquire the euros needed to pay the teachers.

Both of these options require a major financial system overhaul so incentives for banks to make bad loans are eliminated. Neither option fixes the problems that corruption and wasteful government spending create. They will not solve all economic problems, protect the environment or help you lose weight. What they will do is break the power monopoly creditors have so governments can enact policies constant with price stability and full employment.

As Ed Hugh likes to point out, the demographics of Europe show that there will be an increasing burden on the pension system as the worker to retiree ratio becomes smaller. One way to manage this is to employ your whole workforce. That will spread the costs of retirees around. Another is to employ the workforce now. Talented workers are leaving their country in search of opportunities rather than stay at home unable to find a job. By tapping into their innovativeness more will be able to be produced in the future with less labor. The longer they wait to embark on this the more costly real social spending will be. These are not optional options. Careful people who have a habit of being right know that without major restructuring the eurozone is doomed.