The Brutal Battle over the Euro

The Harvard economist Kenneth Rogoff once told me, “Europe is like a couple that wasn’t sure they wanted to get married, so instead they decided to just open a joint checking account and see how things went.” Things went badly, as evidenced by the eurozone’s continuing struggle to move beyond its debt woes and toward any kind of sustained growth in the wake of the 2008 financial crisis. If Rogoff, author of The Curse of Cash,¹ had his way, the euro might not exist—at least in paper or coin form. He argues for getting rid of hard currency of all kinds, not only to combat money laundering and tax evasion, but to allow governments around the world more latitude to run the sort of negative interest rates that will likely be needed to create any growth in the future. But that wouldn’t solve the core issue—a dysfunctional cross-cultural relationship at the heart of the EU. Europe is stuck in a conflict between, depending on how you think about it, France and Germany, or Germany and everyone else.

The central problem is that Germany wants everyone to be more German, meaning thrifty, stable, and willing to observe rules. France, Italy, and many other European states feel that, hey, everyone needs to be cut a bit of budgetary slack now and again. (The main reason Germany is flush, after all, is that the rest of Europe buys its exports, which would be much less likely to happen without a common currency.) The union should share and share alike.

As in every relationship, the truth is somewhere in between. But as the latest round of the eurozone crisis—including trouble at Europe’s largest and most systemically important financial institution, Deutsche Bank, as well as mounting worries over Italian banks and sovereign debt—has made clear, the eurozone continues to suffer from la douleur exquise, struggling to craft a happy union that would benefit all partners, economically and politically.

That’s bad news for us all, since Europe represents about a third of the global economy, which still hasn’t regained its pre-2008 momentum. (Global growth is lethargic and many European countries are struggling to stay out of recession.) The eurozone crisis is a huge blow to the post–World War II order, since the EU is the most benign version of globalization ever attempted. It’s what historian Arthur Schlesinger might have deemed a “crisis of the old order,” which is in this case the neoliberal economic idea that goods, people, and (especially) capital should be able to flow as they will, regardless of national borders. That’s an idea that is now under threat nearly everywhere. Even the International Monetary Fund (IMF) itself, once the standard-bearer of pro-market wisdom, recently released a paper acknowledging that neoliberalism may have been “oversold,” resulting in more inequality as well as economic and political fragility.

As Nobel laureate Joseph E. Stiglitz points out in his recent book The Euro: How a Common Currency Threatens the Future of Europe, the mythology of market fundamentalism certainly skewed the European project from the beginning. Stiglitz, a critic of status quo globalization even before his time at the IMF (during which he produced Globalization and Its Discontents²), explains why the eurozone is basically an economic marriage of convenience rather than a deep political union: its structure was based on the classical economic ideas of Adam Smith and David Ricardo, who held that one need simply create a larger, single market out of a variety of smaller ones in order to make an economy prosperous. Currency, rather than collective political commitment to shared institutions and ideas—for example, a more effective parliament, a banking union, or even eurobonds—was enough to buoy the ship. (As someone who covered any number of euphoric euro launch parties as a European correspondent in 1999, I now feel something like a spectator who watched the Titanic set sail.)

Stiglitz’s verdict is convincing:

The founders of the euro were guided by a set of ideas, notions about how economies function, that were fashionable at the time but that were simply wrong.

They put their faith in markets but “lacked an understanding of the limitations of markets and what was required to make them work.” That lack of understanding included everything from the difficulty of maintaining a shared currency in tough economic times, when some countries might need to devalue their money to survive, to the fact that a lack of shared fiscal policy would make it impossible to transfer wealth (via tax receipts) from richer states to poorer ones, ensuring growing economic inequality between the core and the periphery of Europe.

The bottom line: economic globalization ran ahead of political globalization, with consequences that now range from Brexit and the rise of far-right parties in France, Greece, Germany, and elsewhere, to what will likely be a Japan-style “lost decade” of slow growth and high unemployment in Europe (which will of course only fuel even more partisan politics). The problem of youth unemployment, still in double digits in many countries, is particularly pressing. I am reminded of the one-word answer a former Greek finance minister gave me a few years back, when I asked his advice for millennials struggling with what was then 60 percent unemployment: “Emigrate.”

Stiglitz argues persuasively that it never had to come to this, because a shared currency was never really required for a shared Europe, a project that he deeply supports. Europe could have focused more tightly on a common foreign policy, defense, trade, social safety nets, labor standards, and so on, rather than grasping for the tantalizing low-hanging fruit of monetary union crafted by a group of elite technocrats. More popular political support for such ideas prior to the formation of a currency zone that locked all nations into a fixed interest rate, thus artificially constraining their ability to manage their own economies (and ultimately, their politics), might have resulted in a Europe without, as Stiglitz puts it, such a “democratic deficit.” That in turn would have made it easier to manage the eurozone crisis itself.

Stiglitz doesn’t argue that any of this would have been easy. It’s telling that throughout the two-decade-plus process of creating the eurozone, national referendums on issues like the euro and the European Constitution always revealed significant anti-EU sentiment. Even prior to 2008, large numbers of Europeans were uncomfortable with the idea of more Europe. And yet economic integration without political integration was never likely to work.

Once the fatal decision to form a currency union was made in 1992, problems were compounded by a battle of ideas between Germany, the economic powerhouse of the continent, and France. Those battles had, of course, been going on for some time. The struggle between these nations during World War II resulted in the first steps toward European integration through the Coal and Steel Community of 1951, which was an effort to create economic interdependency so that countries would stop fighting destructive wars—involving either trade or shooting—with one another. But unsurprisingly in such a heterogeneous continent, political, cultural, and social agendas diverged.

In The Euro and the Battle of Ideas, the economists Markus K. Brunnermeier, Harold James, and Jean-Pierre Landau turn a sharp lens on the basic divide between France and Germany. Germans expected that Europe would be built around a culture committed to fixed rules and fiscal prudence. As one regional finance minister in Stuttgart, the heart of Germany’s famous world-beating export industry, told me firmly in 2013, “Balancing our own budgets is the solidarity that we show to Europe; it’s right and good that we do so.”

Memories of the Weimar Republic mean inflation is verboten; many Germans can’t stand the notion of the European Central Bank printing more money, even when growth is so weak that any inflation at all would be welcome in order not only to raise wages, but to decrease the size of the national debts. Debt is to be gotten rid of quickly, preferably by austerity. But of course, when the public and private sectors of all countries attempt austerity at once, the math simply doesn’t work, something that has become painfully obvious in Europe since 2008; as we’ve noted, no nation can grow when the consumer, the corporate sector, and the public sector all stop spending.

The French, meanwhile, see solidarity through the lens of social obligation. As the authors of The Euro and the Battle of Ideas point out, paragraph 21 of the 1793 Declaration of the Rights of Man and Citizen—“the ultimate statement of the ideals of the French Revolution—states that ‘Public relief is a sacred debt. Society owes maintenance to unfortunate citizens.’” While the Germans were focused on a union built around price stability, which they assumed could create real financial stability, the French wanted to expand their own system of a more managed economy; richer nations could and would bail out poorer ones, or better yet, help buoy them with investments in their infrastructure, social safety nets, etc. “Monetary union…would be the Trojan horse that would carry French thinking into the heart of all of Europe,” write the authors of The Euro and the Battle of Ideas.

The 2008 crisis, of course, upended all the Panglossian pretense. It also put Germany, a net creditor, explicitly in the position of control. Very quickly, the story of the eurozone crisis turned into a morality play. Angela Merkel was cast as the thrifty Swabian housewife, protecting Germany’s middle-class prosperity and values. If only Europe followed our example, the message went, there wouldn’t be a crisis for us to fix—but now that the crisis is upon us, Europe should follow us to salvation by trimming budgets and cutting services, even in the midst of a recession, whatever the social and political cost.

Germany, the only country in the rich world to enjoy higher economic growth and lower unemployment after the global financial crisis than it did before, would eventually pay tens of billions of euros for bailouts in countries like Greece, as well as implicitly or explicitly backing hundreds of billions more of debt restructuring and stimulus efforts by the European Central Bank—but only in exchange for austerity plans in which other nations would reduce wages and benefits, slash budgets, and shrink debts.

Yet this logic failed to take into account that Germany grew rich because other Europeans spent freely while Germany practiced austerity. When the Germans suppressed wages in the 1990s in order to bolster their export economy and spur growth, its policies had terrible ramifications for the rest of the eurozone. While Germans sold relatively more and consumed much less thanks to their lower wages, everyone else was forced to do the reverse. Germans got richer, but everyone else got into debt.

There are plenty of examples of free-spending southern European nations that should have managed their public finances much, much better—Greece is the most notable, but Italy, Spain, Portugal, and even France fall into the same category. But the truth is that Germany’s own mercantilist economic strategy has played an even larger part in the European debt crisis. Basic economic logic holds that current account balances between countries must be equal. As German trade surpluses rose, deficits in the rest of Europe increased. If countries like Italy or France are to trim budgets and spend less, Germans must spend more (which would require a huge cultural shift), or agree to more integration, which would involve things like explicit fiscal transfers to poorer nations—the sort that California, for example, regularly makes to Kentucky.

So far, Germany has been willing to do neither. And of course the pressure from other political problems, most notably the migrant crisis (Merkel’s initial, brave action on that score may cost her the chancellorship), make it harder and harder to convince the German public and policymakers that more European togetherness should be the aim of Germany—which is ultimately the only country with the economic clout to hold the currency union together.

It also underscores something darker and more cynical: a growing belief among a large proportion of Europe that the eurozone is a selfish union, a system that not only benefits Germany disproportionately, but benefits the elites, and in particular the financial elites, most of all. This interpretation hasn’t been helped by the way in which the bailouts of countries such as Greece were handled. There was, as described above, a real blame-the-victim tone to the financial problems of the countries on the periphery.

Yet as the authors of The Euro and the Battle of Ideas wisely note, German and French banks were the largest holders of Greek debt. Bailing out Greece wasn’t just neighborly kindness—it was also a way of orchestrating a back-door bailout of rich countries’ banking systems. On this score, the Germans in particular look hypocritical, since their banks spent much of the prosperous years leading up to the crisis trading in risky debt products, such as subprime mortgages, that blew up after 2008. Southern Europeans, eager to paper over the economic woes that were an inevitable part of a badly structured union, were only too eager to take the credit being offered by the “prudent” Germans. Indeed, German, French, and Dutch politicians alike are currently in an unseemly regulatory race to the bottom to try to attract the financial business that is very likely to leave London post-Brexit.

No wonder there’s a loss of faith among populations told to put their trust in the euro by technocrats who fly 35,000 feet over individual nation-states and don’t have to live with the realities of mass youth unemployment, a looming pensions crisis, the difficulties of successfully integrating immigrants, and the ongoing threat of recession. Economic globalization has run ahead of political globalization—not just in Europe but nearly everywhere.

Stiglitz argues that there are still ways to patch up the existing union—if only Germany could acknowledge its part in the crisis, and if stronger institutions could be created to support the eurozone (starting with a real banking union and mutually shared debt), then the economics of the situation would be managed. Indeed, more togetherness would help solve not only the debt crisis, but potentially the migrant problem (if there were a broader range of European countries with strong economies, migrants wouldn’t have landed disproportionately in Germany) and the threat of Russia (a fractured Europe is an easy target for Vladimir Putin, a petro-autocrat looking to distract his own population from problems at home).

Yet Stiglitz, who also sketches out a halfway solution of a “flexible” euro that might allow countries to have more exchange-rate control, has little hope that the changes needed to preserve the eurozone will be made. Brexit, the fall of centrist parties throughout Europe, as well as regional independence movements in Spain and elsewhere, suggest a “significant probability” that more countries will pull out. Unfortunately, those are unlikely to include Germany, which would actually be best placed to execute an orderly unwinding of the eurozone by going back to the deutschmark and giving up some of the disproportionate benefits to its export sector that it has enjoyed under the euro. (Italy, which also has a strong manufacturing sector, would see an immediate uptick in its own economic competitiveness.)

Sadly, the most likely solution is a continuation of the muddle-through approach, punctuated by more emergencies, as in Greece or Cyprus, that push the stability of the union to the breaking point. In view of the other major problems in the global economy (slow growth in the US, a debt-ridden China, rising inequality and fractious politics in any number of countries), there’s a risk of the floodgates opening up. “That these dramatic events would have profound economic and political consequences not just for Europe but for the world is an understatement,” writes Stiglitz. Translation: we should brace ourselves, over the next few years, for what may be a difficult economic divorce.