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The Euro's Problems Have Been There from the Start

The euro, the EU's best known product, launched with so many inherent problems it should have been named the Edsel. It was based largely on wishful thinking, and in many respects it's a miracle it has survived as long as it has.

The EU is a bold and, in many ways, successful experiment in international relations. Its primary purpose has always been to prevent World War II: The Sequel. That mission has been accomplished. There has not been a war between the powers of Europe for nearly 70 years. I'm not sure the last time this happened, but I think the date has the letters "B.C." at the end of it. It has done this by knitting together the nations of Europe by making it ever easier for goods and services to cross the borders of its member states.

Unfortunately, the EU ideal fell prey to the institutional equivalent of the Peter Principle. It got promoted into things it had no business doing (at least in its current shape).

A brief history of "Europe"
The EU and the euro can both trace their origins to 1957's Treaty of Rome, which established what was then known as the "Common Market" to promote economic prosperity. Thirty-five years later the interested parties signed the Maastricht Treaty and the European Union was born with the ultimate aim of introducing a single currency -- which it did in 1999.
In doing so, the governments of Europe didn't just put the cart before the horse -- they put the cart before the discovery of the horse. This currency has never had the political power or institutions needed to make it work. Even though there is a central bank that issues euros, it's never been very clear what they are being issued against.

To understand this, let's look at our own currency. Dollars are issued against the "full faith and credit of the United States." That is, the market assigns them value based on the perceived economic strength of all the states together. (Many people get nervous when they figure out that money is a collective illusion. This is a reasonable reaction.) This happens because the federal government is viewed as being responsible for the nation in total. It can make laws about spending and taxation across all 50 states, which is pretty good backing for the money it issues.

Until recently, euros were perceived in the markets as standing for the economic strength of all its members. Now people aren't so sure what the euro represents. This was bound to happen.

Europe like Oakland: No "there" there
The European Central Bank has no power to promote economic growth by regulating the taxing or spending of its members. It can issue money and loan money and it can set key interest rates. That's it. It cannot set taxes or control spending. It is not supposed to be able to buy debt, but it has started doing that anyway. All it can do is set guidelines for how much debt each member nation is supposed to have. Penalties for non-compliance are, well, non-existent. Once they admit you to the club, they can't kick you out.

So the euro is not based on the ECB's ability to ensure that enough taxes are collected to repay debts. (Unlike the U.S., that is, where, um, we don't collect enough taxes to pay our debts. Let's ignore that for now and hope the rest of the world continues to do the same.) It is based on the value of the assets held by the ECB. Those assets include the bonds each nation pledges to the ECB in return for currency. As with the American mortgage market, this worked fine as long as times were good.

As we know, Greek bonds are not worth as much as German bonds -- so the stronger economies must bear the burden of the weaker ones.

In 1998, UK Foreign Secretary William Hague called the euro, "A burning building with no exits." This week he told The Spectator magazine:

I described the euro as a burning building with no exits and so it has proved for some of the countries in it. Greeks or Italians or Portuguese have to accept some very big changes in what happens in their country, even bigger than if they weren't in the euro, and Germans will have to accept that they are going to subsidize those countries for a long time to come really, for the rest of their lifetimes.
Saying "I told you so" isn't always pleasant.


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