– Mark Twain
That the euro has fallen into crisis a mere decade after its introduction is hardly surprising. The intrinsic problems in its design were evident to economists as widely separated intellectually as the British euro pessimist Wynne Godley and the American 'father of monetarism', Milton Friedman.
Writing in 1992, Godley observed that: "The central idea of the Maastricht Treaty is that the EC countries should move towards an economic and monetary union, with a single currency managed by an independent central bank. But how is the rest of economic policy to be run? As the treaty proposes no new institutions other than a European bank, its sponsors must suppose that nothing more is needed. But this could only be correct if modern economies were self-adjusting systems that didn’t need any management at all."
"I am driven to the conclusion that such a view – that economies are self-righting organisms which never under any circumstances need management at all – did indeed determine the way in which the Maastricht Treaty was framed," he added. "All that can legitimately be done, according to this view, is to control the money supply and balance the budget… If a country or region has no power to devalue, and if it is not the beneficiary of a system of fiscal equalisation, then there is nothing to stop it suffering a process of cumulative and terminal decline leading, in the end, to emigration as the only alternative to poverty or starvation."
As the father of monetarism, Friedman can be counted as one who did believe that "all that can legitimately be done is to control the money supply and balance the budget”. Yet in 1997, he too disparaged the prospects for the euro, because Europe did not meet the requirements for a successful currency union.
"A common currency is an excellent monetary arrangement under some circumstances, a poor monetary arrangement under others…," Friedman said. "Europe’s common market exemplifies a situation that is unfavourable to a common currency. It is composed of separate nations, whose residents … have far greater loyalty and attachment to their own country than to … the idea of "Europe.”… goods move less freely than in the United States, and so does capital. The European Commission … spends a small fraction of the total spent by governments in the member countries. They, not the European Union’s bureaucracies, are the important political entities… wages and prices in Europe are more rigid, and labour less mobile. In those circumstances, flexible exchange rates provide an extremely useful adjustment mechanism."
One might hope that, with economists as disparate as Godley and Friedman able to so easily agree that the euro was always a bad idea, its unwinding – or at least the addition of the missing elements from a genuine common currency, such as fiscal union – could also be easily achieved. But current events indicate that Europe may persist with its unsustainable system until the social collapse and political disunity that Godley and Friedman anticipated finally destroys perhaps even the EEC itself.
There are many political reasons for this dogged determination to follow folly to its end – including the disparate benefits and costs of the euro to different countries, the inherent inertia in multi-country political agreements, and Weimar Republic-based fears that fiscal expansion will cause hyperinflation.
But economic theory has also played a role, by promulgating the belief that government debt should be constrained, while private debt can be left unmonitored. This belief was entrenched in the Maastricht Treaty’s limits on public debt, and is being enforced today via the selective imposition of austerity programs on the weaker economies that are in breach of these limits.
Table 1: Selective enforcement of Maastricht rules; countries not in breach shown in italics (OCED Data)
|Country||Debt 2010||Deficit 2012|
The root of this belief is the Neoclassical 'exogenous' model of money creation, in which, as Friedman said, "nothing is so unimportant as the quantity of money expressed in terms of the nominal monetary unit.” According to this belief, the money supply is determined by the actions of the central bank, the level of private debt is determined by the supply of and demand for loanable funds, and private banks, as mere intermediaries between savers and borrowers in the loanable funds market, can be ignored in macroeconomics.
Ironically, though belief in this vision of money played a major role in the design of the European Monetary Union, and it is accepted by neoclassical economists who argue for austerity as the solution to the crisis, it is also adhered to by neoclassical critics of austerity. With unabashed hubris, this latter group – the self-described New Keynesians – are now claiming to be vindicated by the crisis, while appropriating Hyman Minsky and casting themselves as the future of economics in the process.
"We economists who are steeped in economic and financial history – and aware of the history of economic thought concerning financial crises and their effects – have reason to be proud of our analyses over the past five years," Project Syndicate columnist and former US Treasury Department deputy assistant secretary Brad deLong argues.
"So the big lesson is simple: trust those who work in the tradition of Walter Bagehot, Hyman Minsky, and Charles Kindleberger," he says. "That means trusting economists like Paul Krugman, Paul Romer, Gary Gorton, Carmen Reinhart, Ken Rogoff, Raghuram Rajan, Larry Summers, Barry Eichengreen, Olivier Blanchard, and their peers. Just as they got the recent past right, so they are the ones most likely to get the distribution of possible futures right."
The revisionism in this argument is breathtaking.
While there is no certainty that this Neoclassical juggernaut can be stopped, it is certain that it will roll over non-Neoclassical opposition unless a coherent, empirically accurate, and compelling alternative theory is given proper consideration.
Steve Keen is a professor of economics and finance at the University of Western Sydney and author of Debunking Economics and the blog Debtwatch.