The Euro is an Abomination

A client recently commented to me that they thought a major part of the problem in managing the financial crisis in Europe has been the European Central Bank’s sole mandate to control inflation. This stands in contrast to the US Federal Reserve Bank’s “dual mandate” to minimize inflation and unemployment. Despite protests to the contrary – the ECB has effectively operating with a de facto dual mandate as it is increasingly interventionist in ways that make most “monetarists” weep.

It is true that if the ECB continued to only act in a manner to restrain inflation, they would have likely acted in a very differently over the last two years – and probably to Europe’s detriment. As the relatively monetarist economist Ann-Marie Meulendyke pointed out in a recent blog “Kicking the Can Down the Road Once More“:

Over time, governments control their deficits through tough decisions on what activities are appropriate for government spending, and by creating tax structures that finance that spending, are manageable to the economy, considered reasonably fair by the populace, and therefore, enforceable. Over shorter periods of time, deficits are also highly dependent on the state of the business cycle. The 3 percent limit could not really be expected to hold in a significant downturn, when tax revenues fall and welfare payments rise.

So, the ECB’s approach (even to monetarists) was probably too restrictive an envisioned, and the recent crisis have (probably) illustrated that fact, but the reason for that restriction was simple – the Euro really doesn’t make sense. As Meulendyke points out:

The Euro is such a contradiction, that it really shouldn’t work. Fiat currencies are traditionally seen as backed by a government that has taxing power, with the issuing central bank reporting to that government. Instead, the central bank that issues the Euro has voting representatives from all the countries that use it. The European Union government is weak and does not have traditional powers to tax and determine spending.

The real issue is that the standards established were overly restrictive because of the weakness of the central state. The rigid (and now very theoretical) standards imposed on member states meant that an overkill approach to fiscal discipline was the only reasonable way that the union could work. The problem was that there really wasn’t a consensus built around the role of the state and the relative responsibilities of individuals to that state in the form of taxation and what “reasonable” benefits should look like.

In the coming months, that consensus will either form among Europeans – or you will start to see a collapse in the union as the temporary measures collapse.