We have been so critical of the euro, the ECB, and the spendthrift socialist states in the eurozone that perhaps we have missed something important. On the one hand, things haven’t worked out as envisioned by the Maastricht Treaty and there is a lot of political upheaval in Europe. Another way to look at it is that it has imposed a discipline on member states that forces them to accept the logical consequences of their policies.
Pre-euro, each state had control over their money supply and when they ran into fiscal trouble they could always monetize their debt by printing money and buying, directly or indirectly, their own sovereign debt. The outcome was always price inflation, but rarely bankruptcy, or if bankruptcy, it was an event that occurred farther down the road.
When the European Monetary Union was established, each member country had to give up some sovereignty by ceding the European Central Bank the authority to create money. In addition there were fiscal requirements each state had to meet, but they were ignored which is, of course, why they are in a crisis.
By giving up the right to print its own currency a state couldn’t inflate its way out of fiscal deficits. But that didn’t stop them from spending. So now they have no way to avoid a crisis and they are being forced to deal with their fiscal issues. Which is as it should be. If Greece defaults, which I believe they will (technically they already have), the country will be forced into fiscal sanity by cutting spending, reforming their public sector, liberalizing their economy, and booting out those politicians who encouraged their profligacy. Which is what is occurring now. It wouldn’t have happened if they controlled their own currency.
The condition to this discipline is that the ECB doesn’t print money and monetize sovereign debt of member states. While they have done some of this, there seems to be political resistance to debt monetization, mainly from Germany and France. They had better make sure it continues that way.
The risk is that the EMU falls apart. That could happen if because of political upheaval in the affected states, regimes hostile to such monetary discipline are elected and opt out. This would allow them to pursue the road to monetary inflation, but politicians look no farther than the next election and expediency will win over ultimate consequences. “In the long run we are all dead.” — J. M. Keynes.