Any hint that a country might dump the euro would trigger runs on banks, as depositors would seek to withdraw their euros. Banks would collapse. Deprived of buyers for their debt, countries would default. This would impose further losses on banks inside and outside the defaulting country. Without viable banks, borrowers would be starved for credit. There would be capital controls restricting the shift of funds abroad. If one country (say, Greece) left the euro, it might precipitate runs and capital flights elsewhere. Writing in the Financial Times, Citigroup chief economist Willem Buiter sketched this grim outlook:
“Disorderly sovereign defaults and eurozone exits . . . would drag down not just the European banking system but also the North Atlantic financial system. . . . The resulting financial crisis would trigger a global depression that would last for years, with GDP likely falling by more than 10 percent and unemployment in the West reaching 20 percent or more. Emerging markets would be dragged down too.”
Given these terrifying possibilities, hardly anyone is eager to tempt fate and see whether they might actually occur. Buiter himself rates the probability of this doomsday outcome at no more than 5 percent; the assumption is that European governments — or someone — will avoid this fate by continued bailouts (loans to weak governments). But this creates other problems. It imposes austerity on countries and removes control of their budgets to third parties: the European Union or the International Monetary Fund (IMF).
The logic is plain. If debtors need rescuing, then the rescuers ought to have some say over the policies that might cause trouble. Under the latest agreement among European leaders, member countries have to submit their budgets to Brussels to certify that any deficit does not breach a ceiling of 0.5 percent of national income. There would be some unspecified transition, because most budgets are now in violation.
The potential for intrusiveness — and resentment — is obvious. Brussels might order tax increases or spending cuts. National sovereignty over basic political choices is being outsourced. Too much power is being centralized away from nation states. A backlash against the idea of Europe is possible and probable.
So Europe is trapped in purgatory. What’s economically sensible is politically treacherous, and what’s politically sensible is economically treacherous. Moreover, the euro’s promise has been turned on its head.
When introduced in 1999, the euro’s overriding goal was clear. As an engine of shared prosperity, it would strengthen a common European consciousness. Germany’s power would be subordinated to the larger project of a united Europe. Now, everything is reversed: The euro is undermining Europe’s economy, sowing conflict (Britain has rejected the latest package) and elevating Germany — as the economically strongest state — to set terms for dealing with the crisis.
Much of this was predictable and, indeed, was predicted. Here’s a commentary of mine from 1997: “A single currency (the dollar) works in the United States because wages are flexible and workers are mobile. Workers move to find jobs. . . . Europe lacks these advantages. . . . One way countries can offset differences in competitiveness is through flexible exchange rates. . . . A single currency would eliminate this possibility.” Others, more eminent, issued similar warnings.
Because the euro’s economic advantages were oversold, it was also doomed politically. “The great potential tragedy here is that . . . (it) would spawn disunity.” Europeans “would quarrel over who’s to blame for the single currency’s failing to meet its inflated (and unrealistic) expectations. There would be disillusion with the larger idea of Europe.”
Perhaps Europe will overcome the present crisis through some combination of loans from the European Central Bank and the IMF along with policies to improve economic growth. This is the best imaginable outcome, and many others — much worse — are possible. But even the best result would not be very good for Europeans or for us. It would leave, as I noted back then, “a weakened, resentful Europe (that) would not make the partner America needs in the 21st century.”