The man who predicted the European debt crisis
By Charles Lane,
Europe’s financial crisis is rapidly metastasizing into a political one, and the coherence of the European Union is more doubtful than at any previous time in recent memory.
That’s the meaning of last week’s European summit, in which 26 leaders either accepted a German-French plan for tight fiscal discipline or agreed to consider it — while British Prime Minister David Cameron said no, amid nationalistic finger-pointing across the continent.
Europe’s politicians are making a hash out of the once-proud project of United Europe, and, in the process, making a prophet out of Martin Feldstein.
In 1997, before the first euro note had rolled off the presses, the Harvard economist surveyed Europe’s plans for a single currency and, in a lengthy essay in Foreign Affairs, predicted that they would come to grief.
Like many of his colleagues, Feldstein doubted the single currency’s economic viability absent political and fiscal union.
What Feldstein saw with special clarity, though, was the disaster that would ensue even — or perhaps especially — if Europe tried to increase political and fiscal union for the sake of monetary union.
As Feldstein wrote: “A political union of European nations is conceived of as a way of reducing the risk of another intra-European war among the individual nation-states. But the attempt to manage a monetary union and the subsequent development of a political union are more likely to have the opposite effect. Instead of increasing intra-European harmony and global peace, the shift to [monetary union] and the political integration that would follow it would be more likely to lead to increased conflicts within Europe and between Europe and the United States.”
Feldstein foresaw that the trigger for political tension would be a sharp economic downturn, imposing different levels of unemployment on different members of the monetary union, because high-unemployment countries could not recover their competitiveness through currency devaluation.
The ensuing “conflicts over economic policies and interference with national sovereignty could reinforce long-standing animosities based on history, nationality, and religion,” Feldstein warned. “Germany’s assertion that it needs to be contained in a larger European political entity is itself a warning. Would such a structure contain Germany, or tempt it to exercise hegemonic leadership?”
Sounds like a summary of Europe’s current predicament.
Britain is divided between euro-skeptics who think Cameron is a national hero and europhiles who think he has severed their ties to the huge continental market. In France, meanwhile, President Nicolas Sarkozy responds to criticism of his alleged subservience to Germany by claiming a compensatory victory over the financiers of perfidious Albion.
German Chancellor Angela Merkel pursues her long-term plan for a European budget-balancing rule, untroubled, it seems, by the fact that this is a recipe for ruinous austerity in the short run.
Merkel, like many of her countrymen, cannot or will not see that southern Europe’s debt crisis is the mirror image of Germany’s immense trade surpluses, and that Germany, too, must adjust if the euro is to be saved.
A recent PricewaterhouseCoopers report lays out four possible endgames. In the most benign, the European Central Bank takes mass quantities of bad debt onto its balance sheet and Europe avoids a depression at the expense of higher inflation and slower long-run growth.
The only difference among the other choices — organized default by the euro zone’s biggest debtors; a Greek exit from the euro; and the rise of a new, smaller euro zone led by France and Germany — is the depth of the recession each would trigger.
In 1997, Feldstein thought that a failed currency union could lead to war. That seems far-fetched, even now.
But today’s blame game among Europe’s politicians may soon seem mild indeed. A full-scale backlash against the EU, and its Franco-German leadership, can hardly be ruled out.
Europe could become a much more troubled and self-absorbed region — less able either to counter the United States in world affairs or to support it. The collateral damage to the U.S. economy from a European slump may exacerbate transatlantic tensions.
Postwar Europe was right to forge a single market and common international stance. But the single currency was a bridge too far. Instead of creating a Europe wealthier and more diplomatically potent than the sum of its parts, the euro is impoverishing much of the continent and reducing it, once again, to a squabbling gaggle of nation-states. They should have listened to Feldstein.