Prominent American economists are weighing in on the Greek debt crisis, with more than a hint of schadenfreude. The title of a New York Times op-ed by Gregory Mankiw says it all in one smarmy sentence. “They told you so: Economists were Right To Doubt the Euro.” Economists are condescendingly scolding the Europeans for venturing into a single currency without the proper underlying economic conditions. Paul Krugman has relentlessly excoriated the leaders of Europe for being what he calls “self-indulgent politicians” who have “spent a quarter-century trying to run Europe on the basis of fantasy economics.” The conventional wisdom seems to be that the problems of the euro zone are, as economist Martin Feldstein once put it, “the inevitable consequence of imposing a single currency on a very heterogeneous group of countries.”
What this commentary gets wrong, however, is that single currencies are never the product of debates about optimal economic solutions. Instead, currencies like the U.S. dollar itself are the result of political battles, where motivated actors try to centralize power. This has most often occurred “through iron and blood,” as Otto van Bismarck, the unifier of Germany put it, as a result of catastrophic wars. Smaller geographic units were brought together to build the modern nation state, with a unified fiscal system, a common national language that was often imposed by force, a unified legal system, and, a single currency. Put differently (with apologies to sociologist Charles Tilly), war makes the state, and the state makes the currency.
The U.S. case is instructive. America used to have a chaotic multitude of state currencies and privately issued bank notes, with complex exchange rates between them. This only changed thanks to the Civil War. The American greenback was created in 1863 when Abraham Lincoln’s Republican Party muscled through legislation giving the federal government exclusive currency rights. It was only able to do this because Southern legislators, who opposed more centralization of power, had seceded from the American union. The Union side wanted a common currency to help the war effort by rationalizing revenue raising and wartime payments. But it was also a potent symbol of the power of the federal state in the face of the challenges of a disintegrating union.
All of the institutions that saved America’s common currency from Krugman’s “fantasy economics” were the result of hard fought political battles. The U.S. already had some of the building blocks for a fiscal union. Alexander Hamilton, the country’s first secretary of the treasury, prioritized the ability to issue and raise debt at the federal level and build a robust financial system. Randall Henning and Martin Kessler have documented the vitriolic 19th century fights over federal bailouts of the U.S. states, which finally resulted in state level balanced budget rules, but only as part of a bargain over increased federal fiscal relief. Banking union in the United States likewise took a long period of time to build, and only came about as a result of a series of horrific financial crises, culminating in the Great Depression. Most strikingly, the U.S. did not have a permanent national bank until the U.S. Federal Reserve was finally set up in 1913. A series of severe financial crises had created political will to centralize monetary power in a federal reserve board. Even so, the Fed still stayed at the center of a federal system of regional banks.
Economists argue about whether U.S. institutions provide a good model for Europe. Josh Barro, in the Upshot column at the New York Times, explicitly compares the euro zone to the U.S. federal system, arguing that fiscal redistribution can cushion the impacts of crisis. Martin Sanbu of the Financial Times disagrees, and claims that fiscal union is not as necessary as American economists believe. However, Barro doesn’t really appreciate the historical conditions that allow a single currency to come to life, while Sanbu is wrong on the timing of U.S. fiscal history Both these accounts lose sight of the broader reality: that money has always and everywhere been part of broader projects of political consolidation. This means that it has always been highly contentious.
European leaders weren’t stupid or self indulgent when they decided to move ahead with the euro, without fiscal union or strong Europe-level democracy. They just cared more about politics and international security than economics. They wanted to build a Europe that had transcended the divisions of the Cold War, and bind together Germany, which was reunited and much more powerful, with the rest of Europe. When they did think about economics, they hoped that a strong euro, anchored in an independent European Central Bank located in Frankfurt and built on a commitment to protecting the stability of the currency, would help resolve the problems of currency depreciation, spiraling inflation and economic instability that came with the weak currencies of the “Club Med” countries to the south of Europe.
European leaders, the IMF and the European Commission have done a terrible job at handling the Greek debt crisis. However, criticizing the euro because it doesn’t meet the ideal economic conditions for a single currency is missing the point. The same is true of every project to create a common political system. History does not unfold as a series of neat and sterile decisions made by people rationally trying to create economically optimal policies. It emerges through political struggle and hard bargaining, in which people fight to try to reshape politics, recognizing that even their greatest victories are likely to be messy and inefficient, but hoping that their successors will be able to improve on them. That was the history of the U.S. dollar. We’re still waiting to see whether it will be the history of the euro.
Kathleen R. McNamara is associate professor and Director of the Mortara Center for International Studies at Georgetown University and the author of “The Politics of Everyday Europe: Constructing Authority in the European Union.”