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The euro
June 2010


When I was eight years old, I was given a book about the kings and queens of England. My favourite picture showed King Canute sitting on a throne at the beach holding his hands up to the incoming tide in a successful demonstration of his inability to turn it back. Canute's courtiers had apparently believed that his majestic qualities enabled him to suspend the laws of nature.

I interpreted the story as a hilarious example of man's hubris, of the absurd power people will ascribe to the mere will of their dear leaders (and in some cases, though not Canute's, of the absurd hubris of the leaders themselves). For years, I thought everyone interpreted it thus. But many were laughing only at ancient regal hubris. Substitute a modern variety of dear leader — an elected president or an unelected European Commissioner — and they are happy to believe that reality will yield to his glorious intentions.

We are now watching the tide of economic reality lapping over the thrones of those dear leaders who took their countries into the euro. Hundreds of billions of euros are being confiscated from European taxpayers for the sake of saving the currency. This must disappoint the neo-Canutists because it was supposed to be the other way around. The euro was supposed to save the people of Europe. 

Before the introduction of the euro, many warned that it was unlikely to work. Where there is a single currency, there is a single rate of interest (for any given term or maturity). Different borrowers pay different rates, but this reflects only their "risk premium" on the underlying "risk-free rate". 

Within any economy with a single currency the ideal rate of interest may vary from region to region. Roughly, rates should be higher in those regions where consumption is higher. So, inevitably, some regions will have the wrong rate of interest. Within the UK, the north would sometimes have benefited from lower rates than London. And, as everyone now knows, in the eurozone, interest rates have been too low in the so-called Pigs (Portugal, Ireland, Greece and Spain). 

In an optimal currency zone this problem is ameliorated by three things. First, the regional economies are not overly divergent. They usually experience trends or shocks that require interest rate changes in the same direction at the same time. Second, there are low barriers to labour mobility between the regions. Third, there are automatic "fiscal transfers" between the regions. When the north of England suffers and London thrives, tax money flows out of London and into Newcastle as social welfare spending. None of these conditions is satisfied by the eurozone. Its states should not share a single currency. Consider Germany and Greece. Their economies are highly divergent. The law may allow Greeks to move to Germany but their different languages and education create high barriers. Nor do German taxes fund Greek social welfare or vice versa.  

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June 3rd, 2010
7:06 PM
Agreed. But the obstacles to the survival of the Euro are even greater - and more intangible, too. European economic union, with no matter how many bells and whistles, will not work without a European nation. Only this would allow the depressed regions to acquiesce in long-term depression. I've written more here:

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