The creation of the euro was either the greatest historic achievement of the last centuryor its worst delusion.
Not to be glib, but the answer is both: The euro represents a magnificent step toward fulfilling moneys highest purposesto serve as a medium of exchange, a unit of account, and a store of valuebut its also fraught with problems borne of wrongly commingled economic objectives and political aspirations.
Hence, Europes single currency is proving both a boon and a bane to free market capitalism. While it facilitates economic transactions across borders and helps to optimize investment, the euros vulnerability to the bad behavior of individual member nations calls into question its ultimate dependability.
Howor whetherour allies across the Atlantic manage to resolve the fundamental conflict between providing sound money and bailing out spendthrift governments will have a crucial impact in determining Europes future. And our own.
At issue is whether government should be involved in the fundamental task of issuing a reliable form of money. Given that politicians have a penchant for short-term fiscal indulgence at the expense of long-term monetary stability, there is an obvious conflict of interest.
The Europeans opted to deal with this conundrum by designating a monetary authoritythe European Central Bankas a supranational institution ostensibly immune to political pressures that might emanate from member states. Focusing on price stability as its paramount objective, the ECB has done a laudable job resisting calls for easier monetary policy; in the 12 years since the euro was introduced, it has delivered inflation averaging about 2% annually and has gained stature as an alternative global reserve currency to the U.S. dollar.
But what to do now? With Greece flummoxed by strikes and social upheaval as it wrestles with a 12.7% budget deficit and potential debt default, its not clear to what extent fiscal profligacy will be resolved through monetary laxity. Asked whether the ECB would bail out Greece and other struggling European nations, ECB President Jean-Claude Trichet responded in a Fox Business Network interview last Friday: It is not the ECB which is at stake; it is the governments of Europe. They have said in their summit that they stood ready to do whatever was necessary to maintain financial stability in the euro area. I stick to that statement myself.
While Mr. Trichet is trying to draw a line between the monetary institution that stands behind the euro and the governments of the 16 nations that comprise the euro areaand whose central bank governors sit on the ECBs Governing Council, its main decision-making bodyit is not so easy to separate them.
The whole purpose of forging a single currency, after all, was to foster greater European economic integration. And the broader notion behind that concept, some five decades in the making, is that economic integration begets political integration. For a continent that suffered two devastating wars in the last century, it seems a most worthy goal; indeed, brochures distributed by the European Commission for purposes of explaining the history behind the euro carry the title: One Currency for One Europe.
If there were any doubt that Europes political fate is intertwined in the euros continued viability, it was dispelled by French President Nicolas Sarkozys observation, apropos of the Greek situation, earlier this month. We cannot let a country fall that is in the euro zone, he told French farmers. Otherwise, there was no point in creating the euro.
The United States faced a similar dilemma early in its own history. Confronted with the need to have a common currency among the newly-established states that had become a single sovereign nation following the Revolutionary War, yet wary of granting money powers to a federal Congress, the Founding Fathers chose to place limits on government to prevent it from abusing the public trust. Excessive money issuance through bills of credit issued by state governments to serve as legal tender had already proven to lead to financial disaster; unless money was defined in precise terms to determine its value, it could not function as a meaningful unit of account.
In other words, money was to be a standard in the same way that official weights and measures were standards. States could not debase money for political reasons or to surreptitiously reduce their debts. In the debate over the governments proper monetary role in 1784, Thomas Jefferson asserted, If we determine that a dollar shall be our unit, we must then say with precision what a dollar is.
In the Constitution adopted three years later, legal tender coinage was limited to gold and silver. Congress was given the power to coin money and to regulate its valuethat is, to specify the legal value of the coins in terms of a number of dollars. While Congress was permitted to borrow money on the credit of the United States, this was strictly a fiscal power that had nothing to do with creating money.
All of which suggests that Europeand Americawould do well to tap the wisdom of the past in seeking to fulfill its political destiny without sacrificing its monetary integrity. Contrary to George Soross pronouncement that the euro is flawed because there is a common central bank, but you dont have a common treasury, the way to save the euro is to remove it even further from the compromising process of government fiscal policy.
Its interesting that Mr. Trichet, lamenting that finance lost contact with its raison detre in a March 12 speech at Stanford University, invoked lessons from an earlier era. There is a widespread perception that banking crises in times when money was convertible into gold had apocalyptic consequences for bank depositors. This is not true. The estimated average loss on assets born by depositors in banks that were closed down as a consequence of financial crisis was minuscule.
Mr. Trichet cited the importance of well-capitalized banks to defend against financial innovation that has come to serve itself rather than the real economy, and placed his faith in more international regulation. While he is right to worry about our increasingly wag-the-dog world of speculative finance, the way to reconnect financial flows with productive enterprise is to empower individuals through honest money.
Capitalism needs a sound monetary foundation to function properly. Its something our Founders worked out a long time ago.