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History doesn't bode well for future of the Eurozone

Maintaining monetary union without real fiscal or political union eventually imposes unsustainable costs on someone.

June 27, 2012|Michael Hiltzik
  • Many experts claim to have foreseen the flaws in the euro at the time of its launch in 1999.
Many experts claim to have foreseen the flaws in the euro at the time of its…

Any traveler among the former French colonies of West Africa in the early 1990s could have foretold the future of the euro. The prospects weren't pretty.

Most countries of Francophone West Africa were then, as they are still, members of a single currency zone very much like the Eurozone. Legal tender for the 13 countries was a pair of essentially identical currencies known collectively as the CFA franc — named from the French acronym for "African Financial Community."

France, which kept the CFA fixed at an exchange rate of 50 CFA to one French franc, had created the zone partially to maintain political ties for its former colonies, but mostly to maintain its mercantile dominance. The CFA kept Francophone Africa economically dependent on France and gave the mother country a convenient market for its products and a source of cheap raw materials. A mandate that CFA countries keep large financial reserves in France fattened its treasury.

By 1990, however, the relationship turned into a subsidy from France to its faltering former colonies of as much $3 billion a year. As the individual African economies diverged, the CFA benefited rich countries, such as cocoa-producing Ivory Coast, and helped impoverish others, such as Senegal, whose major exports included peanuts.

Two schools of thought developed regarding the future of the CFA. One was that devaluation was inevitable. The other was that it was impossible — partially because of the difficulty of keeping the momentous change secret so insiders, including government leaders, couldn't profit from advance knowledge, and partially because the resulting fall in working-class living standards would foster unrest across the zone.

Inevitability finally prevailed. France instituted a devaluation in 1994, cutting the exchange rate of the CFA versus the franc to 100 to 1, with predictable consequences: Workers whose real income had been cut in half went on strike to double their wages. Inflation soared and unemployment spread throughout the zone. Governments tottered. And Africa's overall economic prospects barely budged.

Sound familiar?

The lesson of the CFA for the Eurozone is that maintaining monetary union without real fiscal or political union eventually imposes unsustainable costs on someone — in the CFA case it was France, in the Eurozone it's Germany. The bill payer eventually insists on changes to lower the bill, and those changes typically fall hardest on the workers stuck at the bottom of the economic pyramid. Bondholders and other investors who reaped profits in the good years will generally manage to protect their investments when things turn down, often by liquidating labor costs through the imposition of wage freezes and layoffs. You can think of Greece as the Senegal of the euro.

None of this really comes as a shock to professionals in international finance. Indeed, you could fill Dodger Stadium — or more appropriately, Paris' soccer venue, the 81,000-seat Stade de France — with the experts who claim today to have foreseen the flaws in the euro at the time of its launch in 1999. But these were papered over for more than a decade, or until the flaws turned into cracks and, ultimately, crevices.

The fundamental flaw is that the countries of the Eurozone, which comprises 17 members of the European Union and a handful of non-EU states, are simply too diverse, economically and politically. As David O. Beim, an expert in international finance at Columbia University, put it last October, "Germany and Greece should not share the same currency." The former is a highly efficient, low-inflation, export-oriented economy, the latter an inefficient, inflation-beset importer of goods.

Beim notes that in the 15 years before these two countries were yoked together in a single currency, the Greek drachma depreciated 82% against the German mark. What made the euro's architects think that this powerful trend would evaporate with the creation of the Eurozone? Wishful thinking, perhaps, but this is one way in which the euro appears to represent the triumph of hope over experience.

Economic diversity isn't in itself a recipe for currency failure. Some regions of the U.S. bear the same resemblance to one another as Greece and Germany. (Think of the Rust Belt versus Silicon Valley.) But they're united by a nationwide fiscal policy and a single monetary authority (the Federal Reserve). Not so the Eurozone, where unified policy decisions must yield to the sovereignty of its individual members and where, contrary to the hopes and wishes of the euro's creators, nationalism has been rising, not waning.

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