Why the Euro is inherently problematic

The following from Mish Shedlock explains why the Euro has a lot of inherent problems that are not going away soon.  The whole Euro project was rushed and based on little more than idealism, optimism and hope.  The assumption 12 years ago that centuries of distinct-and often antagonistic-cultures and languages within Europe would melt away in short order was little more than wishful thinking.  I can tell you that the vast majority of Spanish people speak only Spanish and would not want to live anywhere except where they were born and grew up.  Only a very small elite is cosmopolitan and comfortable outside of Spain.  Many Spanish don´t even want to leave their region.

Please consider some pertinent snips from A Primer on the Euro Break-Up by Jonathan Tepper of Variant Perception.

Europe exemplifies a situation unfavourable to a common currency. It is composed of separate nations, speaking different languages, with different customs, and having citizens feeling far greater loyalty and attachment to their own country than to a common market or to the idea of Europe.

Professor Milton Friedman, The Times, November 19, 1997

Before the euro was created, Robert Mundell wrote about what made an optimal currency area. It is a groundbreaking work that won him a Nobel Prize. He wrote that a currency area is optimal when it has:

1. Mobility of capital and labor – Money and people have to be willing and able to move from one part of the currency area to another.
2. Flexibility of wages and prices – Prices need to be able to move downwards, not just upwards.
3. Similar business cycles – Countries should experience expansions and recessions at the same time (technically this is referred to as “symmetry” of economic shocks).
4. Fiscal transfers to cushion the blows of recession to any region – If one part of the currency area is doing poorly, the central government can step in and transfer money from other regions.

Europe has almost none of these characteristics. Very bluntly, that means it is not a good currency area.

The United States is a good currency union. It has the same coins and money in Alaska as it does in Florida and the same in California as it does in Maine. If you look at economic shocks, the United States absorbs them pretty well. If someone was unemployed in southern California in the early 1990s after the end of the Cold War defense cutbacks, or in Texas in the early 1980s after the oil boom turned to bust, they could pack their bags and go to a state that is growing. That is exactly what happened.

This doesn’t happen in Europe. Greeks don’t pack up and move to Finland. Greeks don’t speak Finnish. And if Americans had stayed in California or Texas, they would have received fiscal transfers from the central government to cushion the blow. There is no central European government that can make fiscal transfers. So the United States works because it has mobility of labor and capital, as well as fiscal shock absorbers.

The fundamental flaw of the euro is that it provides one monetary policy for the entire euro area. This has led towards wildly divergent real effective exchange rates and has produced asset bubbles. …


2 Responses to Why the Euro is inherently problematic

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