Friday, August 03, 2012
July 31st was Milton Friedman’s 100th birthday, and his
birthday present is to watch the ‘European Project’ come crashing to the
ground, just as he predicted that it would. I doubt that it gives him any
pleasure. In fact, Friedman told Robert Mundell (the ‘Father of the Euro’) that
since the experiment had already been entered into, he hoped that he would turn
out to be wrong.
But he hasn’t been.
The discussion between these two brilliant men was
sponsored by The Institute for Research on Public Policy in May of 2001. If you
have the time, read it over. You’ll end
up knowing more about currency economics than anybody has a right to, and
you’ll learn more than anybody in any position of power in international finance
knows about things like currency unions and fixed and flexible and pegged and
unpegged (and gradations between) exchange rates . But the real clash was
between the genius who thought up the Euro and the genius who was skeptical of
it.
Friedman nailed it right at the beginning:
“There is no historical precedent for such an
arrangement. It involves each country’s giving up power over its internal
monetary policy to an entity not under its political control. Such a system has
economic advantages and disadvantages, but I believe that its real Achilles
heel will prove to be political; that a system under which the political and
currency boundaries do not match is bound to prove unstable.”
In other words, when the accountability for creating
money is separated from the accountability for spending money, chaos results.
Mundell argued that the Euro and similar schemes which he
hoped would be imitated around the world were worth it because they would lead
to a higher standard of living:
“Countries with a unified currency system trade a great
deal more with one another and are able to exploit the gains from trade and
therefore have a higher standard of living.”
But Friedman argued that, in fact, the Euro would not be
economically successful because Europe lacked sufficient economic freedom:
“A flexible exchange rate would enable each of them to
have the appropriate monetary policy. With a unified currency, they cannot. The
alternative adjustment mechanisms are changes in internal prices and wages,
movement of people and of capital. These are severely limited by differences in
culture and by extensive government regulations, differing from country to
country. If the residual flexibility is enough, or if the existence of the euro
induces a major increase in flexibility, the euro will prosper. If not, as I
fear is likely to be the case, over time, as the members of the euro experience
a flow of asynchronous shocks, economic difficulties will emerge. Different
governments will be subject to very different political pressures and these are
bound to create political conflict, from which the European Central Bank cannot
escape.”
As we’ve seen a thousand times since this debate in 2001,
as the economic case for the Euro weakens, advocates fall back on national
security arguments. Mundell argues that the Euro is a bringer of peace:
“My own view about the politics of the euro is that it
will provide a catalyst for increased political integration in Europe, which,
after two centuries of a Franco-German rivalry that has periodically engulfed
the entire world, is highly desirable. Increased political integration would
also enhance Europe’s voice on the world political stage and allow Europe to
share some of the leadership role and burden of the United States. In my view
there are few, if any, risks associated with an increased power position of
Europe in world affairs.”
Friedman argues that instead, a unified currency in an
environment of low economic freedom and competing political agendas will be a
bringer of strife:
“My difference with Bob which reflects what I earlier
labelled (d) is exemplified by my pessimism and his optimism about the euro. We
agree that the euro has no historical precedent. I believe we also agree that
its attainment was driven by political, not economic, considerations, by the
belief that it would contribute to greater political integration —the much
heralded United States of Europe—that would in turn render impossible the kind
of wars which Europe has suffered so much. If achieved, political integration
would render the monetary and political areas coterminous, the historical norm.
Will the euro contribute to political unity? Only, I believe, if it is
economically successful; otherwise, it is more likely to engender political
strife than political unity.”
Now, I have a
great deal of respect for Dr. Mundell. He’s been kind enough to allow me to
interview him, and I’ve learned a lot from him. He is required reading around
here. And he’s right about a lot of things, even in cases where Friedman was
wrong. But in this case Friedman was able to foresee with far greater accuracy
the future course of the European monetary union than its intellectual father.
I suspect that Dr. Mundell’s political idealism got the better of him in this
case.
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