Western economies are in trouble. Europe’s crisis is well known. Excessive borrowing by countries on the fringe of the European Union have put their financial system on the verge of collapse. In the United States, borrowing to finance two wars and prevent a major financial fiasco over the last 10 years, have left the United States with a fiscal time bomb in its future. Both crises have at their core ideological rigidity that has overridden common sense and intellectual analysis.
Standard practice for economic policy makers to deal with a balance-of-payments crisis and financial problems is to devalue the currency. By devaluing, a country’s exports become competitive, allowing balance of payments to return to balance or a slight surplus, then debts to foreigners could be repaid. In recent years, the International Monetary Fund has provided bridge financing while demanding tight fiscal policies in the countries receiving aid. External bond holders often extended maturities as confidence in the ability to pay rose. In the late 1990′s the Asian financial crisis was dealt with in this manner.
The current crisis in Western Europe would fit this model were it not for the existence of a common currency: the Euro.
The ideology behind the creation of a common currency for Europe and for European Union is rooted in the tragic history of the 20th century. At the end of World War II, Germany was divided with a powerful Soviet Union facing the West in Europe. One of the solutions to keeping Germany in the Western orbit but denying them the ability to threaten its neighbors in the future was to create a customs union, i.e. a trading bloc with no internal tariffs, which was advocated by leaders such as Paul Henri Spaak of Belgium and Jean Monet of France. In 1951 the first of these, the European Coal and Steel Community was created. This success was followed in 1957 with the creation of the European Economic Community expanding ECSC to all goods. At the time, Euratom, a common program for the development of nuclear energy was also included. The original six countries were: Belgium, The Netherlands, Luxembourg, France, Italy, and Germany. England joined in 1971. Following the reunification of Germany and the end of the Cold War the EEC expanded to include 27 countries representing most of Europe.
The Eurocrats in Brussels, and Europhiles in many governments on The Continent , saw this expansion as an opportunity to further the dream of Europa Unis by establishing a common currency.
Many economists, beginning with Robert Mundell in the 1960′s, examined the complexities of establishing a common currency area. Most advocated the establishment of a central bank as well as significant fiscal oversight. All acknowledged that the fundamental problem was achieving fiscal balance in a diverse group of sovereign entities. In 1973 the international finance section of the Economics Department at Princeton University, in a pamphlet titled, “The Case for European Monetary Integration, ” sounded a prescient note of caution when the author, James C. Ingram, wrote, “Public investments made possible by bond issuance in Community capital markets, should be used to increase the productive capacity of the region and not to just maintain consumption levels. To finance unemployment compensation or other income maintenance programs by external borrowing would be asking for trouble!”
The Maastricht Treaty that collapsed the three European Communities into the European Union set up a process and some rules for the common currency. Monetary and fiscal issues were addressed.
The European Central Bank was established. Unlike the Federal Reserve in the United States,which has a dual mandate to control inflation and maximize growth, the ECB has only to control inflation. This was done to assuage the sensibilities of Germans remembering their hyper-inflation of the 1920′s that led to disastrous consequences for the rest of the world.
Title Six of Chapter One of the Maastricht Treaty deals with fiscal policy in the vaguest of terms. Article 103 states that members shall “regard their economic policies as a matter of common concern.” The Eurocrats in Brussels are allowed to review and comment on member states’ fiscal policies but there is no mechanism for dealing with internal imbalances, and no sanctions for rogue policy-makers. As a lecturer once told me in Amsterdam in 1971, “The problem with the European ideal is that there is a Court but there is no Sheriff.” Buttressed by the European ideal, it was just assumed that all would do the right thing. A collapsing Euro has proved this to be wrong.
In the United States, a similar ideological rigidity is on the verge of causing financial chaos. Republican “young guns” Paul Ryan and Henrico’s own Eric Cantor have sworn fealty to Grover Norquist and his no-tax-for-any-reason pledge. Ryan has proposed a budget that lowers tax rates, increases spending on Defense, and relies on unspecified cuts to balance the budget. No serious observer of politics, economics, or third grade math believes that this will work.
“Plupublican” Presidential Candidate Mitt Romney has adopted this rubbish. It seems as if the Republicans in Congress consider their oath to Grover Norquist to take precedence over their oath to preserve and defend the Constitution.
President Obama appointed Erskine Bowles and Alan Simpson to come up with a sensible plan to close America’s fiscal chasm. It requires tax increases as well as benefit cuts. So be it.
During the recent Republican Presidential primary season all of the candidates stated that they would not vote for a plan that was 90% cuts in spending and 10% in tax increases. If we do have a meltdown, we know where the blame lies.