The euro could never have delivered on the benefits promised to smaller, poorer economies. The different rates at which nations joined the common currency did much to create today's problems.
Even worse, the inflexibility implicit in the common currency will create more pain in Europe than is commonly expected to rectify the Eurozone's very fundamental problems.
The surface facts of Europe's sad situation are by now familiar. Greece, Ireland, Italy, Portugal and Spain have become so mired in debt that they have threatened default. Greece and Ireland have received aid from the European Union with conditions that effectively dictated their economic and financial policy and infringed on their sovereignty.
The standard story used to explain these events is almost as familiar as the facts. It holds that indulgent policies and a lack of foresight in these peripheral nations led to an excessive use of debt that now threatens their financial viability and by extension the viability of the common currency and the EU. The tale goes on to say that now more responsible, thrifty, and hardworking countries, particularly Germany, must protect European finances and the European Union by lending to these irresponsible member states while guiding their policies along more prudent paths.
Irritating as the moralizing tone of these explanations is, it must be conceded that Greece, Ireland, and these other nations did indeed spend more than Germany relative to their resources. And now, if the EU and the euro are to avoid grievous harm, Germany and other more fiscally sound members of the Union have to take action.
But in their rush to condemn, EU officials seem to have forgotten how-when gathering nations to join the euro-they encouraged the borrowing that they now deplore. They told the smaller, weaker nations that the euro would enable them to borrow more easily and cheaply than they could in their own currencies by offering lenders a more liquid and stable investment. They argued that these lower rates would relieve strain on national finances and encourage quicker development by increasing the flow of credit.
The argument recurred as each nation considered joining. In 2007, when Iceland faced its decision, a major domestic advocate, the Kaupthing Bank, noted pointedly how the common currency's relative stability would reduce the cost of credit.
Euro advocates in the UK also made the low interest rate argument.
In fact, the notion of lower interest rates ranked second on the Liberal Democratic Party's 12 reasons for joining the euro. Remarkably, even Estonia, joining the euro in the midst of the sovereign debt crisis, noted cheaper financing costs as a benefit. And for a while, reality seemed to back up those claims. Greece, after it joined the euro, could borrow at rates of half a percentage point to a full percentage point higher than Germany paid, a considerable reduction from spreads of 2.5 to 3.5 percentage points or more over Germany when Greece borrowed in its old national currency-the Greek drachma. Ireland, Italy, Portugal and Spain could make similar comparisons.
But a big part of the argument constituted a deception, willful or not. Though the currency in which debt is denominated does affect rates, the relative cost of borrowing has more to do with the creditworthiness of the borrower, as is now painfully clear.
But the erroneous low-rate mentality helped erode this critically important credit consideration by encouraging Europe's weaker, poorer, countries to borrow and spend more than they otherwise would have. Now the EU's leadership has not only abandoned the old arguments about active borrowing, it has repudiated them, leaving questions about how many of these weaker economies would have joined the euro in the first place had they realized the limits of this benefit.
Of still greater fundamental significance in creating today's mess are the imbalances built into the euro from the start. Greece, Ireland, Italy, Portugal and Spain were allowed to exchange their domestic currencies into euros at higher rates than their economic fundamentals of productivity and profitability could justify. But Germany made the exchange at a much lower rate than its economic fundamentals needed. In its most direct impact, the low rate of Germany's exchange made its products more attractively priced than the products of the periphery nations.