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The following article appeared in Left Business Observer #82, March 1998. It retains its copyright and may not be reprinted or redistributed in any form - print, electronic, facsimile, anything - without the permission of LBO.
In just a bit over nine months, the euro will be born, and the next stage in the process of European economic and monetary union (EMU) will begin. Of the fifteen countries that make up the European Union (EU), eleven (Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain) will begin a three-year process of dissolving their national currencies into a single continental one (whose symbol is shown nearby). Three (Denmark, Sweden, and the UK) are holding off on this step, and one (Greece) just wasn't tough enough to make the cut this time around.
That cut was made mainly on the basis of the state of government finances, specifically the budget deficit and the amount of debt outstanding. Few other considerations, like income levels or industrial structures or demographics or culture, entered the picture. Americans accustomed to thinking of Western Europe as a less austere and less orthodox way of doing capitalism should revise those thoughts immediately; Europe is now run by econocrats and central bankers, and it has become the most austere and most orthodox region of the world, with balanced budgets and hard money taking the front seat, and everything else either in the back seat or left behind entirely.
An outsider dipping into the literature on European unification for the first time is quickly struck by the absence of any canonical story of how and why it's been taking place. Has it been a way to bind Germany to keep it from dominating the continent, or, in the words of the now-dead Thatcher advisor Nicholas Ridley, is it just a "German racket to take over Europe" (a position shared by U.S. conspiracy connoisseur and radio host Dave Emory). Was it a way to solidify the European welfare state or undermine it? Was it undertaken out of various national interests, or as a way to transcend nationalism and prevent a rerun of war, depression, fascism, and war again? Was it a way to go head-to-head with the other economic giants, the U.S. and Japan, or a way to retreat behind comforting walls? Or are all these things true, each in its own time and place?
One is also struck by the persistence and gradualism of the whole process, with every step planned out, intensely argued and compromised, but largely out of public view. The single currency is a dramatic innovation, but it comes after nearly 50 years of preparation, and 26 years after a formal pledge to move towards economic and monetary union. From time to time, governments have turned to their subjects for approval, but unification has hardly been driven by popular passion. Polls show Europeans broadly in favor of monetary union, while knowing next to nothing about its details; it's doubtful that Europeans would have approved of the single-currency project if they'd known it would come with sustained unemployment rates of over 10%. EMU has mainly been driven by financiers, multinationals, politicians, and elite bureaucrats.
Non-Europeans have hardly thought about the process at all, a luxury they can no longer afford. EMU is almost certain to have major effects on the outside world, even on the United States, which often thinks itself immune to external influences. If the euro succeeds, it's almost certain to present a serious rivalry to the dollar's role as the world's central currency; if it fails, financial chaos could ensue. It may fail because of its own internal contradictions, or because ordinary Europeans finally rebel against rule by central bankers. But if it fails, it would be a profound setback for the whole global neoliberal package.
On January 1, 1999, the euro will come into existence. Its exchange rate with existing national currencies will be fixed - "irrevocably," according to the Maastricht Treaty, the 1992 document that established the timetable for EMU - and they will begin to disappear. New government bonds will be issued in euros, and old ones will be redenominated. Stocks and other financial assets will also be redenominated, and banks will offer euro accounts. European businesses will shift gradually into trading and keeping their books in euros. On January 1, 2002, euro notes and coins will enter circulation, and the process of exchanging the continent's 12 billion existing banknotes for paper euros will begin. On July 1, 2002, national currencies will cease to be legal tender within participating countries, and the euro will be the only game in town.
This is a logistical nightmare. Every vending machine will have to be recalibrated, and every business computer reprogrammed. A computer consultant told LBO that Wall Street's computers are in no shape to handle the euro's birth, and they've already got their hands full with the 2000 problem. But the logistics, while no small matter, are nothing compared to the political economy of the transition.
In orthodox economic thinking, money is fairly simple stuff - just a medium of exchange, a convenient substitute for barter, capable of no mischief on its own. Though some forms of nonorthodox economics, like stodgy versions of Marxism, share this notion of monetary neutrality, the more interesting ones don't. Because far from being some mere lubricant for trade, money is one of our most important institutions of social organization. Buying just a package of gum with a few coins links together hundreds, maybe millions, of people in a chain of production and distribution, every phase of which is subject to the disciplines of market competition, whose instrument is money. In Marx's phrase, we carry our bond with society in our pocket.
Europe is embracing a new, continent-wide form of money well before all the social structures to support it are fully in place. National governments will still retain important powers, and, despite heavy intra-European trade, lots of the continent's economies remain national and local. Languages and cultures also remain highly national and local, and compared to the U.S. there's not all that much movement of people across borders (tourists aside). Workers displaced in Buffalo often move to Texas; those displaced in Lille rarely move to Dublin in search of employment.
And although speculative movements of capital often cause currency values to rise or fall, over the very long term, the value of one currency against another is determined by the relative productivity of their underlying economies. For example, for most of the post-World War II period, the dollar lost value against the mark and yen because German and Japanese productivity levels were growing much more rapidly than the U.S.'s. This makes sense because the value of a currency is determined ultimately by what you can buy with it, and what you can buy with it most easily are the products of its national industries.
In Europe, German industry sets the productivity pace and everyone else tries to keep up. In most cases, that has been a losing battle, as the charts below show. But because of their commitment to monetary union, policymakers have done whatever was necessary to prop up their currencies against the mark. In practice, that has meant excruciating austerity - keeping interest rates high enough and budgets tight enough to please investors and draw in sufficient capital to boost the exchange rate. This austerity is supposed to have wondrously tonic effects over the longer term; weaker plants will be shut and businesses will go under, thereby boosting average productivity. It hasn't worked as advertised, and there are few historical instances where it ever has. Britain has tried this strategy several times, first in the 1920s, when it fixed a very high exchange rate for the pound. British industry couldn't compete against more efficient foreign competitors, and a near-depression was the result. Britain tried the same strategy again in the early 1990s, with similar results; in 1993, London withdrew from the European exchange rate mechanism and allowed the pound to sink in value. The economy recovered, in that sickly British way, but the Continent languished, and it still does.
Europe has already been suffering from the preparations for monetary union, but what will happen when this long overture ends and the first act begins? It seems likely that the present strains will continue, and perhaps intensify, as Portuguese and Italian firms are thrown into even more direct competition with German ones. To Europe's planners, though, insofar as they have thought about the social bases of economic union, things will sort themselves out as the currency does most of the work - a process that Timothy Garton Ash has called "a hair-raising adventure...of unification through money."
Money is of course only one of the pillars of a modern state; the others, like budgeting, the military, and the police will remain national responsibilities even after 2002. It's remarkable how weak the nonmonetary institutions of the European Union are. Concerning the monopoly over legal violence claimed by the state, Maastricht uses strained language, resolving "to implement a common foreign and security policy including the eventual framing of a common defence policy, which might in time lead to a common defence," maybe, sorta, someday. There is no executive branch to speak of; the Council of Ministers, which comprises the cabinet ministers of member governments, serves a kind of collective executive role, setting major policy and ironing out differences among member states. There is also a Brussels-based bureaucracy called the European Commission that issues regulations and judgments, but mainly of a fairly technical nature, and proposes legislation to the largely powerless European parliament. The parliament has few stated functions and no formal power to initiate legislation. Of course, member states are ultimately responsible to their electorates, but with something as apparently arcane as European unification, this is a pretty weak popular check on the technocrats. In many ways, with all the important economic questions almost entirely insulated from politics by design, the EU is a technocrat's dream.
Or, more exactly, a central banker's dream. As the timetable for monetary union progresses, the national central banks will gradually be absorbed into a European System of Central Banks (ESCB) with a European Central Bank (ECB) at the top. As national moneys recede and the euro takes their place, the national central banks will increasingly defer to the ECB.
The ECB's governors will be appointed by national governments according to the usual Euro-consensus process, but they will be among the most "independent" central bankers in the world, meaning isolated from any popular influence. The Maastricht Treaty specifies that the president of the ECB and its governing board must be restricted to "persons of recognized standing and professional experience in monetary or banking matters," language even more restrictive than the U.S. law regulating appointments to the Fed's board of governors "due regard to a fair representation of the financial, agricultural, industrial, and commercial interests" of the country and its regions. The Fed, according to law, is also supposed to make policy "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." (For U.S. law on the Fed, click the button below.) The ECB's charter says nothing about this; its primary mandate is "to maintain price stability." which is thought to mean an inflation rate of 2% or less. Of course, the Fed typically does what it damn well pleases despite the law, but the more restrictive language of the ECB's charter says something about the priorities of the people who created it.
Click here to see the U.S. law on the Fed:
Virtually every country in the EU except Britain (3.7%) and Greece (5.2%) met or beat that 2% inflation number in 1997, and at considerable cost in sluggishness and unemployment. EU inflation rates have trended steadily downward, from over 5% in 1990 to 2% today. This performance, treated as a great triumph in the business press, is the result of intensely tight monetary and fiscal policy.
Some numbers can put a measure on that tightness. Real long-term interest rates averaged over 5% in the early 1990s, high by any standard, and remain over 3% today, high against an EU-wide unemployment rate of 12%. The best measure of budgetary tightness is the so-called cyclically adjusted deficit, one that strips away the budgetary effects of boom and slump to expose the effects of policy shifts. (As unemployment rises, so do deficits, as tax revenues fall and social spending rises. The cyclically adjusted figure is a statistical approximation of how government finances would look were the unemployment rate held constant.) In 1990, the EU's average adjusted - or "structural" - deficit was 5.2% of GDP, according to IMF estimates; in 1997, it was 1.3%, a shift of nearly 4 percentage points. The U.S. went from 3.4% to 0.8% over the same period, a shift of 2.6 points, but with a much friendlier interest rate environment. Deficit reduction needn't always drive economies into stagnation or worse, especially if the fiscal tightness is offset by falling interest rates. Europe, though, has been getting the double-barreled treatment, with both tight budgets and tight money, with no sign of relief or recovery.
On the contrary, the squeeze must go on, and in some countries, for a long time. The Maastricht criteria say that to qualify for joining the euro zone, a country's annual deficit must be 3% of GDP or less, and its accumulated debts should be no more than 60% of GDP. Those criteria are represented on the nearby chart as the shaded Zone of Virtue. As that chart shows, the EU authorities were quite liberal in their judgments of who met those criteria; no country made it into the chart's shaded Zone of Virtue.
(Blue squares represent the 10 of the 11 countries in the first round, with Luxembourg missing because of its extreme tininess; yellow squares show the three voluntarily not in the first round; the red box is for Greece, which didn't qualify; and the black box is the U.S., which, though it likes to stick its nose into everyone's business, is not yet claiming to be part of Europe. Still, the U.S. is in the best fiscal shape of the lot.) True hardasses lament this sluttish interpretation of the Maastricht criteria, but it would have been very embarrassing if no one had made it into the first round, and it would have been politically dicey to exclude Italy. So exceptions were made on the grounds of past progress towards the Zone of Virtue, and on the condition that progress towards budgetary balance and debt reduction continue.
While all the countries in the first wave of EMU have reduced their annual deficits, most have found it impossible to get them low enough to keep the stock of outstanding debt from rising relative to GDP. When you're barely growing, even a relatively small deficit, like one under 3% of GDP, is enough to push the debt/GDP ratio higher. In fact, only the three most indebted countries of 1994 (Belgium, Italy, and Ireland) have shown progress in reducing their debt ratios over the last three years; most of the others have a lot more work to do. But even those countries with relatively light debt loads may well squeeze now in the hope of building up credits for some future emergency, meaning that the fiscal squeeze will continue indefinitely.
Europe may be shedding many of the so-called automatic stabilizers that were once embraced to keep recessions from getting out of hand. The deficit strictures will keep countries from spending their way out of recessions, and there won't be any automatic mechanisms for the central government to cushion a national shock. In the U.S., regional recessions are softened somewhat by a reduction in the federal tax burden and increases in spending (unemployment insurance, welfare, and the like). If world timber prices were to collapse, say, Finland would take a sharp hit, but it would be powerless to ease monetary policy, which will be set at the Union level, and constrained from running a stimulative budget deficit.
A number of crucial issues around European unification hinge on arcane but important matters of central banking. Europe is increasingly becoming a land ruled by central bankers, so how they go about their business should become something of more general interest.
There's just no precedent for the challenges that European central bankers are about to face. For decades, they've set monetary policy for what are called small, open economies - ones with relatively limited internal markets and at the mercy of larger outside forces; most export 20-25% of their GDP. That means the exchange rate is an object of obsessive attention; a rising currency will cheapen imports and boost the price of exports, pushing trade accounts in the red; a falling currency could stimulate exports but at the price of raising import prices and pushing up inflation. A reasonably healthy small, open economy wants a stable currency, and achieving that is the major goal of central bank policy.
But most EU trade is with other EU countries; well under 10% of exports go outside the region, meaning that the Union will now become a large, (relatively) closed economy like Japan and the U.S. Central bankers will have to change their operating style radically, and it seems they're not quite sure of how to go about their business. Central bankers and their economists are constantly trying to figure out just how monetary policy works - how changes in central bank policy influence the real economy. Does it work because lower interest rates mean cheaper mortgages and higher stock prices, which stimulate spending and goose up animal spirits? Does it work through changes in the quantity of money relative to the supply of goods on offer, with more money meaning more to spend? Does it work through effects on the exchange rate, with a falling currency stimulating exports, and a rising one dampening them? Does it work by influencing the quantity and terms of credit (how hard it is to get a loan, and how onerous) more than the price of credit (the interest rate)? Though these can be topics of almost theological dispute, never resolved, they're of immense practical importance for making policy. But however monetary policy works, there's no doubt that the economic landscape of Europe has changed radically, meaning that Europe has signed itself over to central bankers who are entirely unprepared for the job.
Nor does the ECB, with its minimalist charter to maintain price stability above all, have its financial emergency procedures worked out. The Fed regulates and supervises banks, and is prepared to throw money at a financial panic; the ECB has no explicit supervisory responsibilities, deferring apparently to national CBs, and its bailout plans aren't in evidence - even though EMU is virtually certain to cause great turbulence, as formerly protected national financial institutions face fresh competition. But the only words in the Maastricht Treaty devoted to bailouts - certainly a familiar and crucial aspect of modern financial life - are part of a prohibition: should any EU member country hit a wall, aid from the Union is expressly forbidden.
EMU will almost certainly unleash massive cross-border mergers and the creation of U.S.-style financial markets, domestically freewheeling and more deeply tied to the outside world. Or, more precisely, that process, already underway, will accelerate the closer formal union becomes. As existing European financial assets (stocks, bonds, and bank assets) are redenominated in euros, it will create the largest financial market in the world, one about 20% larger than the U.S. Though national distinctions will persist - a French government bond, though denominated in euros, will still be an obligation of the French government, which will probably be perceived by the markets as less risky than Italian or Spanish bonds - the tendency of monetary union will be to homogenize these over time. The U.S., which has grown accustomed to tapping into the world's savings with ease, will find that the euro zone might give it a run for its money.
For global finance, the big question is whether the euro will challenge the U.S. dollar's role as the world's principal trading and reserve currency. Today, important international commodities, notably oil, are priced in dollars, meaning that changes in the value of the dollar are barely felt in the U.S. Since World War II, countries have kept most of their foreign exchange reserves - essentially rainy-day funds kept by central banks - in dollars (specifically in the form of U.S. Treasury bills), which has boosted demand for Washington's paper, and thereby kept U.S. interest rates lower than they would otherwise have been. And the U.S. has been borrowing heavily abroad for decades - our net debt to the outside world is now around a trillion dollars - and all but a few pennies of that total has been in dollars too. Doing business with the outside world almost exclusively in your own currency is one of the major prerogatives of empire. And lots of foreign economies operate on expatriate U.S. currency; to get that currency, foreigners must turn over valuable assets to the Federal Reserve, like Treasury bills, but the Fed simply hands out pieces of green paper that cost almost nothing to print in return. (There are, of course, many intermediate steps in this process, but that's what it boils down to.) All these advantages are worth scores of billions of dollars to the U.S. every year, and should the euro challenge the dollar's global role, then these profits would erode.
Will it happen? Will euros take the place of dollars in Buenos Aires and Moscow? Will Asians and Latins shift their reserves out of dollars and into euros? Will OPEC stop pricing oil exclusively in dollars, and will the foreigners who finance the U.S's chronic trade deficits start demanding that some of those debts be denominated in euros? After all, a country with a trillion dollar debt might have an incentive - someday if not tomorrow - to run the printing press to pay off the debts, thereby depreciating the value of the currency. Will, in other words, the U.S. begin losing some of the prerogatives of empire as the euro develops - assuming it does develop?
Exhibiting that famous American tendency to look on the bright side, William McDonough, president of the Federal Reserve Bank of New York, found a silver lining in a potential loss of the dollar's privileged status: "But should a different international monetary system ultimately emerge in which other currencies, such as the euro, play an increasingly important role alongside the dollar, there would be benefits for the United States as well. Such a development would, for example, impose greater market-led discipline on the United States and, in the process, help us address our chronic low-savings problem." Structural adjustment comes home.
Having a single currency means today's 11 national financial systems will eventually become a single one, and that American-style financial markets may well replace today's bank-centered systems, especially if that transformation is encouraged by the ECB. This is important in several ways. Weak institutions will fail or be taken over, jobs will be eliminated, and nonelite salaries cut. At the same time, U.S.-style stock and bond markets, and with them the impatient, low-cost, high-profit style of doing business, could take the place of more sedate bank shareholders. Pooling European stocks into what will become a single euro-denominated market will produce something vast by global standards, and if banks sell their shares, it will become even vaster. It could well become a playground for U.S.-style takeovers and restructurings. There is also apparently a rich unmined vein of junk bond possibilities in corporate Europe.
Cutbacks in public pension schemes to meet the deficit constraints will probably result in the growth of U.S.-style private pension plans, which would provide the cash and trading lusts the new markets will require, and, if U.S. experience is any precedent, the managers of these funds will be powerful influences on corporate managers to fire workers and outsource. Wall Street feels well-positioned to take profitable advantage of these changes; they can invent new instruments and trade old ones with a speed that leaves German bankers woozy. From Wall Street's point of view, the loss of the dollar's privileged role could be more than offset by fresh business opportunities in the Old World.
These financial transformations would provide additional pressure for the creation of U.S.-style labor markets, meaning little job security and a huge low-wage, low-productivity service sector. Kinko's and Pizza Hut would replace the dole, and one would be happy just to have a job, any job. That's what the IMF and The Economist mean by "flexibility."
Another possibility, familiar to Americans, is that EU countries could end up like U.S. states, each trying to outdo the other with loose regulations and business subsidies, but without any important federal presence to act as a fiscal or political counterweight. As Perry Anderson points out in an essay in the excellent collection he edited with Peter Gowan, The Question of Europe (Verso, 1997), the evolving Eurostate could be a realization of Friedrich Hayek's dream of a minimal state with maximal markets, even down to the details of Hayek's imaginings. In 1939, the right-wing icon wrote that his cause would be served by a multinational federation, since people will resist control by a government composed mostly of foreigners. If the federation limits the power of its national units, and national sentiment causes people to resist the impositions of a federal government, "much of the interference with economic life to which we have become accustomed will be altogether impracticable under a federal organization."
Hayek may be wrong about the mechanism - people may not be as resistant to collective action across borders as he thought - but it is hard for a weak federal structure like the EU to do anything controversial in its present form (except sign over economic policy to central bankers). So it might play out as Hayek imagined, that European union will weaken national government and replace it only with a small state; the EU's Brussels bureaucracy may pump out a formidable supply of paper, but its 15,000 employees put it on a par with the state of Montana.
But it could play out differently - the evisceration of national economic sovereignty may force the continental state to do something more than coin money in sharply limited quantities, especially if Europeans resist the Americanization of their labor markets and public services, or if the deflationary effects of EMU threaten total economic implosion. Should that happen, the central bankers' dream could turn into their nightmare: a reconstituted Eurostate on a continental scale promoting rather than repressing employment, and redistributing incomes in the interest of economic recovery and social cohesion. In 1998, though, that looks like a remote possibility; in 1998, orthodoxy is in the driver's seat.