A new study prepared by the Dutch financial institution, ING, called "Quantifying the Unthinkable," has warned that a collapse of the Euro as the European single currency would lead to a global economy cataclysm. The worldwide banking system would face a new and far more disastrous crisis than the one experienced during the last two years. A real economic depression would threaten the planet.
If Europe is facing such a catastrophe it must not be forgotten that it is the making of the governments and the monetary central planners who imposed the Euro on the people of Europe. And like Dr. Frankenstein, they are now terrified of the consequences of the monster they have created.
It is important to remember that the Euro is not a market-generated institution. It is a political creation inspired by the French and German governments in opposition to the desires and choices of their own citizens. Public votes on the implementation of the Euro were avoided like the plague, and in those countries where the people had a say, the answer was often a resounding, "No." Only "outside" political pressures and fears drove more countries into the Euro-Zone, when in fact economic integration and prosperity were all possible without a monopoly currency over the continent.
The political elites in Europe, and especially in France, wanted a European-wide currency as a means to have global power against the financial and political dominance of the United States in the post-Soviet era. It was viewed as a tool in the "great game" of international diplomacy and strategic influence. All the references to the "transaction costs" saving from a single currency stretching from the Atlantic to the borders of Russia were secondary propaganda to the wider political goals: a United States of Europe centrally controlled and regulated from Brussels, with special influence on its policies emanating from Paris and Berlin.
But even from the narrower economic perspective, all the rationales for a single currency issued and managed by a European central bank were examples of what Austrian economist and Nobel Laureate, Friedrich A. Hayek, once called the "pretense of knowledge."
We need to remember that central banking is a form of central planning. A central bank possesses monopoly control of the money supply. It determines the quantity of money in circulation and therefore influences the value, or purchasing power, of the monetary unit. It can also influence (at least in the short run) some market rates of interest, which can affect the amount and direction of investment.
Throughout the twentieth century, governments again and again have used their central banks to finance budget deficits through money creation—and have continued to do so in the 21st century. The end-products of such monetary mischief have been prolonged periods of price inflation, which eat away at people's accumulated wealth; distort market prices resulting in imbalances between savings and investment, and supply and demand; and create disincentives for long-term business planning and capital formation.
Thirty-five years ago, Hayek warned of the dangers from European-wide monopoly money, and made the case for competitive currencies among which the citizenry may freely choose (See, F. A. Hayek, Choice in Currency: A Way to Stop Inflation, published by the London-based Institute of Economic Affairs in 1975).
Hayek explained that due to the influence of Keynesian economics over monetary and macroeconomic policy, governments were invariably guided by short-run goals in the service of special interest groups. The consequence was the constant abuse of the printing press, with its resulting price inflation, to feed the seemingly insatiable demands of those privileged and politically influential groups.
Hayek concluded that some method had to be found to free ordinary citizens from the government's monopoly control over the medium of exchange. The answer, he suggested, is to allow them to use whatever money they choose. Hayek said:
There could be no more effective check against the abuse of money by the government than if people were free to refuse any money they distrusted and to prefer money in which they had confidence. Nor could there be a stronger inducement to governments to ensure the stability of their money than the knowledge that, so long as they kept the supply below the demand for it, that demand would tend to grow. Therefore, let us deprive governments (or their monetary authorities) of all power to protect their money against competition: if they can no longer conceal that their money is becoming bad, they will have to restrict the issue.
Make it merely legal and people will be very quick indeed to refuse to use the national currency once it depreciates noticeably, and they will make their dealings in a currency they trust.
The upshot would probably be that the currencies of those countries trusted to pursue a responsible monetary policy would tend to displace gradually those of a less reliable character. The reputation of financial righteousness would become a jealously guarded asset of all issuers of money, since they would know that even the slightest deviation from the path of honesty would reduce the demand for their product.
Governments remain today, as much as when Hayek spoke these words, under the sway of political ideologies that insist it is the duty of the state to regulate the market in the service of powerful special-interest groups, to redistribute wealth, and to secure "safety nets" under most aspects of everyday life. The budgets and deficits of many EU countries, and the fiscal crisis they have now gotten themselves into demonstrate this beyond any doubt.
The Euro's monetary central planners still presume to have the wisdom and ability to target rates of price inflation and move interest rates in directions they consider "optimal." I would suggest that just as the central planners in the old Soviet Union were not wise or informed enough to successfully plan the supply of shoes and the production of bread, the managers of the European Central Bank cannot know what interest rates should be or what target to set for the general level of prices. Interest rates should be set by the market to bring the actual supply of savings into balance with the demand for loans. Both the general level and the relative structure of prices should be determined by those same market forces, that is, people's willingness to trade money for goods and goods for money.
It is said that the Chinese word for "crisis" means both "danger" and "opportunity." It is certainly the case that the fiscal irresponsibility of most of the European Union governments has put the economic and financial structures of their countries in grave danger. But hoping that the European Central Bank can set it all right – or to delay the inevitable until some "someday" when "something" will provide a way out without the consequences of decades of fiscal mismanagement – will only mean truly dangerous inflationary forces being set loose. Because the only way for the European Central Bank to try to "paper over" this problem is by printing a lot of paper money. And Europe has already seen several times where that leads during the last hundred years.
The "opportunity" from this crisis is to admit and accept that the Euro plan was a wrong idea. It is necessary for the member governments in the Euro-Zone to begin a new plan for an "orderly retreat" back to national currencies. This is not the first time that a single currency has had to be dissolved into separate national currencies. This happened in 1919, following the disintegration of the old Austro-Hungarian Empire in Central Europe; or more recently with the collapse in 1991 of the Soviet Union into fifteen independent republics, or the splitting of Czechoslovakia into two separate countries, or the breakup of Yugoslavia.
There are lessons to be learned from these historical cases that should be carefully studied and applied to begin and complete the process of bringing the Euro "experiment" to a close with the least pain and disruption in a financial and fiscal environment in which each of the European governments will have to get their own economic affairs in order.
Even in the short run, however difficult the transition will be, those European countries that have less of a fiscal problem to get into order will at least be able to avoid being pulled into a worst vortex by their more irresponsible fiscal neighbors, if they remained within a single currency zone.
In addition, if a new multi-currency world reemerged in Europe, it should be accompanied, as Hayek suggested, with the freedom for the citizens of all of these nations to choose which currencies they prefer to hold and use in exchange. National governments should not attempt to lock their respect citizens behind barbed-wire currency barriers and restrictions.
Market freedom in money would act as a powerful force and incentive for the individual European governments to move in a more fiscally responsible direction, if they do not want to see their own national currency dramatically depreciate relative to other monies. This would serve as an additional and important "external" discipline, as Hayek also emphasized, to try to get political elites to move their domestic policies into more stable and sustainable paths.
Or will Europe continue on its present course, and go over a fiscal and monetary cliff that it otherwise might have avoided?