The euro is our currency
Michael Pettis - Economist - Article in La Vanguardia -
Over the next few years, as the economy continues to deteriorate, the debate is likely to intensify about whether Spain should or should not abandon the Euro. The defenders of the single currency, especially the political and financial elites, argue that only the euro can prevent Spain from becoming a Third World country. If it makes a responsible adjustment through wage deflation and fiscal austerity, they claim, the country will emerge from the crisis stronger than ever.
Over the next few years, as the economy continues to deteriorate, the debate is likely to intensify about whether Spain should or should not abandon the Euro. The defenders of the single currency, especially the political and financial elites, argue that only the euro can prevent Spain from becoming a Third World country. If it makes a responsible adjustment through wage deflation and fiscal austerity, they claim, the country will emerge from the crisis stronger than ever.
But will it manage to get out? By giving up the peseta, Spain also renounced control of national monetary policy, largely like countries governed by the gold standard system at the end of the 19th century. And, like them, the low competitiveness of its exports means that it now has to go through the same difficult adjustments to reduce prices.
The cost will be great. According to American economist Barry Eichengreen, under the gold standard the burden of adjustment was borne mainly by workers through unemployment and low wages. The political emancipation of workers in the 20th century, Eichengreen adds, prevents Western democracies from returning to gold, because in a modern democracy workers rightly refuse to pay that cost.
If Eichengreen is correct, it is likely that Spanish workers will also refuse to pay the cost of preserving the Euro. However, leaving the eurozone, will it condemn Spain to long-term economic decline? Almost certainly, no. In France, a similar debate took place many decades ago that can shed some light on current problems.
After the First World War, which blew up the monetary agreements of previous years, Paris faced the question of what to do with the franc. Like most countries, France went through serious inflation during the conflict, making it difficult to return to pre-war gold parity, largely as has happened over the last decade in Spain, where inflation in relation to Northern Europe has made the country uncompetitive.
In the early 20th century, it was widely accepted that a serious country had to stay on the gold standard system. It was considered irresponsible not to do so and condemned the country to economic stagnation. For much of the first half of the 1920s, France fought hard to return to the gold standard according to the pre-war exchange rate.
However, it could not do so. Inflation eroded the value of the franc so much that French industry became uncompetitive; and, in the first half of the decade, the country suffered high unemployment and low growth. In 1928, ceding to the inevitable and amid political uproar, President Poincaré devalued the franc.
France's capitulation to monetary irresponsibility mortified its bankers and earned it scornful insults from Britain and the rest of Europe. Both in France and abroad, confident predictions were made that the national economy would plunge into inflation and stagnation.
That didn't happen. In fact, the French economy recovered. Truth be told, the devaluation of the franc was not an act of irresponsibility, but a belated recognition of a monetary reality.
Moreover, while France's competitors struggled to maintain their overvalued currencies, French economic results soon outperformed those of rival countries. When much of the world was dragged into the crisis of 1930-31, the country largely remained immune to the deep depressions suffered by the United States, Great Britain and most of the industrialized world.
Other countries ended up having to devalue their currency and Paris maliciously condemned the irresponsibility of those same countries that had criticized France so much a few years earlier. With gold accumulating in the Bank of France thanks to an already strong export sector, France once again saw itself with pride as the world guarantor of monetary rigor.
It was a mistake, a mistake that the historian Tom Kemp called a "nearly pathological addiction" to monetary orthodoxy. As one country after another devalued its currency in the early 1930s (the United States eventually did so in 1934), France's competitive position rapidly weakened, though the country remained firm in its stance not to resort to devaluation again.
The French economy then began to suffer greatly. While the rest of the world adjusted their currencies, France again suffered deflation, low wages, and unemployment; this enraged workers, weakened the economy, and brought the country to the brink of economic and political collapse.
When the global recovery began in 1934, France's situation only worsened.
In 1936, Paris was unable to maintain the value of the franc and was disgracefully forced to abandon the gold standard again.
The cost of waiting was huge. In the end, France was one of the countries most affected by the Great Depression.
And all the suffering was in vain. The country was forced to devalue again; and when it did, it had to bear the additional burden of closed factories, angry workers, and poor infrastructure.
And all the suffering was in vain. The country was forced to devalue again; and when it did, it had to bear the additional burden of closed factories, angry workers, and poor infrastructure.
What lesson can be learned for Spain? At least two. The first is that the ability to manage national monetary policy is a very important political tool, even though some irresponsible leaders have often abused it.
By pathologically clinging to the euro, Spain places itself at a huge disadvantage against Germany and other capital surplus countries in Europe and the rest of the world.
As with France's attachment to gold in the 1920s and 1930s (which seemed responsible at the time, but in retrospect turned out to be tremendously foolish), Madrid's desperate struggle to maintain the euro for as long as possible will not one day seem heroic but madness. The euro does not serve the Spanish economy as it is currently organized, and refusing to recognize it is not a sign of maturity or responsibility.
The second lesson is that the attachment of bankers and those in charge of formulating economic policies to responsible monetary behavior is not always justified. The economic cost of maintaining an overvalued currency during a period of weak global demand can be so high that it undermines the very credibility that monetary rigidity is intended to achieve. Spanish and foreign investors will not applaud a Spain that heroically clings to the euro if the economy is shattered and unemployment remains high for years.
Not only does the case of France illustrate this danger. During the 1920s and 1930s, the countries that abandoned the gold standard sooner also emerged from the Great Depression sooner. The longer a country defended its currency (as was the case with the United States, France, and the Gold Bloc countries), the worse the consequences.
In a long-term global contradiction, inflexibility harms growth and even credibility. Spain should learn from history. There is no doubt that participating in the euro has advantages, but the history of monetary unions shows that the benefits only exist during periods of rapid global growth and increasing liquidity. When the cycle of globalization ends, monetary unions always collapse.
Europe is not an optimal monetary zone; and in a world with weak global demand, the cost to Spain of submitting to Germany's monetary and fiscal needs will be very high. And all for what? After years of effort, Spain will be forced to abandon the euro anyway.
The later it does so, as the case of France so clearly teaches us, the greater the sufferings will be.
