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Increasingly, one hears predictions that the euro will go the way of thegold standard in the 1930’s.And, increasingly, the reasoning behind such forecasts seems persuasive. Butdoes that mean that the euro doomsayers areright?
Following the 1929 stock market crash, Europewas hit by a massive deflationary shock. Output collapsed and unemployment soared. Unableto agree on coordinated reflationary action,governments opted to move unilaterally. One after another, they abandoned thegold standard, depreciating their currencies. By loosening credit in this way,they recovered, one after another, from the Great Depression.
Today, Europe has been hit again by amassive deflationary shock. This time, the constraint on reflationary action isthe euro. Governments lack a national currency to depreciate, and lack thepower to relax credit, having delegatedmonetary policy to the European Central Bank. As unemployment again rises to catastrophic heights, they will have no alternative, it is said, but to abandonthe euro unilaterally.
I wrote the book on Europe and the goldstandard. Literally. In Golden Fetters:The Gold Standard and the Great Depression, published in 1992, I arguedthat the deflationary engine that was the gold standard was a key cause of the 1930’s depression, and that abandoning itopened the door to recovery.
Yet I am reluctant to believe that things will turn out the same way thistime. Four differences lead me to believe that maybe – just maybe – the eurowill survive.
First, mounting an appropriate monetary response iseasier when you have a single central bank. Under the gold standard, it still would have been possible for centralbanks to reflate their depressed economieshad they moved together. Unfortunately, getting central banks to move togetheris easier said than done. Central bankers speak different languages. They vieweconomic prospects through different lenses.
By contrast, were the ECB to adopt decisive measures, it could reflate theentire eurozone and obviate the need forcountries to act unilaterally. But, while the ECB has the capacity, thequestion remains whether it is has the will.
A second difference is that, notwithstanding recent cutsin social programs, the unemployed receive more extensive public support thanin the 1930’s. This makes populist pressure to abandon the eurocorrespondingly less severe – the key questions, of course, being how muchless severe, and whether the political center can hold.
A third difference is that the political preconditionsfor a cooperative response are better today. In 1931, France refused to help stemthe Central European financial crisis because it believed that Germany wasrearming, in violation of the Treaty of Versailles, signed at the end of WorldWar I. Political tensions between France and Germany may very well grow in thecoming months and years, following François Hollande’s victory in the Frenchpresidential election, but they will not begin to rise to that level.
Moreover, European countries today are prepared togo to great lengths to save the euro, fearing that its collapse wouldjeopardize their single market. By contrast, when countries started abandoningthe gold standard in 1931, tariff barriers had already gone up. There was nolonger a single market to protect.
Finally, abandoning the gold standard was less disruptive than abandoningthe euro would be. Reintroducing national currencies today would take weeks, ata minimum, whereas Britainin 1931 could take sterling off gold whilethe markets were closed for the weekend. Back then, countries still had theirnational currencies; they could simply stop supporting them. Bank deposits,along with most other private and public debts, were denominatedin that national currency.
Today, these assets and liabilities are all in euros. Reintroducing thenational currency in order to depreciate it, but leaving the euro value ofother financial instruments untouched, would destroy balance sheets and wreak financial havoc. The alternative –converting those other instruments into the new national currency – would tie up the offending country in litigation foryears.
Each of these differences casts doubt on the notion that the euro will gothe way of the gold standard. But a fifth difference points in the otherdirection. In the 1930’s,countries could not act together because they could not agree on a diagnosis ofthe problem. Each attributed the Great Depression to different causes, leadingthem to prescribe different remedies, which they administered unilaterally.
Agreement today on the diagnosis facilitates mounting a common response.Unfortunately, there is growing evidence that themedicine on which European countries have agreed – austerity – is killing thepatient. There is now talk of adjusting the dosage,but talk has not yet given way to action.
Will things turn out differently this time? There is no question that thegreater scope for cooperation that exists today bodeswell for the euro. But it is the precise policies on which European governmentscooperate that will tell the tale.
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