The Greek financial crisis is a mere deck chair on a political Titanic: European monetary union is inherently unstable without fiscal and central bank union. Fiscal/central bank union would require political union, a political impossibility. Thus, EMU cannot move past its current unstable state. Retreating to a mere trade union offers most of the benefits of EMU, at a fraction of the complexity and distortion.
Thus, almost inevitably, the euro area will shrink or break up, while the EU trade area will thrive.
Why is EMU inherently unstable? Because it is, by its nature, a transitional condition. Fiat currency, central bank and fiscal policy are logically a single module: a governing entity manages its fiat currency through fiscal and monetary policy to achieve domestic political goals (rational or irrational, short or long term oriented).
If a country tries to use someone else’s fiat currency without control of the monetary and fiscal policy of that currency (as occurs, for example, when Argentina dollarizes or when China pegs, or when Greece euro-izes), the result, every time, is systemic imbalance: inflation/deflation, current account deficit/surplus, etc. This happens because the solution to such imbalances is to revalue the currency — but they can’t, because it’s someone else’s currency.
To eliminate these distortions, the inevitable end is always either to unify more (merge politically) or less (stop using someone else’s currency).
Some EU framers understood this, and from the beginning intended EMU to be a transitional step toward political union. However, as it turned out, EMU was opposed by a popular majority in nearly every country where it was adopted. Going further — giving up the national budget to Brussels — is obviously impossible in the foreseeable future. So one has to ask if an inherently transitional state, with its inherent distortions, can persist indefinitely.
At this point, it makes sense to ask why Europe ever wanted this. The answer is rooted in World War II. When European politicians hatched these ideas in the early 1950s, militant nationalism was a vivid memory. The intended benefits of the EU were something like these:
- Minimize cross-border transaction costs.
- Present a united geopolitical force vs the USSR.
- Prevent nationalist warfare among European states.
But in the 60 years it has taken to get this far, conditions have completely changed. There is little external military threat. Intra-European warfare sounds quaint. Europe’s trade union, coupled with modern IT/comms technology, has already greatly reduced cross-border transaction costs.
Under modern geopolitical conditions, a mere trade union may be Pareto-optimal: with a fraction of the complexity and distortion of a currency union, a trade union achieves most of the economic benefit, provides most of the necessary bargaining power vs Russia, yet avoids, for example, the inherent division between fiscal management styles of Mediterranean and non-Mediterranean countries.
A partial euro breakup may thus be inevitable, but, given the impossibility of political union, may also be for the best. In essence, Europe is doing something today that makes no sense — just because it made sense 50 years ago.