Robert Mundell - Euro Is Here To Stay - Financial Post

10/08/2022 14:24 Robert Mundell: Euro is here to stay | Financial Post
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Robert Mundell: Euro is here to stay

The euro has 'passed its youth with flying colours,' is a world currency par excellence and has great future as an
international reserve asset
Terence Corcoran
Jun 08, 2012 • June 8, 2012 • 14 minute read • Join the conversation
The euro has “passed its youth with flying colours,” is a world currency par excellence and has great future as an international reserve
asset
Forbes Conrad/Bloomberg files
Forbes Conrad/Bloomberg files
If you owe the CRA money, pay up as soon as possible because the prescribed
rate is…
In recent months, Robert Mundell, the Nobel economist widely recognized as “the godfather of the euro,” has taken his lumps in the media and in
some economic circles. In his critics’ eyes, the euro has been a failure. It’s only a matter of time before the whole dream of a united European
currency zone is blown apart. Greece should go, and maybe some of the other fiscal and banking train wrecks — Spain, Portugal, Ireland — should
also be cut adrift. Paul Krugman, never a Mundell fan, recently took another shot. “The odd thing, given Mundell’s elevation as the ‘godfather of
the euro,’ was that his optimum currency area analysis actually suggested that it was a bad idea given the lack of labour mobility. The importance
of fiscal integration,” said Krugman, “also made the case against the euro even stronger.”
STORY CONTINUES BELOW

Mr. Mundell, now 79 and still active as a commentator, speaker and adviser to governments, has seen all this before and he will have none of it. In
an e-mail interview with the Financial Post‘s Terence Corcoran, Mr. Mundell says the euro will disappoint his critics. “The euro — barring a
political revolution in Europe — is here to stay.”
The euro faces challenges, to be sure, but Mr. Mundell sees the European monetary union as a political and economic triumph. “The euro is a world
currency par excellence,” he said. “It is second only to the dollar. Indeed, it is challenging the dollar as a stable global unit of account and could
have a great future as an international reserve asset. The euro has passed its youth with flying colours.”

The fiscal and banking crises in Europe cannot be blamed on the euro, any more than the fiscal and banking crises in the United States can be
blamed on the existence of a United States monetary union under the dollar. He dismisses the claims of critics who say that the euro was a mistake
because Europe is not a fiscal union. “Very few countries in the world have a fiscal union. It would be almost impossible for a large country to have
a complete fiscal union. Canada and the United States do not.”
On a range of subjects related to the euro, Mr. Mundell sees problems that must be solved, offers solutions, but stands fast on his core conclusion:
“Never before has there been a currency union that covers so large a share of the world economy and grown so successfully and so rapidly within
the space of a decade and a half.”

On Greece: “Should Greece follow the path of Argentina? That would result in a horrendous drop in the standard of living and social benefits and
if that were politically possible why not do it inside the euro?”
What’s to be done: “The necessary adjustment is clear to everyone and the successful model is the United States. The first is the creation of a
unified banking system for Europe.”
Should the euro/dollar be managed? “The huge swings in the dollar-euro exchange rate — and between areas that have about the same rate of
inflation — have aggravated the financial problems of every country in the world and are at the root of most of the crises.”
On the Fed: “The Fed fails to understand the significance for U.S. monetary policy of the creation of the euro.”

The full text of Terence Corcoran’s interview with Robert Mundell appears below.
FP COMMENT:What can or should be done now to save the euro? Or is it, as many commentators claim, at the end of its life?
MUNDELL: The euro is not the problem. The problem within the European Union and the European Monetary Union is government deficits and
the debts of a few countries, mostly in Southern Europe. It is a failure of fiscal discipline that has threatened the solvency of the debt-ridden
countries whose high deficits are due in large part to the current recession in Europe and more generally the slowdown of the world economy. The
debts would only become a problem for the euro if these deficits led the European Central Bank (ECB) to create substantial inflation to try to bail
out these countries.

It is curious how American and sometimes North American economists have tried to nail the deficit problem as a “euro” problem. If the
Government of Canada or Newfoundland or Ontario ran up their public debts, and had big current deficits to boot, would that be a debt-deficit
problem or a loonie problem? If California is on the verge of insolvency would that be a U.S. dollar problem or a debt-default problem for
California?
Many prominent American economists hated the idea of the euro and predicted its collapse if it came into being. They now seem to be trying to
validate their past predictions. But bygones are bygones and the euro — barring a political revolution in Europe — is here to stay.
After the first three years of its existence, the euro has been on average quite consistently above the value at which it started ($1.18). (See graphic)

If the euro is a problem for Europe, it’s because the euro has been too strong, not too weak. Moreover, if a small but fiscally weak country like
Greece were to exit the euro outside the auspices of the European Monetary Union leadership — in my opinion a great disaster for the people of
Greece — the euro might even be stronger. A currency union is like an alliance—shedding a small member with more liabilities than assets can
make the union stronger.
What is often missed by economists is that the creation of the euro was a political event of great importance to the future of European integration.
Before World War I, Europe was, in Max Weber’s phrase, “mistress of the world” (he called America “Europe overseas”). The two World Wars and
the end of the Cold War led to the collapse of colonialism and a diminution in European power below its equilibrium and certainly its optimum.
The euro is more than just the icing on the cake on the single European market and the European Union (EU), it is the glue that keeps the core of
Europe together. Never before has there been a currency union that covers so large a share of the world economy and that has grown so successfully
and so rapidly within the space of a decade and a half.

This is not to say that there is not a great deal to be done to make it a better currency union. The process of deficit adjustment has to continue,
with austerity, structural reform and new investment strategies. Fire engines have to be ready to put out the financial fires that are engulfing
Greece, Portugal, Spain, Cyprus and Italy. Money has to come from the ECB, the European Financial Stability Facility, and the International
Monetary Fund. Above all, bailouts have to be linked to some transfer of fiscal authority from countries that have become insolvent to the
European Commission acting under the auspices, for constitutional correctness, of the European Council.
The euro is a world currency par excellence. It is second only to the dollar. Indeed, it is challenging the dollar as a stable global unit of account and
could have a great future as an international reserve asset. The euro has passed its youth with flying colours. But it must be recognized that the
euro area suffers from two great defects. One is that there are 17 banking systems in the euro area, and the other is that there are 17 nations with
treasury bills and bonds.

Correction of both defects requires a jump in European leadership and public acquiescence toward a shift of ‘If the euro is a
sovereignty from the nation-states toward the centre. The necessary adjustment is clear to everyone and the
successful model is the United States. The first is the creation of a unified banking system for Europe, already problem for Europe,
proposed by Mario Draghi, the president of Europe’s central bank. This would result in substantial increases in it’s because the euro
efficiency and productivity.
has been too strong,
The other reform needed is the creation of eurobonds and eurobills. The euro area is now splintered into 17 national not too weak’
treasury bills and bonds, which makes them not very satisfactory reserve assets for central banks and asset
managers. Euro area bills and bonds would give Europe a potential supply of international capital from central banks that are or will soon be
overweight in dollars. The rest of the world would be a willing lender and happy to shift from other assets to those denominated in euros.

Of course political reform is also needed. I think ultimately the European Commission should become the executive power, and the Council should
be turned into an Upper House of Parliament, with national representations that take some account of population size.
FP COMMENT:Paul Krugman and others are now claiming that your original paper, “The Theory of Optimum Currency Areas,” required
labour mobility and fiscal union. Europe didn’t have either; therefore the euro was a mistake.
MUNDELL: My argument for Optimal Currency Areas said nothing about fiscal union. Very few countries in the world have a fiscal union. It would
be almost impossible for a large country to have a complete fiscal union. Canada and the United States do not. In the United States, the central
government spends maybe 22% of GDP while total government spending is about 37%. Every country’s fiscal structure is different, depending on
the way in which spending and taxes are divided among the federal government, the state or provincial government and the municipalities.

A fiscal union is not a prerequisite for a monetary union. The argument that monetary unions require fiscal unions is a recent idea based on new
functions of government to give assistance to specific economic groups hit by asymmetric shocks. This kind of specific relief to hard-hit segments
would be better carried out at the federal government level, as in the U.S. or Canada, rather than the local level. But it does not require fiscal union
in any comprehensive sense.
Historically, monetary unions have been established in ancient empires and nation states without regard to fiscal union. Even after the U.S.
consolidated state debts into a national debt in 1792, states were sovereign with respect to debts and deficits. When several defaulted in the 1840s
they were not bailed out and nobody imagined that the problem had anything to do with the U.S. monetary union.

This is not to say that Europe might not be better off with a redistribution of functions from the nation-state to the “federal” level, including
defense and social security unification. But if these shifts of responsibility are made along with corresponding shifts in the powers of taxation, they
should be made on grounds of efficiency and economic justice, not on grounds that they are necessary for monetary union.
FP COMMENT:You reviewed fiscal union but didn’t cover labour mobility. Krugman claimed the other day that your original optimum
currency area analysis “actually suggested that [the euro] was a bad idea given the lack of labour mobility.”
MUNDELL: My original 1961 article emphasized labour mobility but did not make a judgment about whether there was enough labour mobility
within Europe for fixed exchange rates or a monetary union. On the contrary, it argued that the issue of labour mobility was a key factor in the
arguments of other economists, including [Nobel economist] James Meade, who thought (back in the 1950s) that there was insufficient labour
mobility in Europe to justify a single currency, and Stanford University’s Tibor Scitovsky, who thought that fixed exchange rates or a common
currency would promote more labour mobility.

I argued that labour mobility was a question of degree. Because of location or cultural preferences as well as legal ‘It is a colossal
constraints and differential social security systems there is never complete labour mobility, even within single
countries. How much is enough? My answer was that the advantages of a common currency in terms of information mistake to attribute
and transactions costs, etc., have to be enough to overcome any disadvantages arising from insufficient labour the financial
mobility. I argue that the gains from a common currency in Europe have been and are sufficient in the case of
Europe. It is a colossal mistake to attribute the financial problems of Greece and other countries to insufficient
problems of Greece
labour mobility between the euro area countries. and other countries to
insufficient labour
mobility’

FP COMMENT:Europe seems to have more than a fiscal crisis. It also has a banking crisis. Spain’s fiscal situation is moderate; the
problem is the banking system. The argument is that the euro provided a false sense of cohesiveness and stable value, thereby
encouraging extravagant borrowing and lending. Is this a valid comment?
MUNDELL: Yes. The common currency created a “sense of permanence” and increased capital mobility. It might even have brought about a too-
rapid convergence of wage rates between areas where productivity was unequal. The currency union was successful but it left a lot of unfinished
business. The steps that Europe needs to take to resolve its crisis will move it in the direction of a more complete union. Thus we hear calls for a
unified banking system in Europe and Europe-wide financial instruments like eurobonds and eurobills. The steps that are needed to resolve the
crisis will move Europe toward a more perfect union.

FP COMMENT:The media is full of commentary on the benefits of Greece, Spain and maybe others leaving the euro. For example, the
euro is said to prevent Greece from using a devalued Drachma to help fix its fiscal and economic problems.
MUNDELL: Yes, Greece can’t devalue without its own currency. But Greece’s problem is not an overvalued currency. The problem is an excess of
debt and budget deficits. Greek debts are now denominated in euros. If Greece created a new currency in order to devalue, its debts would still be in
euros and devaluation would not change that fact. Of course, Greece could repudiate its debts in euros but if it were going to take that Draconian
step it could do it without creating a new currency. Should Greece follow the path of Argentina? That would result in a horrendous drop in the
standard of living and social benefits and if that were politically possible why not do it inside the euro?

FP COMMENT:Last year you suggested a managed dollar-euro relationship. With the United States facing fiscal crisis, what hope is there
for international monetary stability or, to use your phrase, “a world currency.”
MUNDELL: Stabilizing the dollar-euro exchange rate is a long way from a world currency but it would be a step toward an improved international
monetary system.
The current monetary arrangements involve “managed flexible exchange rates” with each country managing its own currency, giving each
monetary independence. With no world currency this would result in complete chaos, but in practice the dollar has stepped into the breach and
served some of the functions of a world currency.
The dollar once represented the mainstream of the world economy. For example under the Bretton Woods system [which ended in 1971] the United
States fixed the price of gold and other countries fixed their currencies to the dollar, giving the world a global dollar standard. After the U.S. went
off the gold price fix, the dollar remained a world currency. But the creation of the euro in 1999 split that mainstream into two big blocs. The huge
swings in the dollar-euro exchange rate — and between areas that have about the same rate of inflation — have aggravated the financial problems
of every country in the world and are at the root of most of the crises since fluctuation exchange rates began in the early 1970s.

“The most recent crisis was detonated by the soaring dollar against the euro
in the last half of 2008; the euro reached a high of $1.64 in June 2008, and
fell in October to a low of $1.23. Around the same time the price of gold
tumbled from $980 to $720, oil prices crashed about 70% and the U.S. CPI
monthly inflation rate fell from an annualized 5.5% in June 2008 to 0% at
the end of the year, and -2% in March 2009. These data are all symptoms of a
too tight money on the part of the Fed and the blunder exacerbated the
housing downturn and the recession in 2008 and spread the financial panic to
every country whose exchange rates were fixed to the dollar.
A great risk to risk to recovery in the U.S. is a strong dollar and a great
risk to fiscal insolvency in Europe is a strong euro. Actions to stabilize
the dollar-euro rate (with the Fed supporting the euro when it went, say,
below $1.25, and the ECB supporting the dollar when the euro went to $1.35),
combined with monetary cooperation on targets between the Fed and the ECB
would remove the instability of the dollar-euro exchange rate as a threat to
global prosperity and would benefit the entire world economy. The US dollar
as a global unit of account and reserve asset may still have an edge on the
euro, but the mainstream of the world economy, which once was dollar
territory is now split between the dollar and euro areas and neither
currency is completely satisfactory any longer as an anchor of stability or
global unit of account. Cooperative policies between the Fed and ECB to
avoid conflicts in monetary policy would make for a healthy improvement in

the macroeconomic stability of the entire OECD area and make a much-needed
contribution to global macroeconomic stability.”
Similarly, it is easy to see how the Fed erred in the late 1970’s and early 1980’s. In the late 1970s, the dollar fell by 50% against the German
Deutschemark and the United States ended the decade with three years of double-digit inflation. Tighter monetary policy was needed. Then, when
the dollar soared in the early 1980s, the United States went into a recession. In that case the fed had too tight a monetary policy, misjudging the
consequences of the soaring dollar.
The Fed fails to understand the significance for U.S. monetary policy of the creation of the euro. The huge euro currency area, second only to the
dollar, makes the dollar-euro exchange rate, along with the price of oil, one of the two most important prices in the world. When the dollar soars it
brings deflation and recession in countries fixed to the dollar, and when it tumbles, it brings on inflation and currency speculation.

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