The proper functioning of the gold standard required a high degree of flexibility in wages and prices. If exchange rates cannot depreciate, wages and prices need to fall when a country has an unsustainable current-account deficit. But, as peripheral Europe can now attest, this is a cumbersome, painful, and politically unpopular form of economic adjustment. Expect the backlash against it to grow in the months and years ahead.
The news focus today is on how hard it is for the eurozone periphery to adjust and return to growth, owing to the combination of high public debt and actual or perceived austerity measures. But there is a flip side to the problem: capital is flowing to Germany as the regional safe haven, making credit more readily available there. The dynamics of adjustment within the eurozone exacerbate the underlying imbalances—Germany is becoming more competitive while the periphery remains uncompetitive.
The recent Greek elections have brought more radical parties to the fore. Alexis Tsipras, the head of the Coalition of the Radical Left has a valid point: “internal devaluation” —cutting wages and prices—is failing as a strategy. His alternative appears to be to abandon the euro. If Greece can’t do better than this, he argues, then it should leave.
But this is not about Greece any longer. Italy, Spain, Portugal, and even Ireland face the same issues, but are at an earlier stage in the backlash. Unemployment is rising, their economies are not becoming more competitive, and the interest rates on their debt continue to rise. These countries may eventually decide to leave. And, even if they don’t make that choice, fear of such exits can easily become self-fulfilling.
The euro system was designed to deliver prosperity and stability for all. It has clearly failed for some countries, and it may fail for many. Severe mismanagement by European politicians has caused damage that will last for decades.
Perhaps a stronger fiscal union, a central ministry of finance, and debt sharing would reduce the difficulties and imbalances enough to allow the euro to survive. Perhaps adjustment will start to work just in time.
There is a lot of shouting in the jury room. Expect a verdict soon.