Thinking about the Euro Jude Wanniski September 30, 1997

The enthusiasm which the London stock exchange showed last Friday for a rumor that Tony Blair’s Labour government might hook onto the Euro prompted The Wall Street Journal to run a lead editorial this morning on the topic: “The Euro, Another Look.” The unsigned piece, almost certainly written by WSJ editor Robert Bartley, is the only commentary we’ve seen in either the domestic or European press that gets close to the mark. For that reason we recommend it, although the observations that follow make it clear where our thinking differs. First of all, we wholeheartedly agree with its conclusion: “Whatever the Euro does for Britain, Britain would be good for the Euro. The world can only profit from movement back toward exchange-rate stability, and if Britain joins, this prospect becomes far more serious. Serious enough, indeed, that we could hope over the long run it would reach the shores of not only Britain, but Japan and the United States.”

Where we partly disagree with the WSJ is in its identification with the source of Europe’s difficulty in cooking up a common currency. We agree the Eurocrats should not have focused on budget deficits in designing criteria for entry to the monetary union. We emphatically disagree with the WSJ when it says the Europeans instead should have focused on “the one number that does encapsulate the European economic problem, the percentage of output that passes through the hands of government -- which is half or more in most continental nations.” This view also is also held by Fed Chairman Alan Greenspan, who insists fixed exchange rates will not work in a welfare state. It is this argument that Greenspan uses to warn that fixing the dollar/gold exchange rate will not work as long as government insists on financing a welfare state. This is textbook baloney, disproved by simply noting that among the currencies in the world, one of those which has lost the least amount of purchasing power during the past 40 years is China’s.

The WSJ also makes a half-baked argument that the Eurocrat idea of setting criteria that will lead to “convergence” of the nations involved is backward: “You don’t do convergence to fix currency rates, you fix the rates to get convergence.” In other words, the Eurocrats somehow think that if every participant has a budget deficit smaller than 3% of GDP, the Euro will hold together after its birth. The Journal says it is the other way around: If you fix rates, those participants who remain profligate will be punished by higher interest rates, which they could only avoid by cutting spending: “Over time this might force the welfare states to bring spending in line, forcing the European nations to compete on industrial development and tax rates the way states do in the common currency area administered by the Federal Reserve.” Oh, really?

The problem with this analysis is that “over time” the Euro system would be blown to bits before a fixed rate “might force the welfare states to bring spending in line.” There are only two ways the Euro can succeed, holding together for a long enough period so that minor adjustments can be made. One is to make the tax systems virtually identical throughout Europe, which is a task that might take a generation if Europeans were serious about it. The only other practical way, which we believe is what may finally happen at the last minute, is to fix the Euro/gold exchange rate. The fact that there is absolutely zero talk of anything like this happening does not bother us in the slightest, as we observe how desperately Europe wants to make the Euro work. The anxious Zeitgeist in Europe’s capitals these days is a fear of being left behind by the dollar bloc of the Americas and the yen/yuan bloc of Asia. Their only shot, they figure, is integration, into a political and commercial bloc that is only possible with a common currency. If it can be done only with gold, that’s how it will happen.

It really isn’t possible for any single country of Europe to fix its currency to gold, because that act alone would disrupt commercial relationships throughout Europe. For all countries to fix to a gold/Euro at once would cause no disruptions within Europe. Interest rates would simply fall in every country and stock markets would boom too. The reason London stocks jumped on Friday on the rumor of integration into what is essentially a D-mark bloc is that sterling’s link to the D-mark via the Euro would slice significant risk from sterling assets. For the D-mark and Euro to link to gold would slice enormous risk from the whole system. The biggest threat at the moment is the variations in tax policies throughout Europe. Even small errors at the Eurobank in the Euro’s value relative to gold, up or down, would be transmitted at variable rates to the tax structures of member states. Floating exchange rates provide a buffer against the political irritations these transmissions would otherwise generate, but they are expensive.

The WSJ editorial this morning expresses hope that Europe will find a way for the Euro to work, and that somehow the experience then will leapfrog the Atlantic, then the Pacific to Japan. It is much more likely that the process first would begin in China, which is already integrated, with a common currency that could easily be linked to gold with no disruptions to its commercial relationships here or in Asia. With $200 billion in liquid monetary reserves, including Hong Kong’s, Beijing could link to gold tomorrow and withstand any speculative assault. When the smoke would clear, Chinese government bonds would be prime credits worldwide. Not only would all Southeast Asian countries be able to link to the Chinese yuan -- protecting themselves forevermore from the depredations of George Soros and his ilk. (Just kidding.) So would Japan, finally breaking loose from the bullying of the U.S.Treasury.

Why, the WSJ should have asked this morning, doesn’t the United States with one stroke solve all these issues and fix the dollar to gold? Mr. Clinton could do so with the stroke of a pen, before breakfast or between the third green and the fourth tee. The problem is that there remains a significant industry in the United States that lives off chaos, especially the kind that occurs through wobbly exchange rates and currency fluctuations. As the Greenspan Fed has chipped away at these wobbles during the past decade, the chaos industry has shrunk on its own. It now is not the power it once was. It will finally lose out to stability when it is clear that either the Europeans or the Asians are about to jump first. For that reason, we join with the WSJ in cheering Tony Blair toward the Euro, adding our own cheers to those in Beijing who are thinking gold. In a recent chat with Greenspan in his office, I mused aloud on how nice it would be if the fix were in on January 1, 2000, for the whole world to make the jump together. As his term is up a few months later, he officially would still be around to preside over the celebration.