For obvious reasons, I spent a bit of time reading a pair of articles by Robert Mundell titled “The Case for the Euro, Part I” and “The Case for the Euro, Part II.”
Both articles appeared on the opinion pages of the Wall Street Journal in March of 1998, the eve of the launch of the common currency for Europe.
What’s fascinating is Mundell, often considered the father of the euro, gives no consideration at all to the debt crisis that now threatens to destroy the common currency. It appears, at least from these articles, the possibility of a debt crisis both triggered and exacerbated by the euro just didn't concern him.
Mundell’s a very smart guy, of course. But in advocating the revolutionary idea of a common currency for Europe he completely failed to appreciate that it would have severe unanticipated consequences. In fact, the Wall Street Journal articles read as if Mundell believed he understood all the possible outcomes from launching a new government program of money control and creation. The novelty of the common currency seems to have not been a particular cause for worry at all.
One of his arguments against flexible exchange rates now seems especially weak. Mundell engages in a kind of reductio ad absurdum when it comes to flexible exchange rates, arguing that if flexibility made sense for individual nations, it would also make sense for subregions.
My point was rather to show that if the argument for flexible exchange rates is valid at all, it is only valid for single-region countries. Flexible exchange rates will not help solve British regional unemployment problems in Wales or Scotland, or Italian problems in the Mezzogiorno, or U.S. problems in the Appalachians, or German problems east of the Elbe, or Canadian problems in the Maritimes.
If the argument for devaluation were valid, it could be applied to every state or subregion in any country, with a proliferation of new currencies so they could be devalued!
But what we can now clearly see is Mundell was missing the link to fiscal policy and national identity. Flexible exchange rates are unnecessary to relieve the problems of Appalachia because we can relieve those problems with fiscal policy or movement of human capital. We can create empowerment zones, shifting the tax burden away from problem areas, or redistribute wealth via transfer payments.
Because there are no language barriers within the U.S. — and only slight cultural barriers — we can count on people in the “problem” regions to move into the regions with stronger economies.
None of this is available in Europe. For very good reasons Germany is showing that it is strongly opposed to using fiscal policy to transfer wealth to Greece, Italy or Spain. Cultural and language barriers prevent the free movement of labor.
In other words, the safety valves that make subregional flexible exchange rates unnecessary — and therefore ridiculous — aren’t available in international currency zones.
And that’s why we have a crisis.
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