ROME – Increasingly, one hears predictions that the euro will go the way of the gold standard in the 1930’s. And, increasingly, the reasoning behind such forecasts seems persuasive. But does that mean that the euro doomsayers are right?
Following the 1929 stock market crash, Europe was hit by a massive deflationary shock. Output collapsed and unemployment soared. Unable to agree on coordinated reflationary action, governments opted to move unilaterally. One after another, they abandoned the gold standard, depreciating their currencies. By loosening credit in this way, they recovered, one after another, from the Great Depression.
Today, Europe has been hit again by a massive deflationary shock. This time, the constraint on reflationary action is the euro. Governments lack a national currency to depreciate, and lack the power to relax credit, having delegated monetary policy to the European Central Bank. As unemployment again rises to catastrophic heights, they will have no alternative, it is said, but to abandon the euro unilaterally.
I wrote the book on Europe and the gold standard. Literally. In Golden Fetters: The Gold Standard and the Great Depression, published in 1992, I argued that the deflationary engine that was the gold standard was a key cause of the 1930’s depression, and that abandoning it opened the door to recovery.
Yet I am reluctant to believe that things will turn out the same way this time. Four differences lead me to believe that maybe – just maybe – the euro will survive.
First, mounting an appropriate monetary response is easier when you have a single central bank. Under the gold standard, it still would have been possible for central banks to reflate their depressed economies had they moved together. Unfortunately, getting central banks to move together is easier said than done. Central bankers speak different languages. They view economic prospects through different lenses.
By contrast, were the ECB to adopt decisive measures, it could reflate the entire eurozone and obviate the need for countries to act unilaterally. But, while the ECB has the capacity, the question remains whether it is has the will.
A second difference is that, notwithstanding recent cuts in social programs, the unemployed receive more extensive public support than in the 1930’s. This makes populist pressure to abandon the euro correspondingly less severe – the key questions, of course, being how much less severe, and whether the political center can hold.
A third difference is that the political preconditions for a cooperative response are better today. In 1931, France refused to help stem the Central European financial crisis because it believed that Germany was rearming, in violation of the Treaty of Versailles, signed at the end of World War I. Political tensions between France and Germany may very well grow in the coming months and years, following François Hollande’s victory in the French presidential election, but they will not begin to rise to that level.
Moreover, European countries today are prepared to go to great lengths to save the euro, fearing that its collapse would jeopardize their single market. By contrast, when countries started abandoning the gold standard in 1931, tariff barriers had already gone up. There was no longer a single market to protect.
Finally, abandoning the gold standard was less disruptive than abandoning the euro would be. Reintroducing national currencies today would take weeks, at a minimum, whereas Britain in 1931 could take sterling off gold while the markets were closed for the weekend. Back then, countries still had their national currencies; they could simply stop supporting them. Bank deposits, along with most other private and public debts, were denominated in that national currency.
Today, these assets and liabilities are all in euros. Reintroducing the national currency in order to depreciate it, but leaving the euro value of other financial instruments untouched, would destroy balance sheets and wreak financial havoc. The alternative – converting those other instruments into the new national currency – would tie up the offending country in litigation for years.
Each of these differences casts doubt on the notion that the euro will go the way of the gold standard. But a fifth difference points in the other direction. In the 1930’s, countries could not act together because they could not agree on a diagnosis of the problem. Each attributed the Great Depression to different causes, leading them to prescribe different remedies, which they administered unilaterally.
Agreement today on the diagnosis facilitates mounting a common response. Unfortunately, there is growing evidence that the medicine on which European countries have agreed – austerity – is killing the patient. There is now talk of adjusting the dosage, but talk has not yet given way to action.
Will things turn out differently this time? There is no question that the greater scope for cooperation that exists today bodes well for the euro. But it is the precise policies on which European governments cooperate that will tell the tale.