SAN FRANCISCO: Hidden behind the euro's falling exchange rate is a life-and-death struggle between it and Europe's welfare state. Either the euro subverts the welfare state, or Europe's welfare state will subvert the euro. Despite today's weakness, smart money should bet on the euro.
The euro's disappointing performance - falling from a value of a $1.18 at its inception to a recent low below $.90 - is in large part due to Europe's reluctance to adopt structural reforms to increase economic flexibility. ECB Chief Economist Otmar Issing writes: "Germany and other European Union countries share the blame for the euro's weakness because they failed to make their economies more flexible."
But there is a world of difference between the euro's need to tame the welfare state and its ability to do so. Harvard economist Martin Feldstein, indeed, believes that "the single currency will be a political impediment to reform." "Politicians", writes Feldstein, "can now blame the ECB for high unemployment and complain that it is a powerful force beyond national control."
Another, more likely, outcome exists: if anti-competitive policies pursued by a country sink the euro, they will be condemned as "anti-European." For Europe's political leadership, the euro is a sine qua non -- an experiment that cannot, and will not, be allowed to fail. If short-sighted national economic policies threaten the euro, they will spark powerful countervailing political pressures on offending parties to cease and desist.