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The Non-Crisis of the Euro

BERKELEY – The global financial crisis has breathed new life into hoary arguments about the euro’s imminent demise. Such arguments often invoke Milton Friedman, who warned in 1998 that Europe’s commitment to the euro would be tested by the first serious economic downturn. That downturn is now upon us, but the results have been precisely the opposite of what Friedman predicted.

Unemployment is rising – and with it populist posturing. In countries like Italy, already suffering from Chinese competition, and Spain, which is experiencing a massive housing bust, the pain will be excruciating. Yet neither country shows any inclination to abandon the euro.amp#160;

They understand that even whispering about that possibility would panic investors. They see how countries like Denmark that maintained their own currencies have been forced to raise interest rates to defend their exchange rates when the United States Federal Reserve and the European Central Bank are cutting interest rates. They see how, if there was still a lira or a peseta, they would be experiencing capital flight. They understand that they would have to fend off an old-fashioned currency crisis at the worst possible time. They appreciate that there is stability and security in numbers.

Similarly, the euro-collapse scenario in which such countries successfully pressure the ECB to inflate, compelling Germany to abandon the euro, has shown no signs of developing. The ECB, protected by statutory independence and a price-stability mandate, has shown no inclination to accede to pressure from French President Nicolas Sarkozy or anyone else.