Finance: The Euro Risk

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The American public and officials in Washington are underestimating the risks to the U.S. of the new European Economic and Monetary Union, and its new currency, the euro. The reason for concern is not that the EMU will mean a stronger Europe that can challenge the U.S. economy. Quite the contrary, the EMU is likely to weaken European economies, leading to more trade friction and economic isolation. But the most important problems the EMU can cause are political, bringing increased conflict within Europe and with the U.S.

The EMU is ostensibly about substituting the euro for 11 national currencies and transferring responsibility for monetary policy from individual national central banks to a new European Central Bank, but the EMU's real importance is political. The advocates of the EMU see it as an important step toward creating a strong political union. The idea of a United States of Europe was conceived at the end of World War II by politicians who believed that abolishing national governments would prevent a repetition of the major wars that had engulfed Europe during the previous 75 years.

Although this argument seems far less persuasive after 50 years of European peace, the single currency is applauded by European federalists as an important step toward a federal government. Since there is no major country in the world that does not have its own currency, abolishing national currencies is a major move toward abolishing European national states. When Spaniards and Italians have euros in their pockets instead of pesetas or lire, they are bound to feel more like "Europeans."

Transferring monetary policy to the new European Central Bank is a major step in shifting power away from national governments. Although the motivation for the move to a single currency is political, it will have important economic effects. European countries will have higher unemployment because a single currency and a one-size-fits-all monetary policy will not be able to accommodate national differences in cyclical conditions. Outside the EMU, when growth slows and unemployment rises, a fall in a country's interest rates can provide an offsetting stimulus to demand. But with a single currency for all Europe, there can be only one set of interest rates. The European Central Bank will make decisions based on the overall economic conditions in Europe, essentially in France and Germany. A smaller country with weak demand will just have to accept rising unemployment unless there is also weak demand in the larger countries, as there happens to be now.

Europeans who point to the employment success of the U.S. as evidence that a single currency will not raise European unemployment do not recognize the important labor-market differences between Europe and the U.S. When local employment declines, Americans move to areas where jobs are more plentiful; that is unthinkable in a Europe divided by linguistic and cultural barriers. And American wage flexibility allows employment to remain much more stable when the availability of local jobs declines.