The American Nobel laureate Milton Friedman (1912-2006), who would have turned 103 today, was not a big fan of the European project.
We can ascertain Friedman’s views on the euro by looking back to the early 1950s. At the time, Germany was battling with a large current account deficit, and Friedman published a memo on the subject in 1953 entitled “The Case For Flexible Exchange Rates”.
Friedman argued that floating exchange rates are generally preferable to fixed exchange rates. The reason was that, if an economy is hit by a shock, prices and wages adjust. But not all prices are flexible, and wages in particular tend to be rigid. By contrast, a floating exchange rate has infinite flexibility to adapt when a shock hits the economy.
This insight was the basis for Friedman’s opposition to the euro. He warned particularly of the problems a common currency would cause for the rigid European economy, as prices and wages in Europe would not be flexible enough to adapt.
Friedman also stressed that the euro would lead to political division. What he wrote in 1997 was almost prophetic:
“The drive for the euro has been motivated by politics not economics. The aim has been to link Germany and France so closely as to make a future European war impossible, and to set the stage for a federal United States of Europe. I believe that adoption of the euro would have the opposite effect. It would exacerbate political tensions by converting divergent shocks that could have been readily accommodated by exchange rate changes into divisive political issues. Political unity can pave the way for monetary unity. Monetary unity imposed under unfavourable conditions will prove a barrier to the achievement of political unity.”
As farcical negotiations over Greece’s debt problems continue, it transpires that Friedman was right. The crisis is now being used by European politicians to ensure further political integration. The German finance minister Wolfgang Schäuble, for example, recently talked about the need for common European taxes.
But political centralisation in Europe is not the same as popular cohesion. The risk is, however, that in practice it is the Germans and French who will make the decisions (and pay the price) in this “United Europe”. If the Germans are going to pay for the Greeks’ problems, then the Germans should also be able to determine Greek economic policy.
Friedman had more to say on that count. In 1965, he wrote about the implications for UK economic sovereignty of the crisis of the British balance of payments in the Bretton Woods fixed-exchange system:
“Personally, I disagree sharply with the policies that the Labour government wishes to follow... Yet that does not alter the fact that British internal policy was shaped by officials who were not responsible for Britain itself and in directions that had not emerged through the regular political process. In this respect, I find myself in complete sympathy with those Labour supporters who regard it as nearly intolerable that the ‘gnomes in Zurich’ should have a veto power over internal British economic policy.”
It is not hard to see why this foresight is relevant to the current climate. Now the Greeks’ version of Labour is Syriza and, although it is hard to say anything positive about them, one must also feel a certain sympathy for the Greek people, who have now been left with the perception that the “gnomes” in Berlin and Brussels create economic policy for Greece.
Unfortunately, Friedman was right – the euro has led not to peace and cohesion in Europe but conflict and division.