Why the Euro went so badly wrong

It promised so much… what happened?

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A look at one of the world's worst economic disasters.

The foundations for the European Union lay in the wreckage that was early post-war Europe, with a new generation of politicians desperate to find a way to prevent such a calamity ever happening again.

It was a noble aim, but their political ambition greatly overshadowed their economic competence, and their rushed attempts to force a bunch of disparate countries into a federal Europe, which was always their aim, were doomed to fail.

A federal Europe would have, as one of its necessary constituents, a common currency. So get everyone to jump on the eurozone cart, and a horse will be along to pull it shortly. Such was the idea.

Currency union

If you ask a bunch of economists to list the requirements for a successful currency, I expect most would suggest that the body in control of a currency should also control its own fiscal policy.

The idea is that money supply and interest rates are just part of the toolbox, with tax collection, redistribution, government borrowing and expenditure being their essential counterparts.

The euro dreamers weren't stupid, and they knew that perfectly well. In fact, a centralised European fiscal policy was exactly what they wanted to achieve. But without having it at the outset, they knew they had to get fiscal policies across all of the EU states more closely aligned if they were to give the new currency a chance.

That's what the Maastricht Treaty of 1992 was all about. It committed the member states to keep inflation within a narrow range, but, more importantly, it imposed a rule that government deficit in any one year should not exceed 3% of gross domestic product (GDP) for the previous year. If those targets could be achieved, there would hopefully be sufficient economic convergence for the next steps towards federalism.

Not going to make it

Unfortunately, it soon became clear that a number of European economies, most notably Italy, were simply not close to the requirements. The sensible thing to do might have been to push back the timescale and spend another decade or two working towards economic convergence before jumping into the deep water of currency union.

But that wouldn't satisfy the fast-track federalists. They wanted union, and they wanted it within their political lifetimes, so that it would be their names that went down in the history books.

So, in subsequent treaties, economic requirements were weakened, and as long as fiscal policies were sort of generally moving in the right direction, all would hopefully work out in the end.

Cooked books

But as we now know, it didn't. The weakened fiscal requirements meant that European states could enter union with very fuzzy sets of accounts, and a number of them badly represented the real states of their economies. Italy was nowhere near the original convergence criteria. And Greece's books, well, they might as well have been written by Enid Blyton.

The result was a mix of the prudent Germans with their strong dislike of borrowing, the French a little way behind but with generally sound policies, and the southern states with a historic love of putting government borrowing and spending ahead of productivity.

And they all had brand new abilities to borrow money much more cheaply than before — lenders put far more trust in the ECB and the euro, than in the drachma and lira and the banks of southern Europe.

Borrow like there's no tomorrow

We've seen the result — a massive borrowing and spending spree by countries whose productivity could not support it, and who ultimately could not repay their debts. It was a bit like handing out a joint credit card to every household in the street, with the only real restriction being: "Please try not to spend too much".

Ironically, now that Europe has failed so badly, it's suddenly become time to force sound fiscal policies on everyone again — when the worst economies are already on their knees. Lovers of horse-and-cart analogies really couldn't make it up.

And in further irony, the failures and the austerity regimes are leading to the rise once again of extreme nationalist politics, and are forcing the people of Europe further apart in their views. The Greeks don't want to be told what to do by Germans they didn't elect. And why should they?

What next?

But the tattered federalist ideology remains astoundingly stubborn. Even this week, we've had German ex-Chancellor Gerhard Shröder, talking in Der Spiegel, calling for faster political unification as the way out of the mess. If he thinks there's any chance of that happening now, he's not even in the same solar system as the rest of us.

What we need now is for the old, failed, post-war federalist generation to be put out to pasture, and for Europe to be driven by sound economic policies as a free market of independent states. That, inevitably, must mean the end of the eurozone as we know it. It might not mean total collapse, and once Greece has left (for its own good, to give it the most realistic economic chance it now has), a new version might take shape.

But its architects will need to get their animals and vehicles the right way round. And not mention the war.

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The Motley Fool's purpose is to help the world invest, better. Take Stock is The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it's still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

A version of this article, written by Alan Oscroft, originally appeared on fool.com

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