Lots of people now understand that the euro was a very serious mistake. But most still don’t understand just how badly the project was botched. Let’s start with the obvious. If you are going to launch a grand experiment in monetary policy (like NGDP targeting for instance) you need a back up plan if it fails. My back up plan would be to return to the previous policy.
But the EU did not provide for any backup plan. There is no procedure to unwind the eurosystem if it failed. They simply assumed it would work. They acted like they were 100% certain it would work. That’s not really a good idea, even if the experts were unanimous that the project would succeed. Experts might be wrong. But in this case it was far worse. Many of the world’s leading experts thought it was a horrible idea, and predicted exactly the sort of disaster that has arisen.
There are probably a few times in my life where I’ve felt that both Paul Krugman and Milton Friedman were wrong about some issue, and that I was right. Maybe I’ve even said I was “sure” they were wrong. But suppose God put a gun to my head and threatened to fire if Friedman and Krugman were right. Would I still say I was “sure” they were wrong? The point is so obvious that it really shouldn’t even need making; if leading intellectuals on both sides on the ideological spectrum think an idea is crazy, then policymakers must at least entertain the idea that there is at least a small probability that the idea is indeed crazy. They need a backup plan. The Eurocrats (with the French in the lead) were not willing to entertain this sort of uncertainty.
Would a backup plan have been difficult to devise? I can’t imagine why; we already know how easy it was for countries like the US to devalue during the Great Depression. They would simply have needed to allow for a similar fallback plan. This would have involved holding onto the old currency when it was withdrawn from circulation, and printing new currency at the normal pace, and putting it into storage for an emergency. Then there would be a provision that if the country reverted to the old currency, the bonds and bank accounts would automatically be converted over as well. In that case Greek bonds and bank accounts would have continued to price in devaluation risk, as they did before 2000. If the euro were a success, then the risk premium would gradually fade away over time.
This sort of fallback plan would have allowed the euro to be unwound in a crisis, in much the same way that Britain and Sweden left the EMS in 1992. A bit messy, but nothing like the crisis we are now facing. But the Eurocrats who dreamed up their perfect monetary system were too arrogant to even entertain the prospect of failure. And now we pay the price for that . . . what’s the Greek word?
Update: One commenter suggested that my previous post left the impression that I don’t like Greek culture. Not true. Although I’ve only visited Greece once, based on my impressions I prefer Greek culture to American culture (yes, that’s a low bar.) I prefer American attitudes toward capitalism, but overall I prefer Greek culture. It’s a wonderful country. Apologies to any Greek readers if my post left a bad impression.