Wolfgang Münchau declared recently in his Financial Times column that the euro was a mistake, and pinpointed a key illusion. Advocates “knew that, to withstand the rigors of a fixed-exchange system that resembles nothing so much as the gold standard, countries would have to adjust to economic shocks through shifts in wages and prices – a course, they believed, that the euro’s members would be forced to take.”
That is, the euro’s advocates believed that reforms could create enough flexibility to mainly neutralize Milton Friedman’s warning that in the face of negative shocks, countries with fixed exchange rates would suffer large costs: “If the external changes are deep-seated and persistent, the unemployment produces steady downward pressure on prices and wages, and the adjustment will not have been completed until the deflation has run its sorry course,” Mr. Friedman wrote in “The Case for Flexible Exchange Rates.”
But I never believed that this would work, and I based this skepticism on real evidence. During the run-up to the Maastricht Treaty, which set the whole euro project in motion in 1992, a number of studies focused on the United States – a currency union that functions reasonably well. Was that because America, with its weak unions and competitive labor markets, had more wage and price flexibility than other nations?