Greece debt crisis: Like earlier currency unions, this one will end with a whimper

While flexibility will have to be brought into the eurozone, the path won't be smooth

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The drama continues. There is a long tradition in the European Union of talks going on far into the night until the exhausted participants manage to cobble together some sort of agreement. But these talks about Greece are not like that. There is no obvious compromise that should and could have been reached with just a bit of goodwill.

The Greek government cannot pay its debts, whatever new and greater level of austerity it might impose on its people. As the vote at the weekend shows, even if it tried, they would not stand for it. But the other members of the eurozone cannot write down those debts because to do so would destroy the structure of the edifice. Other countries, including ones that had to be rescued, would have to go to their taxpayers and pump more capital into the European Central Bank and the European Stability Mechanism.

In theory I suppose that could be done. In practice it cannot.

So we are in the early stages of a break-up. When Britons say the eurozone is over, they meet a wall of hostility. We are seen as bad Europeans, or told we simply do not understand the level of commitment on the continent to keep the thing going.

It is true, too, that the euro has popular support. Even in Greece a large majority want to keep it, while in the other weaker members of the zone, voters do not attribute their economic troubles – the high unemployment and lack of growth – to the euro. That is fair in the sense that the euro is not the sole cause of these problems by any means. But membership does make it much harder to compensate for errors once you have made them, and Greece has made them in spades. As my colleague Steve Richards noted this week, a currency union cannot work without political union, “and the crisis in Greece shows that political union cannot follow monetary union”.

Currency unions end more with a whimper than a bang. It may be that there will be some sort of deal that will hold the euro together for a little longer, but we can guess from history what might eventually happen.


Parallels are never exact, but here are three that are helpful. The closest example of a precursor to the euro was the Latin Monetary Union, which began in 1865 with France, Belgium, Italy and Switzerland, to be joined by Greece two years later. A number of other countries associated with the union at various stages, including the members of the Austro-Hungarian Empire, Spain and Russia. So it was a real attempt at creating a European currency. But there were weaknesses: Germany crucially never joined and countries periodically broke the rules; Greece was expelled in 1908 for cheating, although it was readmitted two years later. The union eventually fell apart at the time of the First World War, but by then it had become a part of the gold standard.

The second example is the British gold standard, the longest-lasting example of a currency union without political union. This formally applied to the British Empire but was in effect adopted by other countries as they also linked themselves to gold, making it a global standard. Yet it ran in its pure form only from 1844 (when the pound was freely converted into gold) until 1914. While the gold standard was reconstituted after that war, it broke up when Britain left in 1931. The US hung on, at huge economic cost, until 1934 when the dollar was devalued, while France, also at great cost, delayed its devaluation until 1936.

The third case is the post-Second World War fixed exchange rate system, founded by the Bretton Woods conference in 1944 and which finally fell apart in 1973. This was the system that those of us who learnt our economics in the 1960s were taught avoided both the rigidities of a completely fixed system but also the chaos of floating rates.

Under Bretton Woods, currencies were pegged to 2 per cent on either side of a central rate against the dollar, which itself was pegged to gold. Devaluations could and did occur – sterling devalued in 1949 and 1967 – but the IMF made loans to countries in temporary balance-of-payments trouble to discourage exchange rate movements.

Revaluations occurred too, notably that of the deutschemark in 1961. But by the end of the 1960s it was under huge pressure because of dollar weakness and in summer 1971 the US broke the link between the dollar and gold. The final big effort to save the system came at the end of 1971 with the Smithsonian Agreement devaluing the dollar, but while that was heralded by President Nixon as the greatest agreement in monetary history, it lasted little more than a year. The world moved to floating exchange rates, which in turn were associated with the runaway inflation of the 1970s and 1980s.

So what can this tell us about the future of the euro – aside from the general point that currency unions without political union are fragile beasts? Three thoughts occur.

The first is that there will always be a tug-of-war between the need for stability and the need for flexibility. A fixed exchange rate is one way of providing stability but it is a harsh one. The pain inflicted not just on Greece but on a swathe of countries across southern Europe has been at the outer limits of post-war experience. But currency chaos such as we had in the 1970s is deeply damaging too. The Bretton Woods system was not a bad compromise.

The second is that politicians invest huge amounts of credibility in their ability to maintain a currency union, but in doing so are really reflecting voters’ desire for sound money. That desire is especially strong in Germany and has been ever since the hyperinflation of the 1920s.

The third is that while flexibility will have to be brought into the eurozone, the path won’t be smooth. Whatever happens to Greece now, other countries will need to change their exchange rates against Germany. There may be a complete breakdown but what is more likely is a splitting of the euro into two, a hard euro in the north (a “greater deutschemark zone”) and a soft one in the south. But we are not there yet and I am afraid there is more misery in store.