The late Eddie George once remarked to me that the euro project, which was launched in 1999, came 10 years too early. He was wrong. It was 20 or 30 years too early or perhaps should not have been launched at all. The former governor of the Bank of England was far too strict a constitutionalist to pronounce in public on the issue of British membership but there was little doubt where he stood. For a long time the euro project seemed to be doing well and confounding the sceptics. But with the emergence of the Greek problem the weaknesses of the project are there for all to see.

It is no secret that the German government and business establishment were also dubious about what they saw as a French-led project. What decided the matter for Helmut Kohl, the then German chancellor, was his belief in a federal Europe. He originally hoped that monetary union would be coupled with a political union. But, when he realised that was not to be, he still hoped that the monetary union would itself lead to a political one.

The economic weaknesses could not, however, be hidden for ever. Economists had argued for ages about what they called an optimal currency area; and the magic word “convergence” was often used. The convergence that matters is that of domestic costs. The mistake I made was to suppose that monetary union might itself be a sufficient influence for that convergence.

A country with its own currency has two safety valves, which Greece and others that may be in a similar position lack. First, it can issue its own money; so it can pursue a fiscal policy attuned to domestic needs, without being dependent on the international bond market. Second, and most important, it has the safety valve of currency devaluation. Both these safeguards can be abused; and instead of full employment without inflation a country can end up with inflation without full employment. But it can learn from its mistakes; and it can act without provoking an international crisis. Within a functioning monetary union, however, an individual member has no more control over its macroeconomic policy than the state of Ohio over that of the US.

Meanwhile, we are witnessing a game of bluff and counterbluff between Greece and its eurozone partners. Greece holds more bargaining cards than generally realised. There is a widespread and justified fear that the exit of Greece – which in contrast to Ohio always has this option – would mark the start of the fragmentation of the eurozone. If the Greek authorities play their cards well they have no need to accept financial terms deeply damaging to their economy. They have no need to accept the kind of terms that the International Monetary Fund imposed on Asian countries in the late 1990s and which left such a bad taste that they built up their foreign exchange reserves to avoid such humiliation again.

There are several available options. The first is what Americans call cold turkey. After having negotiated down the European Union’s demands for fiscal “slash and burn” as far as it can, Athens can grin and bear it.

At the other extreme, Greece could leave, or be ejected from, the eurozone. In spite of all the complications, such as renegotiating financial instruments denominated in euros, it could be done. People forget that one of the oldest currency unions in history, that between the UK and Ireland, was brought to an abrupt end when Ireland abandoned sterling – first for the European exchange rate mechanism and then for the euro. Nevertheless, one should hesitate before urging purely destructive courses. A Greek exit would turn the spotlight on other countries – Portugal, Italy and Spain – and eventually on the euro project itself. It is one thing to regard the project as a mistake and another to provoke a messy disintegration.

I am attracted to Professor Martin Feldstein’s idea (Financial Times, February 17) of a temporary euro exit for Greece followed by re-entry at 20 or 30 per cent below the present level. But if that occurred there might not be a euro to rejoin. So it is a last resort. There is an alternative to try first, which might be called an internal devaluation. When Margaret Thatcher was struggling to wean her colleagues from pay and price controls she at one stage considered a compromise: a temporary wage freeze – in an emergency – after which normal negotiating procedures would be restored. In the case of Greece today it would have to be not just a freeze, but a negotiated reduction in nominal wages. Such a course would cut against Greece’s fiercely independent habits and traditions. But surprises can always occur.

Finally, an offbeat idea which is not an alternative to the others, but can run alongside. Countries in the Middle Ages often operated with two or more currencies: an international one such as the ducat or florin, and local currencies with more restricted use. Could not such a local currency, whether or not called the drachma, emerge in this way with or without the sanction of the Greek government? It would surely be better than being crucified by the international financiers.
More columns on

Get alerts on Bank of England when a new story is published

Copyright The Financial Times Limited 2022. All rights reserved.
Reuse this content (opens in new window) CommentsJump to comments section

Follow the topics in this article