Milton Friedman and the Euro

Milton Friedman never found it necessary to hide his feelings with regards to the creation of the Eurozone and the euro currency; he didn’t like it and he felt that it was unlikely to survive a serious economic test. In the year leading up to the launch of the euro in 1999, Friedman stated that he did not believe the Eurozone could last ten years and even as late as December 2005 – less than one year before he died at 94 years of age – Friedman was still very pessimistic:


The euro is going to be a big source of problems, not a source of help. The euro has no precedent. To the best of my knowledge, there has never been a monetary union, putting out a fiat currency, composed of independent states. There have been unions based on gold or silver, but not on fiat money—money tempted to inflate—put out by politically independent entities.

- Interview with New Perspectives Quarterly Magazine, 2005

It has been ten years since the euro became a reality and the Euro Zone, like the rest of the world, is truly in the midst of a deep recession. It would seem that if Friedman’s predictions were to come true, now is the time – so are we likely to see a break-up of the Euro Zone?

I think the short answer is no – the logistics behind a country unilaterally pulling out of the Eurozone or even less likely to be booted out – are staggering. Economies in the member states have become incredibly linked far beyond just sharing a common currency. Borders have essentially been erased and trade and even citizens can move freely between the Eurozone countries.

In some ways, the Eurozone member states can be compared to the provinces and states in countries like Canada or the United States. The difference of course is that Canada and the United States have a long history of nationhood which helps ease the inevitable conflicts that do arise between regions in any country.

Compare this to the Eurozone which exists solely for economic reasons – a citizen of France for example, will continue to think of themselves as French first and while they may be very committed to the goal of a unified Europe, it is unlikely that they will approve of any fiscal policy that would favor another country at France’s expense. It is this reality – which I believe Friedman understood completely – that could lead to the kind of strife and civil unrest we typically think only exists in developing nations.

Inflation and the PIGS

When it comes to fiscal and social policies, there is a tremendous divergence of views within the Eurozone member states, and these differences have already been a source of bitter conflict. Because of these differences, arriving at a Eurozone-level fiscal policy that works for all members has been – and will continue to be – next to impossible. Indeed, it is one thing to manage fiscal policy when times are relatively good and prospering countries are more willing to contribute to under-performing countries, but during difficult times, it might be too much to expect the same level of cooperation.

Portugal, Italy, Greece, and Spain – lumped together by the dubious PIGS moniker – embody the problems facing the European Central Bank (ECB) and how it has struggled to manage the various economies throughout the Eurozone. During the late 1990s and into the new century, Portugal, Spain, and Greece in particular, enjoyed prolonged booms triggered initially by the advantages seen with entering the Eurozone. The economic good times were then extended by lower borrowing costs which triggered a rash of new infrastructure projects and government spending.

Wages began to rise as unemployment fell pushing up prices resulting ultimately in an inflation spiral that soon priced local workers and the products they produced out of the market. With the elimination of trade barriers from other countries, cheaper goods from other countries soon flooded into the PIGS countries.

At the first signs of inflation creeping into an economy, the first act of most governments is to increase interest rates to dampen spending and reign in inflation. However, by joining the Eurozone, these countries gave up the ability to directly manage their own economies through a national Central Bank in favor of the European Central Bank responsible for the entire Eurozone.

Unfortunately for the PIGS at this time, other countries within the Euro Zone – most notably Germany which was coming to terms with the recent reunification of East and West Germany – was in the midst of a recession and the last thing Germany needed was an increase in interest rates. Now I’m not saying that this was the reason that interest rates were not increased to address inflation in the PIGS countries, but it is interesting to note when the ECB was formally created in 1998 by the Maastricht Treaty, it was established in the German city of Frankfurt and the first President – Wim Duisenberg – was the former President of the Dutch Central Bank.

You can decide for yourself if this was a conflict of interest, but by 2003 when Frenchman Jean-Claude Trichet took over the Presidency of the ECB, Germany had recovered from its recession to become the largest economy within the Eurozone. The PIGS on the other hand, are still dealing with record unemployment and growing public anger. This was manifested in the Greek riots late last year which while triggered by a police shooting, were nevertheless fuelled by anger over the state of the economy. This anger eventually spilled over into other jurisdictions including Spain.

So, getting back to Friedman, he may have been off in his original time frame of ten years, but his prediction that the Euro Zone will not survive may yet prove accurate.



About the Author

Scott Boyd has been working in and writing about the financial industry since the early 1990s. As a technical writer and project manager with several of Canada’s leading financial institutions, Scott has produced educational materials for investment system end-users including portfolio managers and traders. Scott now administers and contributes to OANDA FXPedia and regularly provides commentaries for the OANDA FXTrade website.

This article is for general information purposes only. It is not investment advice or a solicitation to buy or sell securities. Opinions are the author’s — not necessarily OANDA’s, its officers or directors. OANDA’s Terms of Use apply.

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