Europe 1914 vs. monetary union today.

• Author: Connolly, Bernard

The difference is that World War I was a tragedy, not a crime. "Monetary union is a tragedy and a crime."

The wonderful book Sleepwalkers: How Europe Went to War in 1914 by Cambridge historian Christopher Clark has rightly received great praise. It provides an illuminating and tremendously well-written disentangling of the multiple forces--constraints, aspirations, misperceptions, paranoid delusions, and, in some ways most important of all, miscalculations that via the system of European alliances produced an appalling conflagration which killed, maimed, widowed, or orphaned tens of millions, destroyed the economic basis of the lives of many millions more, and effectively obliterated what had been European civilization. Clark describes the authors of the tragedy--the "statesmen" of Europe--as being "like sleepwalkers, watchful but unseeing, haunted by dreams, yet blind to the horror they were about to bring into the world."

A century later that same description might seem, to the generous in spirit, to fit the policymakers who created and now sustain the malignant lunacy of monetary union in Europe. Not everyone will find it possible to be so generous-minded; for most of the policymakers who imposed the present-day catastrophe were wide awake. They either knew, in outline if not in detail, what horrors were coming and sought to inflict them for their own purposes, or deliberately shut their eyes to them.

In his summing-up, Clark attempts a compare-and-contrast exercise between the descent into the abyss in 1914 and the euro crisis of 2011-2012. In both episodes, he writes, the problem was one of baffling complexity. As in 1914, the political actors were aware of the possibility of a general catastrophe--in 2012, according to Clark, the failure of the euro--and, although all of them hoped it would not happen, many were prepared to evoke its possibility in order to extract advantage for their own countries, polities, entities, or patrons.

The two great differences, in Clark's view, are that in the euro crisis all the actors have agreed on what the problem is, and that Europe now has "powerful supranational institutions that today provide a framework for defining tasks, mediating conflicts, and identifying remedies that were conspicuously absent in 1914."

Although it does not vitiate the great achievement of his book in helping understand the past, Clark's excursion into the present is wrong in all its key respects. The euro problem is not one of baffling complexity. It is analytically straightforward but, unfortunately, incapable of benign resolution. The ultimate catastrophe would not have been the failure of the euro: the catastrophe was the creation of the euro. The present existence of "powerful supranational institutions" is not something that helps avert disaster and preserve stability, but the feature of the European present that has extinguished those elements of European civilization briefly resurrected in the 1950s and 1960s, already destroyed prosperity, and puts peace and stability in great danger.

The perverse economics of the euro are all too straightforward. Monetary union, everyone who was allowed to look beyond of his nose could always see, meant that divergences between the rate of return on capital between member countries could not be matched by appropriate divergences in ex ante real interest rates. (Indeed, it would, in an analogue of the famous Walters critique of the ERM, produce ex ante real interest rate movements in the wrong direction). Thus, without some Soviet-style attempt to suppress rate-of-return divergences--and to keep the poorer countries of the area poor--monetary union would inevitably create economic and financial instability, with the politically unimportant peripheral countries having no instruments available to cope with that instability. "Europe is France and Germany; the others are just the trimmings," as Charles de Gaulle put it.

The real-side effects of monetary union would have been devastating for the peripheral countries in any circumstances. But things were made even worse by the fostering of the illusion that monetary union, rather than transforming currency risk into credit risk, somehow eliminated risk entirely. (Jean-Claude Trichet's 1994 assertion that "monetary union will permit the elimination of risk premiums" will surely be seen by future historians as one of the most misleading and damaging statements ever...