The euro's fundamental flaws: the single currency was bound to fail.

• Author: Feldstein, Martin

The crisis in Greece and the debt problems in Spain and Portugal have exposed the euro's inherent flaws. No amount of financial guarantees--much less rhetorical reassurance--from the European Union can paper them over. After eleven years of smooth sailing since the euro's creation, the arrangement's fundamental problems have become glaringly obvious.

The attempt to establish a single currency for six teen separate and quite different countries was bound to fail. The shift to a single currency meant that the individual member countries lost the ability to control monetary policy and interest rates in order to respond to national economic conditions. It also meant that each country's exchange rate could no longer respond to the cumulative effects of differences in productivity and global demand trends.

In addition, the single currency weakens the market signals that would otherwise warn a country that its fiscal deficits were becoming excessive. And when a country with excessive fiscal deficits needs to raise taxes and cut government spending, as Greece clearly does now, the resulting contraction of GDP and employment cannot be reduced by a devaluation that increases exports and reduces imports.

Why, then, is the United States able to operate with a single currency, despite major differences among its fifty states? There are three key economic conditions--none of which exists in Europe--that allow the diverse U.S. states to operate with a single currency: labor mobility, wage flexibility, and a central fiscal authority.

When the textile and shoe industries in America's northeastern states died, workers moved to the West, where new industries were growing. The unemployed workers of Greece, Portugal, and Spain do not move to faster-growing regions of Europe because of differences in language, history, religion, union membership, and so on. Moreover, wage flexibility means that substantially slower wage growth in the states that lost industries helped to attract and retain other industries. And the U.S. fiscal system collects roughly two-thirds of all taxes at the national level, which implies an automatic and substantial net fiscal transfer to states with temporarily falling incomes.

The European Central Bank must set monetary policy for the eurozone as a whole, even if that policy is highly inappropriate for some member countries. When demand in Germany and France was quite weak early in the last decade, the European Central Bank reduced...