Is the Euro a Defacto Gold Standard

An incredibly interesting idea from Thomas Palley on the Financial Times blog today. He argues that the institutional structure of the eurozone is built on neoliberal ideas that have been largely discredited over the past two years. As he tells it

The last quarter of the 19th century witnessed a period of sustained global deflation. In the 1896 US presidential election, William Jennings Bryan famously attacked the gold standard as the cause of deflation, declaring “You shall not press upon the brow of labour this crown of thorns. You shall not crucify mankind upon a cross of gold.” Today, euroland is being crucified upon its own cross of gold that is the institutional arrangements behind the euro. Those arrangements have distorted the monetary - fiscal balance, creating deflationary central bank dominance. That balance needs correction and failure to do so could even risk the viability of the euro in its current form.

The euro was introduced in 1999, the high-water mark of neo-liberal economics. As such, its institutional design embeds neo-liberal monetary theory which in many regards rests on the same economic principles as the gold standard. These principles are that fiscal policy is ineffective; inflation is caused exclusively by money supply growth; and the real economy quickly and automatically returns to full employment in response to negative shocks.

All three principles have been fundamentally discredited by the current recession. Around the world, countries have turned to fiscal policy to offset the collapse of private sector spending, and the recession would have been far deeper absent that fiscal response. Money supplies have risen dramatically almost everywhere without matching increases in inflation, showing that the money - inflation link is highly contingent upon economic factors such as unemployment, capacity utilisation, commodity prices, and business expectations of profits. Finally, rather than rebounding to full employment, the global economy looks set for high unemployment that will last years. This possibility was Keynes’ message in his 1936 General Theory.

Owing to its neo-liberal monetary arrangements euroland has run smack into these economic realities. The European monetary union establishes central bank dominance through an independent central bank that is prohibited from providing financial assistance to member country governments. Thus, whereas the US and UK have been able to finance their fiscal and financial market rescue plans with assistance from the Federal Reserve and Bank of England respectively, eurozone governments have received no equivalent assistance. Instead, they have had to fend for themselves in private capital markets, which has raised the costs of policy and dissuaded more aggressive action.

The irony, of course, is that it is interventionist Europe and not the free market ideologue U.S. that is caught in this trap. It is also a powerful argument in Canada against any sort of currency union, informal or otherwise.