When the Euro was introduced, it was pitched as a tool of cross-border harmonization. No longer would EU member states and their citizens have to juggle competing currencies. With the euro in place, money could move more easily across borders, and so, in theory could, goods and services; it was a vehicle for making trade simpler, and reducing the barriers to labor mobility that had arisen from the patchwork of individual currencies across the continent. It was a way toward more Europe, not less.
But with Greece's overwhelming "no" vote on this weekend's referendum, it seems that may no longer be the case. The vote was a rejection of the EU's bailout terms, and a victory for—well, it's not entirely clear yet. But while the eventual outcome is still highly uncertain, it is distinctly possible that it will lead to the long foretold "Grexit," in which Greece leaves the joint currency behind, and, most probably, returns to the drachma. Less Europe, in other words, rather than more.
Greece has been through a lot in recent years, but even still, the transition, which would essentially place the economy on hold while new drachma notes were printed, would be confusing and painful—a problem as much because of the cascade of uncertainty it would unleash as any particular, knowable economic effect. Greeks may have voted "no" in part because they believe the situation cannot get any worse. (As the FT's Wolfgang Munchau writes, "If you have been unemployed for five years, with no prospect of a job, it makes no difference whether the money you do not get is denominated in euros, or in drachma.") Nevertheless, an exit from the Euro would be a new and uniquely complex form of economic frustration.
At the root of all this is that the euro was ultimately a tool not of harmonization, but of centralization. It handed vast power over to the European Central Bank (ECB)—which now controlled the currency—that would previously have been held by local authorities. And that authority, in turn, was divorced from meaningful accountability and responsibility.
As a recent paper on the monetary origins of the the Eurozone crisis by Western Kentucky University economics professor David Beckworth suggests, the ECB badly mishandled its authority, tightening the continent's money supply starting in 2008 and again starting in 2010. (Via Jim Pethokoukis.) The run-up in public debt in Greece and other struggling countries had already begun when the recession hit, but much of it followed the recession. Beckworth argues that the build up in debt was in significant part a response to the ECB's monetary controls.
Greece's creditors, meanwhile, were given false confidence that made agreeing to the loans easier. They weren't dealing with the economically shaky Greece. They were dealing with Europe. The debts would be repaid.
The Greek government, of course, played a substantial role in all this too, running up spectacular debts that the, as a recent International Monetary Fund report indicates, the country may now never be able to repay. But that debt build-up was in large part enabled by the relatively recent transition to the euro, which helped put the nation on better credit footing, and was preceded by ECB's monetary tightening; if the ECB had acted differently, it likely would have softened the recession's blow.
This is what Milton Friedman was referring to in 1997, when he argued that Europe was a poor case for a common currency. The value of a common currency, he wrote…
Depends primarily on the adjustment mechanisms that are available to absorb the economic shocks and dislocations that impinge on the various entities that are considering a common currency. Flexible exchange rates are a powerful adjustment mechanism for shocks that affect the entities differently. It is worth dispensing with this mechanism to gain the advantage of lower transaction costs and external discipline only if there are adequate alternative adjustment mechanisms.
In this case, the ECB was the alternative adjustment mechanism. It failed. And it failed in part because it was a centralized decision maker, out of tune with local interests and out of the loop on crucial local fiscal decisions. It considered itself a protector of Europe's interests more than Greece's. Greek authorities, not surprisingly, felt differently.
The euro, then, made it easier for Greece to run up its public debts, and at the same time made it possible for the ECB to act indifferently in response. Each party had authority, but neither, ultimately, had responsibility. The incentives were misaligned. The euro had centralized—but not harmonized. And now we are witnessing the consequences of that misalignment.