History doesn't bode well for future of the Eurozone

Any traveler among the former French colonies of West Africa in the early 1990s could have foretold the future of the euro. The prospects weren't pretty.

Most countries of Francophone West Africa were then, as they are still, members of a single currency zone very much like the Eurozone. Legal tender for the 13 countries was a pair of essentially identical currencies known collectively as the CFA franc — named from the French acronym for "African Financial Community."

France, which kept the CFA fixed at an exchange rate of 50 CFA to one French franc, had created the zone partially to maintain political ties for its former colonies, but mostly to maintain its mercantile dominance. The CFA kept Francophone Africa economically dependent on France and gave the mother country a convenient market for its products and a source of cheap raw materials. A mandate that CFA countries keep large financial reserves in France fattened its treasury.

By 1990, however, the relationship turned into a subsidy from France to its faltering former colonies of as much $3 billion a year. As the individual African economies diverged, the CFA benefited rich countries, such as cocoa-producing Ivory Coast, and helped impoverish others, such as Senegal, whose major exports included peanuts.

Two schools of thought developed regarding the future of the CFA. One was that devaluation was inevitable. The other was that it was impossible — partially because of the difficulty of keeping the momentous change secret so insiders, including government leaders, couldn't profit from advance knowledge, and partially because the resulting fall in working-class living standards would foster unrest across the zone.

Inevitability finally prevailed. France instituted a devaluation in 1994, cutting the exchange rate of the CFA versus the franc to 100 to 1, with predictable consequences: Workers whose real income had been cut in half went on strike to double their wages. Inflation soared and unemployment spread throughout the zone. Governments tottered. And Africa's overall economic prospects barely budged.

Sound familiar?

The lesson of the CFA for the Eurozone is that maintaining monetary union without real fiscal or political union eventually imposes unsustainable costs on someone — in the CFA case it was France, in the Eurozone it's Germany. The bill payer eventually insists on changes to lower the bill, and those changes typically fall hardest on the workers stuck at the bottom of the economic pyramid. Bondholders and other investors who reaped profits in the good years will generally manage to protect their investments when things turn down, often by liquidating labor costs through the imposition of wage freezes and layoffs. You can think of Greece as the Senegal of the euro.

None of this really comes as a shock to professionals in international finance. Indeed, you could fill Dodger Stadium — or more appropriately, Paris' soccer venue, the 81,000-seat Stade de France — with the experts who claim today to have foreseen the flaws in the euro at the time of its launch in 1999. But these were papered over for more than a decade, or until the flaws turned into cracks and, ultimately, crevices.

The fundamental flaw is that the countries of the Eurozone, which comprises 17 members of the European Union and a handful of non-EU states, are simply too diverse, economically and politically. As David O. Beim, an expert in international finance at Columbia University, put it last October, "Germany and Greece should not share the same currency." The former is a highly efficient, low-inflation, export-oriented economy, the latter an inefficient, inflation-beset importer of goods.

Beim notes that in the 15 years before these two countries were yoked together in a single currency, the Greek drachma depreciated 82% against the German mark. What made the euro's architects think that this powerful trend would evaporate with the creation of the Eurozone? Wishful thinking, perhaps, but this is one way in which the euro appears to represent the triumph of hope over experience.

Economic diversity isn't in itself a recipe for currency failure. Some regions of the U.S. bear the same resemblance to one another as Greece and Germany. (Think of the Rust Belt versus Silicon Valley.) But they're united by a nationwide fiscal policy and a single monetary authority (the Federal Reserve). Not so the Eurozone, where unified policy decisions must yield to the sovereignty of its individual members and where, contrary to the hopes and wishes of the euro's creators, nationalism has been rising, not waning.

The traditional way to resolve imbalances in economic outcomes among countries has been changes in exchange rates. Greece's currency should be worth a lot less than Germany's. If it had continued to fall relative to Germany and other exporters, as it had before 1999, then Greek goods would be cheaper for German consumers to buy, and Greek consumers and industries might wean themselves off ever more expensive foreign imports. The law of supply and demand would be in full force.

But the Greek and German currencies are worth exactly the same. Without recourse to devaluation and revaluation as economic tools, the only way to establish economic equilibrium for Greece and other importing countries such as Italy, Spain and Portugal is by pushing down wages and slashing their workforces: This is done through the "austerity" regimes causing widespread popular unrest in those countries.

Displaced Greek laborers are free to seek work in richer countries across the border, but the lifestyle of guest workers in strange lands doesn't have to be spelled out for them, and the prospects for growth at home recede even more.

The lesson of the Eurozone crisis is that when a mistaken policy goes bad, an increasingly narrow class calls the shots, spreading misfortune far and wide. Just as the future of the Eurozone could be read in the history of the CFA zone, the future of both could be read in an earlier attempt to yoke disparate economies together in a rigid arrangement. That was the gold standard era that led to, and ended with, the Great Depression.

Herbert Hoover memorably recalled the anti-recessionary policies of his plutocratic Treasury secretary, Andrew Mellon, as "Liquidate labor, liquidate stocks, liquidate real estate.... High costs of living and high living will come down. People will work harder, live a more moral life." (There's some doubt that Mellon uttered those exact words, but they surely described his thinking.) An understandable reaction, among people who can witness the consequences at a safe and secure remove.

Recovery from the Depression began only when every country freed itself to make its own monetary and fiscal choices by shedding the gold standard. This was understood by both Franklin D. Roosevelt, who started the process, and Richard Nixon, who finished the job.

The record suggests that the fundamental question for Europe is not "Can the euro be saved?" but "Should it be saved?" Its purported virtues, such as the elimination of currency transaction costs among the member nations, have been far outweighed by the costs it imposes. It is also plain that half-measures to save the euro won't work — the wholesale devaluation of the CFA franc reduced its burden on the French government, but preserved economic imbalances among CFA countries and has done almost nothing to improve the West African economy overall.

Bankers and bondholders in Europe and the U.S. are fixated today on the financial ripples that might be created in international markets by the exit from the Eurozone of Greece, followed perhaps by Spain, Portugal and Italy. But no one has yet outlined how a currency that manacles together so many mismatched economics reaches a stable future, save through an endless sequence of bailouts. Sooner or later, the impossible will give way to the inevitable, and those countries will be left again to make their own way in the world rather than having their path dictated from afar.

Michael Hiltzik's column appears Sundays and Wednesdays. Reach him at mhiltzik@latimes.com, read past columns at latimes.com/hiltzik, check out facebook.com/hiltzik and follow @latimeshiltzik on Twitter.

Copyright © 2019, Los Angeles Times
EDITION: California | U.S. & World