This is what economists don’t understand about the euro crisis – or the U.S. dollar


Kathleen McNamara in the WaPo's Monkey Cage:

Economists are condescendingly scolding the Europeans for venturing into a single currency without the proper underlying economic conditions. Paul Krugman has relentlessly excoriated the leaders of Europe for being what he calls “self-indulgent politicians” who have “spent a quarter-century trying to run Europe on the basis of fantasy economics.” The conventional wisdom seems to be that the problems of the euro zone are, as economist Martin Feldstein once put it, “the inevitable consequence of imposing a single currency on a very heterogeneous group of countries.”

What this commentary gets wrong, however, is that single currencies are never the product of debates about optimal economic solutions. Instead, currencies like the U.S. dollar itself are the result of political battles, where motivated actors try to centralize power. This has most often occurred “through iron and blood,” as Otto van Bismarck, the unifier of Germany put it, as a result of catastrophic wars. Smaller geographic units were brought together to build the modern nation state, with a unified fiscal system, a common national language that was often imposed by force, a unified legal system, and, a single currency. Put differently (with apologies to sociologist Charles Tilly), war makes the state, and the state makes the currency.

The U.S. case is instructive. America used to have a chaotic multitude of state currencies and privately issued bank notes, with complex exchange rates between them. This only changed thanks to the Civil War. The American greenback was created in 1863 when Abraham Lincoln’s Republican Party muscled through legislation giving the federal government exclusive currency rights. It was only able to do this because Southern legislators, who opposed more centralization of power, had seceded from the American union. The Union side wanted a common currency to help the war effort by rationalizing revenue raising and wartime payments. But it was also a potent symbol of the power of the federal state in the face of the challenges of a disintegrating union.

More here.