When the European Union, or its successor, the European Economic Community, was created, it had the most noble of goals in mind. To end centuries of war and bring about economic prosperity for every country within the Union.  And on the whole the European Union has largely succeeded in achieving many of its main objectives. Still, if there is one black spot on the European Union’s resume, and that is the creation of the Eurozone and the single currency of its members, the Euro.

Eurozone Image

This is a controversial topic, to say the least, and the Euro currency has a long list of defenders. From renowned economists, respected politicians, able technocrats, and a whole list of other people, the Euro has enjoyed a broad range of support. Unfortunately, the economic prowess of these individuals is questionable, regardless of the PhD’s or prizes they hold. The simple fact is that many of these people have forgotten the true purpose and functioning of a currency.

A currency is created to facilitate trade. At the microlevel, currencies facilitate trade between individuals and organizations. You go down to the store and buy some eggs by giving some money to the cashier. The store then takes the money and purchases more eggs. Simple enough. At the macro level, currencies are used to facilitate trade between nations. The process is more complex, let’s suffice to say that companies and governments trading across borders exchange currencies.

Eurozone Creation Of Common Currency

Exchanging these currencies can be time consuming and fluctuations in the market can make markets less predictable. In order to do away with these inconveniences, the members of the Eurozone decided to create a common currency. In theory, trade would be facilitated and costs of doing business would be lowered. Noble goals to be sure.

Unfortunately, what policy makers failed to fully understand is that currencies fluctuate for a reason. If a currency is dropping in value it is likely because the economy is slowing, or the nation’s finances are being poorly managed. Likewise if a currency is rising, the country is likely enjoying a strong economy and sound fiscal management. Dropping currencies can boost slowing countries by encouraging an increase in exports, among other things. Rising currencies can cool off overheating countries by discouraging exports, again among other things.

By creating a common currency, policy makers sought to end the fluctuations in exchange rates but that unfortunately did not address the underlying reasons why currencies were fluctuating. It was like trying to put a band-aid on a heart attack. And now over the last several years the differences in the national policies and economic health of the various countries in the Eurozone have reached a breaking point. It is a testament to the extraordinary amount of goodwill and desire to preserve the Eurozone, or at least European Union, that the infighting has remained so calm thus far.

If Greece, or another struggling country for that matter, were allowed to float its own currency, the exchange value would have dropped as the nation’s fiscal health dropped. In some cases this drop in value would have spurred a growth in exports, which have improved the fiscal health of the nation as a whole.

Iceland, for example, had far greater control over its fiscal policies and the Icelandic Krona plummeted in the days following the 2008 fiscal crisis which brought down the island nation’s 3 biggest banks. In 2007, before the onset of the crisis, a U.S. dollar could buy about 60 Krona. At one point in the immediate aftermath of the crisis, a single U.S. dollar could buy nearly 150 Krona. Even now that the country has stabilized, a dollar is still equal to about 120 Krona. The low value of the currency has eased the burden for the country to pay external debts and also helped fuel exports. Iceland now enjoys a respectable growth rate of 2.5 percent and seems well on the way to recovery.

Could the Euro have worked? It’s possible, if all of the countries involved were at similar stages in economic development, had similar economic policies, and also were is similar fiscal shape. Think of it this way, the United States functions quite well even though it is made up of 50 similar states who often pursue different fiscal and economic policies. Still, the difference between California and Texas is far less than the difference between Germany and Greece.

Simply put, the idea of trying to tie together nations as different as those found in Southern Europe and those found in Northern Europe was a bad idea to begin with. Germany and other northern European countries have held up the value of the Euro at a time when Greece, Spain, Italy, and others needed to see it deflate. Now, tensions are coming to a boiling point, and if economic conditions do not improve soon, we may see the Eurozone unwind.