An obscure economic dispute between Metallists and Cartalists reveals an unnoticed difficulty with Emu. Charles Goodhart, a leading financial economist, says that crises in the foreign exchange markets could simply shift to the bond marketsby Charles Goodhart / March 20, 1997 / Leave a comment
Published in March 1997 issue of Prospect Magazine
The conventional economic analysis of Emu compares the balance of savings in transactions costs-the cost in money, convenience and risk of dealing in more than one currency-against a potential worsening of difficulties in macroeconomic adjustment. After all a country’s declining competitiveness can be mediated, and the blow softened, by a declining exchange rate. If there is no insulating national currency, declining competitiveness must translate directly into unemployment. Proponents of Emu tend to be both more optimistic about the size of the transaction cost saving, and more sanguine about any worsening of adjustment difficulties. Those more sceptical about Emu stress the absence of a trans-European mechanism to aid adjustment by transferring wealth from rich areas to poor areas via taxes and benefits, as occurs now within nations. They also doubt the magnitude of the transaction cost savings, and contest the claim of Emu supporters that without a single currency the single market is threatened. Both sets of arguments quickly progress from the economic to the political.
But the conventional view may be too narrow. It ignores the relationship between the fiscal, tax-raising, authority on the one hand and money creation on the other. And by so doing it fails to recognise what may be some of the most significant-and dangerous-of Emu’s side effects. Specifically, there is a danger that national governments within Emu will find their fiscal positions more fragile, and that crises in the foreign exchange markets will simply shift to the bond markets. In order to avoid the heightened risk of default and financial contagion national governments will be forced to adopt a more deflationary stance than desirable.
There has been a continuing debate among academic economists between those who argue that the use of currency is based essentially on the power of the issuing authority (Cartalists) and those who argue that the value of a currency depends primarily or solely on its backing (Metallists). This argument becomes, by extension, one between those who see the evolution of money as a private, market-led response to overcoming the transactions costs inherent in barter (Monetarists), and those, again, who see it as largely dependent on the role of the state.