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Like the gold standard of a century ago, the euro has promoted free trade and investment across borders. The 12-year-old unified currency also shares the gold standard’s greatest flaw: the lack of an escape hatch. If a country runs chronic deficits, it can’t regain competitiveness through the market’s depreciation of its currency. Under the gold standard, exchange rates were fixed, which is to say the escape hatch of depreciation was locked. Under the euro, exchange rates no longer even exist. The escape hatch has been locked, welded shut, and sat on by the leaders of the Continent’s most powerful economies.
What does a country do when it can’t depreciate its currency to lower its prices? Now, as in the 1930s, the only alternative is an internal devaluation, which means cutting wages and other costs, including government benefits. That’s a painful process that creates enormous social stress. In the 1920s and ’30s the impoverishment of the working class led to the rise of Hitler and Mussolini. Even if fascism is averted, punitive austerity can lead to a downward spiral as trade and financing dry up, deflation sets in, debts loom larger, and one country after another gets sucked downward.
Once the euro symbolized common purpose and uplift. But to quote the Depression-era lyricist Lorenz Hart, “When love congeals/It soon reveals/The faint aroma of performing seals.” The seals of 2011 are the hard-money types in Germany, Finland, and other points north who insist that the Greeks, the Italians—and maybe soon the French—must be held to account for their financial transgressions. These calls for fiscal responsibility, and the anger behind them, make emotional sense. But today’s austerity tough guys sound alarmingly like Andrew Mellon, President Herbert Hoover’s Treasury Secretary, who, according to Hoover’s memoirs, said the only way to get the U.S. economy back on track in the 1930s was to “liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate … purge the rottenness out of the system.”
Purging the rottenness nearly killed the patient. In an increasingly relevant 2000 essay called “The Gold Standard and the Great Depression” in Contemporary European History, American economists Barry Eichengreen and Peter Temin wrote that elites were befuddled by a gold standard mentality that “sharply restricted the range of actions they were willing to contemplate.” They added: “The result of this cultural condition was to transform a run-of-the-mill economic contraction into a Great Depression that changed the course of history.”
A gold standard doesn’t have to be deflationary. From the 1870s until World War I, the gold standard more or less worked under the auspices of the Bank of England: Countries that imported more than they exported were forced to make up the difference by shipping gold to their trading partners. Because gold was the ultimate storehouse of value, countries feared losing too much of it. To stanch the outflow of gold, central banks would raise interest rates to push down domestic spending and prices. Meanwhile, the countries that imported gold would see domestic prices rise, which would make them more receptive to cheaper imports and shrink their surpluses. There was discipline and a natural balance.
World War I spoiled the equilibrium. War spending caused inflation, forcing countries to suspend convertibility of their currencies into gold. After the war most countries struggled back onto the gold standard (though not Germany, which suffered hyperinflation). Returning to the old exchange rates required reversing the wartime inflation—namely, imposing punishing deflation. Democracies weren’t as good at imposing austerity as autocracies had been. The rise of labor unions and the introduction of minimum-wage laws made it harder for employers to cut pay, so they cut workers instead.
