Last week the European Monetary System effectively collapsed. A lot of people now look foolish -- not just the finance ministers and central bankers who claimed to know what they were doing but also the pundits who a year or so ago were still proclaiming that the future belonged to Europe. In fact, the breakup of the EMS should not have come as a surprise. As early as the fall of 1990, it was clear that the costs of German reunification were going to lead to massive German budget deficits and that to control inflation in the face of these deficits the Bundesbank would have to raise interest rates sharply. The rest was textbook economics: Other European countries would have to either match those high German interest rates and plunge their economies into recession or abandon the EMS and allow their currencies to fall against the German mark. It was obvious that Britain, Italy and France were going to choose the concrete need for jobs over the abstract goal of currency stability.
Job losses. The collapse of the EMS does have a silver lining, however. Now that the rigid links among currencies have shattered, European nations will be free to reduce interest rates and start on the road to modest recovery -- a path that Britain has been following since September. But the longer-term prospect is disturbing. Europe's leaders have squandered credibility on grandiose and impractical monetary visions. Meanwhile, they have failed to come to grips with ever-growing unemployment. The bigger risk is that they may backslide on the progress they have made in integrating the European market. If that happens, the dream of a united Europe could be postponed for at least a generation.
Originally published, 8.16.93