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BY Heiner Flassbeck

Europe is on the brink of a potentially lethal crisis. A dozen years after the start of the European Monetary Union (EMU) the system is in troubled water and the political leaders, blinded by an anti-government ideology are steering the boat towards some dangerous rocks and risk the end of a long and peaceful ride in a formerly war torn region.

Much has been said about the folly of pushing countries to cut public expenditure, increase taxes and put pressure on wages in the middle of one of the deepest recessions in modern history. However, even the outspoken critics of this approach rarely go to the core of the matter and discuss the long established economic policy strategy of the country that has come out of that recession like a phoenix from the ashes and is still celebrating its unique role and success.

To the contrary, Germany is considered by many as the role model for the rest of the union. That is the biggest mistake and the real reason why Europe is committing economic suicide instead of tackling its problem at the root.

Since the end of Bretton Woods, Germany’s economic policy has been based on two main pillars: competition of nations – the new mercantilism and monetarism. Both are irreconcilable with a monetary union of the European size. Firstly, a monetary union is in essence a union of countries willing to harmonize their rates of inflation and to sacrifice national monetary policies. A country like Germany, fighting for higher market shares in international markets, tries to achieve the opposite. It has to undercut the cost and price level of its main trading partners even if it violates the commonly agreed inflation target.

Secondly, a large monetary union formed by already closely integrated countries becomes a rather closed economy and needs domestic policy instruments like monetary policy to stimulate growth time and again. German monetarism asks for the opposite, the absence of any discretionary action of central banks and relies solely on flexibility of prices, in particular wages.

This is particularly tragic as the monetary union was an excellent economic idea and its foreseeable failure will prevent many useful attempts in the future to replace the vagaries of the financial markets in the determination of exchange rates by an orderly adjustment of the value of currencies to the fundamentals. But the best idea is useless if its protagonists and those politicians putting it into practice fail to understand it. Insofar the history of the euro is the history of a misunderstanding.

From the very beginning neither the European Commission (EC) nor the European Central Bank (ECB) were up to their task of controlling the core of the system effectively. Eventually, this is the result of the failure of mainstream economic thinking. The crucial institutions were misled in their attempt to form a union with diverging economic concepts instead of designing a new economic policy strategy for all. They began to realise their failure only in the face of the crisis – but now the time is running out for successful changes to save the euro.