The adoption of the euro by a number of EU countries (known as the Eurozone) represented the beginning of a dangerous experiment. A common currency is only really viable when:
i. all parties using it are very close in terms of wealth-creating capacity per head of population (per capita);
ii. there is a common government that takes responsibility for shifting money from more productive regions to less productive ones, as happens for regions within a single country; or
iii. people in less productive regions accept a much lower standard of living than those in more productive regions.
The situation is similar to a single country without a common government. In a single country the productivity of its various regions often differs. Once prosperous regions decline as their industries become obsolete, and new prosperous regions spring up where advantage is taken of new opportunities. In these circumstances a common currency is a problem, because money migrates away from the poorer region as people buy from elsewhere things that either they can't obtain locally or that give better value. Local firms lay people off because they can't sell their products, and money becomes very scarce. People who can relocate easily do so, leaving a core of people without modern skills, or who are unable to work for other reasons. Easy relocation was mentioned earlier in chapter 65 section 65.8 as a factor that acts against self-correcting imbalances. The government of such a country, if it has the interests of the whole of its people at heart, transfers money from more prosperous regions to less prosperous ones, both to set up new productive businesses there and to ensure that the local people are saved from destitution.
Take away the government and no-one has any such responsibility, and therefore the likelihood of there being adequate safety provisions is considerably reduced. This doesn't happen with different countries using different currencies. A country whose industries become obsolete finds its currency becoming depreciated, so imports become dearer and fewer are bought. Local produce is bought instead, protecting local producers, and exports become cheaper for foreigners so more are produced and sold. It's all to do with spending on new wealth, because that spending drives the economy - see chapter 14. Different currencies force a depreciated currency country to increase its domestic spending and reduce its foreign spending, whereas with a common currency there is nothing, apart from restrictions on the freedom of movement of people, which aren't permitted in EU countries, to stop both money and wealth creators in an impoverished country from moving abroad and impoverishing the home country even more.
Reasons for adoption of the single currency were both economic and political. A single currency makes trade between member countries significantly cheaper, easier, and more secure. There are no exchange rate costs and associated administration overheads are eliminated, and exchange rate risks associated with movement in rates between the supply of goods and payment for them are removed. These benefits are substantial, and arise because of the cumbersome nature of trading with different currencies. Politically the move was a major step towards the goal of 'ever closer union'.
There is a European Central Bank (ECB) in Frankfurt whose main responsibilities are to control inflation and ensure financial stability. Each member of the Eurozone has its own central bank, called a national central bank, which is a shareholder in the ECB, and holds a portion of ECB stock capital (reserves) in proportion to its shareholding.[283]
National central banks implement decisions made by the ECB in their own countries and act as lenders of last resort for their own country's banks that get into difficulties - though only for as long as their reserves last. Notably, apart from commercial banks, only the ECB has the power to create money. National central banks have no such power, so if the country as a whole finds itself in economic difficulties it is unable on its own to apply reflationary policies such as buying its own bonds (quantitative easing) or lowering the interest rate. Once its reserves have run out there is no more that a national central bank can do. The government then has to appeal to the ECB and IMF for a bailout.
Each member country is free to issue and sell its own bonds, though their value is not guaranteed by the ECB and interest rates vary independently of other member bonds. Notably the ECB was very specifically not to be a lender of last resort for member countries in difficulties, though following the 2008 crisis the restriction has been lifted, albeit reluctantly, but only on the acceptance of specific and in practice extremely harsh economic conditions by the receiving country.[284]
At the beginning all went well, and investors seemed to believe that all countries had similar wealth-creating capacity per capita because they were willing to lend money to every Eurozone country at very similar rates of interest. As a result several countries that had suffered from high interest rates found that credit was available to them at much lower rates of interest than before, and in response private credit also became available at lower rates, fuelling high levels of debt, productivity booms, high wage levels, and excessive imports. Presumably investors felt that formerly risky countries would exercise more financial prudence in the Eurozone or that they would be protected by membership of the larger bloc, though no guarantee was given.
Things fell apart after the 2008 crash when it was discovered that European banks held large quantities of what were then recognised as toxic assets - mortgage backed securities, collateralised debt obligations and so on - see chapter 54. The financial stability of each country was now judged separately by investors and bond prices diverged very significantly, causing credit to dry up in vulnerable economies where it had formerly been plentiful, resulting in severely deteriorating economic conditions.
Although the 2008 crash was unexpected and precipitated financial havoc in the Eurozone as well as elsewhere, there are reasons to believe that the underlying structure of the Eurozone system would have led to problems eventually without any external trigger. The combination of a common currency, no common government, a central bank with neither responsibility nor willingness to act as lender of last resort, free movement of capital across borders, and member countries of very different character and wealth-creating capacity, contains significant contradictions and instabilities.[285]