What Price Currency Union?

Fighting against Union... currency union

I’ve often wondered during this recent spat of Euro-related crises why the US, which has states which are seemingly as different from each other as two European countries, doesn’t have dollar zone problems. Paul Krugman, in a piece on the history of the Euro, gives a good explanation of why Nevada is fine being in a currency union with California, but Ireland has problems hanging out with Germany:

Climate, scenery and history aside, the nation of Ireland and the state of Nevada have much in common. Both are small economies of a few million people highly dependent on selling goods and services to their neighbors… Both were boom economies for most of the past decade. Both had huge housing bubbles, which burst painfully. Both are now suffering roughly 14 percent unemployment. And both are members of larger currency unions: Ireland is part of the euro zone, Nevada part of the dollar zone, otherwise known as the United States of America.

But Nevada’s situation is much less desperate than Ireland’s.

First of all, the fiscal side of the crisis is less serious in Nevada. It’s true that budgets in both Ireland and Nevada have been hit extremely hard by the slump. But much of the spending Nevada residents depend on comes from federal, not state, programs. In particular, retirees who moved to Nevada for the sunshine don’t have to worry that the state’s reduced tax take will endanger their Social Security checks or their Medicarecoverage. In Ireland, by contrast, both pensions and health spending are on the cutting block.

Also, Nevada, unlike Ireland, doesn’t have to worry about the cost of bank bailouts, not because the state has avoided large loan losses but because those losses, for the most part, aren’t Nevada’s problem. Thus Nevada accounts for a disproportionate share of the losses incurred by Fannie Mae and Freddie Mac, the government-sponsored mortgage companies — losses that, like Social Security and Medicare payments, will be covered by Washington, not Carson City.

And there’s one more advantage to being a U.S. state: it’s likely that Nevada’s unemployment problem will be greatly alleviated over the next few years by out-migration, so that even if the lost jobs don’t come back, there will be fewer workers chasing the jobs that remain. Ireland will, to some extent, avail itself of the same safety valve, as Irish citizens leave in search of work elsewhere and workers who came to Ireland during the boom years depart. But Americans are extremely mobile; if historical patterns are any guide, emigration will bring Nevada’s unemployment rate back in line with the U.S. average within a few years…

In essence, the United States partakes of the advantages of a currency union (easy interstate commerce, allowing long-term interstate economic relationships, etc.) and in return subsidizes states which are suffering unemployment or fiscal imbalance. Whereas states would normally inflate their way out of extreme debt or unemployment, the federal government will prop them up so that the entire nation can work with the dollar. At the same time, because there are no barriers to moving between states the unemployed can seek out jobs in boom towns.

What Krugman only addresses slightly is the consideration that Nevada might be better off with its own currency or even free banking, where there is some market competition for currencies. Krugman does say that Brooklyn is so integrated into the New York economy that changing currencies after crossing into Manhattan would be cumbersome, but it’s unclear at what point economies are integrated enough to call ready for a union. As he says, currency unions have major costs and uncertain benefits. Who is to say that the U.S. hasn’t just internalized these costs in the form of transfer payments between states? Maybe our bailouts are invisible because they are happening all the time, and are just accepted as the price of having Nevada (and all the small, essentially subsidized states) in the union.  And while it would be ridiculous to claim that these costs are equivalent to the violent upheavals currently taking place in Europe, it would also be unfortunate not to examine our assumptions about the optimum size of currency unions.

Photo: My picture at Bull Run, available under CC licence

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2 Responses to What Price Currency Union?

  1. Pingback: As I was saying… | Morton and George

  2. Pingback: America Without the Dollar | Morton and George

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