The Euro’s Failed Dream of a Wonderful Life

The euro looks like a solution that will be costlier than the problems it was meant to address

By STEPHEN FIDLER

Aug. 6, 2015 5:29 p.m. ET

What would Europe be like if the euro had never been born? Unlike George Bailey in the 1946 film classic “It’s a Wonderful Life,” we don’t get the chance to go back and find out.

In the movie, the kindly but suicidal George is taken by his guardian angel to see what the world would have been like without him. The small town in which he grew up and from which he never manages to escape is unrecognizable. Instead of the idyllic Bedford Falls, he finds the violent and crime-ridden Pottersville.

George found he had made a difference for the better.

The euro must have made a difference too. But the eurozone looks more like dysfunctional Pottersville than law-abiding Bedford Falls. It is still in danger of losing Greece, and while much of the rest of the bloc is starting to grow again after years of recession, it has taken rock-bottom interest rates, a weak euro and very low oil prices to help it happen.

Unemployment remains high in many countries, and the reputation of the European Union has taken a battering—even in countries like France that have been at the heart of its development.

“No one can say how Europe would have evolved without the euro,” argued Jean Pisani-Ferry, head of the French government’s policy-planning department, in an article for Project Syndicate, a website hosting opinion pieces. “Over the last 15 years, the eurozone’s economic performance has been disappointing, and its policy system must answer for this.”

Following the euro’s creation in 1999, two years before notes and coins began to circulate, big current-account imbalances emerged between Germany and countries where low interest rates had created credit booms. Come the global financial crisis in 2008, “conditions were ripe for a perfect storm,” Mr. Pisani-Ferry wrote.

While the euro was in one part a political project—designed to fulfill the dreams of a post-World War I generation to unify the once war-ravaged continent—its creation was also motivated by a host of economic arguments, many of which reflected German concerns.

For one thing, after the final collapse of the Bretton Woods system of fixed exchange rates in the early 1970s, many in Germany and elsewhere didn’t trust flexible exchange rates, which were seen as introducing volatility and unpredictability into trade. “Floating exchange rates were not acceptable,” Mr. Pisani-Ferry said in an interview.

It was argued that the EU single market in goods and services would be undermined and possibly eventually destroyed—and German industry damaged—by repeated competitive devaluations from the likes of Italy, Spain and the U.K. Yet, while Spain and Italy haven’t devalued since the 1990s, the U.K. has maintained a flexible exchange rate—without, it appears so far, undermining the single market.

The euro may well have succeeded in staving off flexible exchange rates in Europe. That is because the previous system of a German-dominated fixed-exchange-rate regime would most likely not have survived the events of the past decade, and other European economies would have found it impossible to live with the anti-inflationary rigor of the German central bank.

The euro was also seen as an answer to fears in Germany of the “internationalization” of the German deutsche mark, and the consequences of the mark becoming a reserve currency as an alternative to the U.S. dollar. While the biggest in Europe, the German economy would have been too small to cope with the huge inflows of international money that would have flooded German financial markets, likely leading to a large overvaluation of the German mark that would have devastated the country’s exporters.

In this respect, the common currency has been a success: The euro has taken on the status of an international reserve currency—according to the latest figures from the European Central Bank, the euro constitutes 22% of global official foreign-exchange reserves, compared with 63% for the dollar. But the much larger eurozone economy has been better able to absorb these inflows than Germany alone would have been.

These weren’t the only economic issues driving the creation of the euro, but German economic-policy concerns loomed large. Germany’s economy seems to have benefited, including by avoiding currency volatility and overvaluation. That isn’t to say that there won’t be some costs for Germany in sustaining the common currency—not least in the likely losses on its bailout loans to Greece.

Indeed, from the vantage point of 2015, the euro looks like a solution that will turn out to be costlier than the problems it was designed to address. And not for the first time. “The main responsibility for the century’s disasters lies not so much in the problems as in the solutions,” the historian and poet Robert Conquest, who died this week, concluded after chronicling the history of the Soviet Union.

Yet having created the common currency, uncreating it could be the cause of untold further turmoil. Once you’ve built Pottersville, it is tough to get back to Bedford Falls.

Write to Stephen Fidler at stephen.fidler@wsj.com