The Foreign Service Journal, February 2012

18 F O R E I G N S E R V I C E J O U R N A L / F E B R U A R Y 2 0 1 2 ters. Unless the U.S. can help Eu- rope resolve the euro crisis and rekindle growth on both sides of the Atlantic, U.S. global leadership will suffer greatly. Throughout 2011, European prime ministers seemed to fall like sparrows from the sky: the govern- ments of Ireland, Portugal, Greece, Italy and Spain all experienced turnovers. European lead- ers met on Dec. 8-9, and agreed in principle to a pact to es- tablish binding fiscal guidelines enforced by sanctions. This pact is only an agreement to agree in the future, how- ever, and as this article is being written, it is not clear whether European leaders will muster the will and capac- ity to codify and implement such guidelines. Like it or not, the European debt saga will linger, and even appears to be a harbinger of future crises that will challenge the next generation of American diplomats. To address these challenges, the State Department will need to expand its capabilities in international economics and integrate economics more fully into its foreign policy tool kit. Only by doing so can it discharge effectively its re- sponsibilities to the president and the nation. As it en- hances its capabilities in these areas, the State Department will need to play a stronger role in international financial policy — not at the expense of Treasury and the National Security Council staff, but alongside them. As well as the State Department and the Foreign Serv- ice have been performing up to this point, going forward each will need to raise the caliber of its game. And as they do so, it will be incumbent on presidents to make full use of their capabilities. Original Sin The creation of the euro at the turn of the 21st century was a major step in the integration of Europe and the bind- ing of Germany to a common European future. In the minds of many Europeans, the rise in German power that followed the unification of the country after the fall of the Berlin Wall made this step even more imperative. While Germany gave up its cherished deutsche mark as part of the bar- gain, the “sound money” philoso- phy of the Bundesbank permeated the conceptual framework of the new European Central Bank. After careful preparations, the euro was introduced in stages between 1999 and 2002. At the time, European Union officials were consumed by the project. They looked forward to a day when the euro would rival the U.S. dollar as a reserve currency. For their part, many American officials saw the adop- tion of the euro as a major milestone in the building of a United States of Europe, an implicit goal of U.S. foreign policy in the minds of many. Other Americans, however — though they embraced the political goals surrounding the euro and hoped for the best — harbored worries that the European economy was insufficiently integrated for a common currency. In contrast to what academic economists describe as “an optimum currency area,” labor within Europe was not particularly mobile, especially across national borders. Once the euro was adopted, economic pressures from downturns in one nation could no longer be eased by cur- rency depreciations, and the outward migration of labor from a depressed country to a booming country would not likely be sufficiently large to restore economic balance quickly. Moreover, a monetary policy appropriate for cer- tain nations in the euro zone often would be inappropriate for other nations. In essence, Europe was proposing to form a currency union without a fiscal union. The very small budget con- trolled by Brussels could not begin to serve as an “auto- matic stabilizer” that would take revenues raised in thriving nations and channel them to spending in depressed na- tions, as the federal government budget does between dif- ferent economic regions in the United States. Authorities in Brussels did not have the right to impose discipline on the budgets of nations that adopted the euro as their cur- rency. Finally, the lack of effective machinery to impose a common euro zone fiscal policy had implications for mon- F OCUS State has ably responded to the crisis thus far, but needs to raise the caliber of its game going forward. Alan Larson, a retired career ambassador, is currently sen- ior international policy adviser at Covington & Burling. During his 32-year Foreign Service career, he served as under secretary for economic affairs (1999-2005), assistant secretary for economic and business affairs (1996-1999) and ambassador to the Organization for Economic Coop- eration and Development (1990-1993), among many other assignments.