It has been fashionable over the past few years to examine historical events looking for parallels to the current financial crisis. For obvious reasons the most cited periods have been the 1930s in the U.S. and the 1990s in Japan. (I've pushed back a bit on relying too much on historical narratives here.) But if I were a member of the ECB, or any other policymaker responsible for maintaining the EMU, I'd be begging Sebastian Mallaby's publisher for an advance copy of his new book, More Money Than God: Hedge Funds and the Making of a New Elite. The Atlantic has an excerpt, describing how George Soros and others brought down the British pound in 1992 and ruined any chances of the U.K. joining the Euro. Here's how it went down:
Schlesinger had made it obvious that the Bundesbank was not going to help the pound cling onto its position inside the exchange-rate mechanism by cutting German interest rates. The devaluation of sterling was now all but inevitable.
True to form, European leaders have been hesitant to do much to prevent similar devaluations in the eurozone during this crisis. Interest rate cuts at the ECB have mostly been small and late, and the $1tn bailout fund is only enough to buy time for European banks to repair their damage sheets in advance of a default in Greece (and probably elsewhere). Now we see that Germany is planning austerity measures at home, which will make it far less likely to subsidize other EMU members, while concerns about the debt of Spain, Italy, and even France are steadily mounting.
There is a tipping point, and while we may not be there yet we are getting closer to it every day. When markets become convinced that a devaluation is inevitable they "go for the jugular", to use Soros' language, and it becomes a self-fulfilling prophecy. That happened in 1992, but U.K. officials weren't very quick on the uptake; they cost their citizens hundreds of billions by postponing necessary actions. The same thing may be happening right now. As Mallaby concludes in that excerpt:
The markets had won, and the government had at last recognized it.
In terms of recognizing the inevitable, the sooner the better. But has that lesson been learnt?
UPDATE: Tyler Cowen says things are coming to a head in Spain.