Archive for November 12th, 2011

Reports of the Euro’s Death are Premature

I started serious study of the European Union when it was the ten nation European Community back in 1982.   At that time, the EC was deep in crisis.  Britain was threatening to leave over how much it paid in compared to what it got back, divergent monetary policies were stalling efforts to create a stable exchange rate system, and even Ernst Haas whose ‘neo-functionalism’ was the driving theory behind European integration had labeled integration theory ‘obsolescent.’

At the time I took a course in Bologna, Italy, taught by Gianni Bonvicini on the politics of the West European integration. Bonvincini was strong proponent of integration, and told us that it was all but inevitable that Europe would develop a common currency.  He said European integration always moved in fits and starts, with existential crises causing critics to (sometimes gleefully) claim its demise.   For every two steps forward there was often a step back, but that success was far more likely than failure.

The EC survived that bout of “eurosclerosis” and by the early nineties goods and people could flow more freely than ever as borders became irrelevant — you could cross from Germany to France like one might from Maine to New Hampshire.   When the Cold War ended and barriers to international capital flows dramatically decreased, countries were compelled to adopt tighter monetary policies, thereby making the idea of a common currency feasible.   In December 1991 EC leaders signed the Maastricht treaty to create a common currency and rename the Community “the European Union.”  Although there were many times in the 90s people were certain that the Euro would never actually get off the ground, it was born in 1999 when  the European currencies became permanently fixed.

By that time the EU had 15 states, but only 11 were in the Eurozone.     France, Germany, Austria, Belgium, Finland, Luxembourg, the Netherlands and Ireland were clearly ready.   Spain and Portugal were questionable but overall had a good enough track record of economic improvement.     Italy really didn’t fulfill the criteria, but Prime Minister Romano Prodi’s economic austerity programs of the late 90s were seen as putting Italy on the right track, so it was accepted.

Three states opted out of the Eurozone: the UK, Sweden and Denmark.   A fourth was seen as not being ready:  Greece.  As the EU moved towards the issuance of actual coins and bills on January 1, 2002, the Greeks pressured the EU to bring them into the core group as well.   With only 10 million people their economy was small; any crisis in Greece could be handled.   On the other hand, Euro-imposed discipline might help improve the Greek economy and keep it open to outside investors who prefered Euros to Drachmas.    Ultimately, much to the chagrin of many economists and central bankers, the EU gave in — Greece was able to join in 2001.

Since then the Euro has expanded to many other countries: Malta, Estonia, Slovenia, Cyprus and Slovakia.   These countries have low debt and have done well in recovering from Communist rule.

Overall, the Euro has been a success, maintaining high value and becoming a true alternative to the dollar (even today the Euro trades at $1.37 per Euro, much higher than their original goal of a 1:1 valuation).    Alas, the crises in Greece and now Italy have led many to say “bye bye Euro,” believing that the experiment in monetary union is failing.

Don’t believe it.   The Europessimists of today sound much like those of the early 80s, yet I think Dr. Bonvicini’s claim that success is far more likely than failure still rings true.  The Euro will survive and eventually thrive again, just as the EU will continue to deepen regional integration, redefining the concept of sovereignty.

This doesn’t mean that there won’t be some dramatic moves.   There are rumors throughout Europe that German Chancellor Merkel and French President Sarkozy are talking about a smaller Eurozone, with a number of countries potentially being “kicked out.”    This is possible and while it would be called a “collapse of the Euro,” it actually might be necessary to save the Euro.

The reality is that the Euro itself has functioned and still functions very well as a common currency for most Eurozone members.   They would find it extremely expensive for the currency to somehow go away.   Businesses and banks would recoil at losing the Euro as they’d have to deal with a confusing world of diverse monetary policies and currency exchanges.    With the most powerful economic actors in Europe working to assure the Euro survives, it will.   Moreover, Merkel may not be as dedicated to Europe as Kohl was — but she’s pretty dedicated!

The problem is less the Euro than high debt rates in Italy and Greece.   That’s dragging down the Euro and also threatens the solvency of European banks.   The banks need to be recapitalized in order to protect the European financial system — that’s the case no matter what the currency.   It’s easier to do that with the Euro than with a set of local currencies.   States leaving the Eurozone (Greece, maybe Italy, Spain and Portugal as well) would face a very difficult economic reality.     It would be hard to get investors to commit to a state where currency values would be likely to plummet.   Even if they did default on their debt, the shock to their domestic economies would be immense.

Still, it would be the equivalent of a bankruptcy which would give the states the same chance to start over that bankruptcy gives an individual.   Overtime if they built a stronger more sustainable political and economic structure they could rejoin the Eurozone.   That might actually work better than trying to pursue expensive bailouts of deeply indebted economies.   The taxpayers would rescue their own banks rather than countries swimming in debt — but that might be an easier political sell.

Most people assume that if forced to leave the Eurozone states would simply go back to their domestic currencies.   But it’s possible to imagine a second Eurozone currency for countries “on probation.”  The benefit of this would be that the ECB could also set monetary policy for that currency, recognizing that inflation is perhaps an inevitable short term condition. The goal would be to ‘rejoin’ the Eurozone at some point, and fiscal plans could be developed to reconstruct these sick and in some ways unsustainable economies into ones that could function within the Eurozone.

I’m not sure how feasible a “Euro light” would be — what it would be called, or even if it truly could work as a common currency across the ‘problem states.’    In essence this would be a resurgence of a theory popular in the 90s for a “two speed Europe.”   The wealthier countries would increase integration and become more closely linked then they can now.   The problem states could be put on a strict leash, forced to follow strict guidelines if they want to rejoin the core.   In theory this could actually push integration forward and deepen it.    That would make this like past existential crises — what doesn’t kill the EU only makes it stronger!

There would be immense opposition to such a Franco-German plan, and the short term costs in those two core countries could be large (especially as trade would decline as ‘core country’ goods would become much more expensive in inflation riddled problem countries.)    Rather than this being the death of the Euro, this could be the crisis that the Euro inevitably must face if it is to emerge as a true long term global reserve currency.   And to those who predict that this will destroy the project of European integration, well, people have been predicting that about various crises for over fifty years.   So far they’ve been wrong every time.