The euro will not grow to be old or at least it will lose member states on the way to maturity, has been and still is the feeling among many economists and non-economists. Kenneth Rogoff, former chief economist of the International Monetary Fund predicted a few years ago that Italy and Portugal were the two countries that would leave the euro-ship because they would get seasick. Others added Spain and Greece to the list.
Then there were economists like the American Martin Feldstein who predicted civil wars in Europe due to the euro and the break-up of the euro area. According to some sources, even Alan Greenspan, former chairman of the Federal Reserve has said that the euro will not last.
Current events with the deep fiscal troubles in Greece must be a field day for the anti-euro crowd. Admittedly, they have every reason to see the future of the euro as bleak as that future can be. However, as any investor can tell you, when it seems something can only go one way, chances are that ‘something’ will take the road less traveled. Remember the summer of 2008, when one euro was worth about 1,60 greenback? The exchange rate could only go up, up and away, towards the magical 2-for-1 ratio was the general feeling in the marketplace. The euro was king, the dollar almost knockout. Fast forward six months into the future and the euro was worth 25 percent less.
Could the same happen with the euro and the European Monetary Union? Can Greece actually save the euro instead of destroying it?
A very welcome crisis
History is full of examples where Europe performed a Houdini act when it seemed to be doomed. The internal market followed the stagflationary seventies and the recession at the beginning of the eighties. The euro was agreed in 1992 when Europeans got fed up with speculators destroying various European exchange rate mechanisms and agreements.
After the first decade of the euro, a couple of things have become clear. One of them is that the Stability and Growth Pact (SGP), criteria for the euro membership, peer pressure, naming and shaming, dragging countries to the European Court of Justice, nothing has been able to enforce fiscal discipline in the euro area. It all looked very well on paper (SGP even contains a mechanism for sanctions and even how high financial sanctions would be) but in the real world it just did not work.
Skeptics on the future of the euro point to the troubles in Greece and some other euro-countries that are in similar dire straits. They also repeat the – very valid I might add – argument that a monetary union cannot last without a political union or something that resembles it. Point taken. But could the current crisis within the euro area turn out to be a blessing in disguise? Could Europe, again, take the road less traveled?
Earlier this week, Germany and France proposed a mechanism for more economic co-operation within the euro area and even the establishment of the European Monetary Fund to implement and enforce new fiscal rules in order to prevent any new cases of instability of the euro area in the future due to economic and/or fiscal problems in one or more euro-countries. The proposal is said to include tough penalties, cutting off EU cohesion funds to offenders, temporary suspension of voting rights on the EU level and even a suspension from the euro area membership (now, how they want to do that, I can not wait to find out). If implemented, this would be the most radical overhaul of the European rules in the econo-fiscal sphere since the introduction of the euro in 1999.
Enter Houdiniopulos
Now, if the Greeks actually pull their own Houdini act together and bend the seemingly out-of-control fiscal deficit into a normal deficit, it could be a boon to the European monetary union. Spain, Portugal and Italy could not say to other euro-countries: you helped the Greeks, help us too now but would be forced to follow the Greek example (indeed, a world upside down) of fiscal austerity and implement some serious economic reforms that are long overdue.
Sure, all those austerity measures do not bode well for economic growth in the short term (just as a side note: it is not only Greece or Spain and the other usual suspects that will have to tighten their belt, every euro-country will have to do the same, in various degrees as they are all in the breach of the European fiscal rules). The key phrase here is ‘short term’.
There is ample evidence that economic growth exceeds potential growth in the years after the cutbacks. Sweden, Denmark and the United Kingdom in the early nineties, Ireland and the United Kingdom in the eighties are living proofs of that. If structural reforms are a part of the package, the economy is very likely to emerge stronger out of the crisis. For example, expectations on the performance in the medium to long term could change for the better, making investing in the euro area more attractive. The discussion on whether the euro and the monetary union would survive would also take a pounding, what in turn would remove the risk premiums for various long-term interest rates.
Automatic, not manual transmission
Of course, this is not to say we are there. The proposals by Germany and France, however good, will only work if the sanctions and penalties are automatically imposed. If this is not the case, I would say: do not bother. The main shortcoming of the Stability and Growth Pact has not been the lack of rules and agreements, but the lack of enforcement. And the enforcement was weak due to the fact that setting the sanction-wheels in motion required a decision by European leaders themselves.
Other problems are of the legal and political signature. The ruling of the German constitutional court from1993 that Germany would have to abandon the monetary union if the stability of the euro and the monetary union could not be guaranteed any more, is hanging out there as the sword of Damocles above the future of the euro. Already there are complaints filed with the court to prevent Greece receiving any help whatsoever. Anything that smells like a transfer of national powers to Europe is guaranteed to draw a barrage of legal cases, not only in Germany.
At the very least it would mean that the Treaty on the European Union would have to be amended. That means: ratification process folks. After a recent nightmare of getting the Lisbon Treaty ratified in all member states (which was a very, very close call), doing that once again is the last thing Brussels is waiting for.
Despite all the possible hurdles, the fact is that automatic sanctions in cases of the breach of rules would go a long way towards something resembling a (political or fiscal) union in Europe and hence would help the euro to become as old as the dollar and the pound. I know the chances of the script unfolding this way in Europe are slim. But then again: it would not be the first time Europe delivered when nobody expected it to.
#1 by french derek on March 8, 2010 - 7:39 pm
I believe in the Euro as a currency that will last.
It is often said that that the EU really makes progress only when there is a full-blown crisis. In terms of the EU and Greece, that is now. And, according to Brussels insiders, things are moving fast. Suddenly there seems to be a growing momentum around the idea of an EMF.
Add to this that Germany and France (amongst other eurozone countries) appear to have risen to the attacks by hedge funds. It is often said that the best form of defence is attack: and they are proposing to do just that. They won’t sit idly by awaiting the next attack but are arguing greater control over hedge funds (and similar) actions against the Euro. Hedge funds, etc are useful vehicles – except when they attack currencies.
#2 by M.G. in Progress on March 9, 2010 - 9:08 am
My proposal is more effective but the devil is in the details…
http://mgiannini.blogspot.com/2010/03/stronger-case-of-eu-bonds-common.html
http://mgiannini.blogspot.com/2010/03/make-finance-industry-to-pay.html
#3 by Helen Needle on March 10, 2010 - 4:59 am
Is the EU to advocate neo con economic policies as well as GM crops and another treaty reform? Oh dear, a very bad week.
The UK’s growth in the 1980s and 1990s is used as an example of cut backs producing growth; but at what terrible cost? Was it real growth anyway? Or was it that the profits from North Sea oil and gas came through, plus various investment bubbles?
It all looks a massive error now, we envy France, Germany and the Netherlands.
The UK came out of the reforms massively dependent on finance and banking and with a much smaller manufacturing and industrial sector.
Our energy sector is in a terrible state and a return to central buying may be necessary or the lights will go out in about 5 years. We are dependent on foreign countries for almost all our energy.
Production of oil and gas in the north sea has slumped and investment is low. Recently nationalisation was recommended to avoid a further production decline.
The 1980s in the UK also saw a massive cutting back of financial regulation and governance; the whole world has been hit by the consequences of that reform. It was also the beginnng of mass unemployment, we have had millions of unemployed ever since. In some streets no one has a job, in some houses there are grandparents – and 3 generations – who have never worked.
The UK is now the most unequal country in the EU and we are the bottom of any number of EU quality of life indicators, including worst country to be a child.
Mrs Thatcher’s reforms of the 1980s now look a terrible idea – a ghastly mistake – anyone who follows this route must be in a state of sheer desperation; even then don’t do it!
#4 by Helen Needle on March 10, 2010 - 5:08 am
I see that this blogger, Edin Mujagic, is an advocate of a return to monetarism – as was Mrs Thatcher and Ronald Reagan.
So he’s likely to blame all our troubles on low interest rates and a growth in the money supply. Those of us in the UK have heard it all before, his sort and the resulting appauling policies must be resisted at all costs.
I have noticed that the EU Observer has more and more neo con bloggers, a US influence perhaps? God help us.
#5 by Marcel on March 14, 2010 - 3:13 pm
[i]Despite all the possible hurdles, the fact is that automatic sanctions in cases of the breach of rules would go a long way towards something resembling a (political or fiscal) union in Europe[/i]
Why do you democracy-hating EU-philes keep pushing for political union when the peoples so clearly DO NOT WANT?
Referendums today, please.
#6 by Panayotis on March 14, 2010 - 11:01 pm
When are neoliberal/conservative economists stop the propaganda? There is no evidence that austerity measures bring pain only in the short run! The misery they impose and the shortfall in effective demand cannot be changed by structural measures when there is no expectation for increased revenues and earnings! Especially when euro members cannot individually devalue the euro! The Greek economy does not suffer from high labor costs but absence of entrpreureship which is now going to be constrained further by the lack in demand! What company is going to invest in an economy with a negative psychology and reduced spending. Have you heard of the paradox of thrift! What economics you learn at your Yniversity? Maybe you should take Trichet with you and shave us from your monetary union! It is not serving our needs, except the EU technocrats with their huge salaries whish are a disgrace!
#7 by Marcel on March 15, 2010 - 4:19 pm
@Panayotis:
in other words, you advocate Greece should continue spending money they don’t have and eventually get the dutch and german taxpayers to pick up the tab. I THINK NOT.
The problem plagueing the entire western world is that most of the prosperity has been paid for with money borrowed against the future. In other words, the current generation reaps the benefits whereas the next one will have to pay for it, whilst themselves receiving reduced benefits. Nice going babyboomer politicians, after all, when the bill comes, they will be long out of office on their inflation proof gold plated public sector pensions.