x Abu Dhabi, UAEWednesday 17 January 2018

Gaining currency - fatal-flaw theories about the euro zone

As much of Europe stares into the abyss, four experts tell of early errors in the euro project that may have sowed the seeds of its end

A woman begs in Athens in February when austerity measures kicked in. Despite multi-billion euro rescue packages to prop up Greece, the fate of the euro, the single currency adopted by 17 countries hangs in the balance.
A woman begs in Athens in February when austerity measures kicked in. Despite multi-billion euro rescue packages to prop up Greece, the fate of the euro, the single currency adopted by 17 countries hangs in the balance.

The euro-zone crisis has triggered slumping economic growth and surging unemployment. Despite multi-billion euro rescue packages to prop up Greece, Ireland and Portugal, the fate of the 17-nation single currency hangs in the balance.

Below we talk to four experts about the future of the euro zone: Christian Saint-Etienne, an independent centrist politician from France and professor of industrial economics at the Conservatoire National des Arts et Métiers; Hans-Joachim Voth, a German economic historian and research professor at the Economics Department of Pompeu Fabra University in Barcelona; Professor Hans-Werner Sinn, the president of the Ifo Institute for Economic Research; Paul Goossens, the former editor-in-chief of the Belgian newspaper De Morgen, based in the European capital Brussels.

How did we get into this mess?

Saint-Etienne: When the Treaty of Maastricht [which created the European Union in 1992 and led to the single currency] was negotiated at the start of the process, we forgot to include a euro-zone state. There is no example in monetary history of a currency without a state behind it.

On top of this, 12 or so years ago, Germany decided to improve its competitiveness and took the decision to cut unit labour costs while France, at the same time, put in place a policy of getting out of industrialisation, supposedly entering into a post-labour model. This choice of different models has led to total divergence of performance.

Voth: The euro combined what did not belong together - countries with different economic systems, political cultures, social structures. The big borrowing party in the southern member states massively worsened their competitiveness; the direct result was large balance of payments deficits and a big accumulation of foreign debt.

When the financial crisis struck, one could justifiably ask: where were the economists? Why did no one warn us? This doesn't apply to the euro crisis. For decades, renowned economists like Barry Eichengreen had been warning against taking a step that virtually amounted to a revival of the gold standard and removing the option of currency devaluation as a way to regain competitiveness.

Sinn: The euro led to a convergence of interest rates. That encouraged the southern countries to take on excessive debt. It led to an inflationary overheating, which eroded their competitiveness. Now the countries are too expensive and have to become cheaper. The trade unions and everyone else are resisting that. The result is mass unemployment and a continued need for transfer payments.

Goossens: One of the most important causes is the defect in the way the euro was constructed; that you take away the monetary policy on issues such as interest rates etc from the individual states but on the other hand you do not have a fully fledged central bank. Everybody pretended that something like this could not happen and now that it is happening, Europe does not react as a bloc but the national interests are dominant.

It all goes back to German reunification, which the French could only swallow in exchange for a common currency, the euro. Germany then put a brake on the powers of the European Central Bank and made it only fight inflation. And then it put a brake on anything that could make the monetary union work on a political level to keep a national foot between the door. Plus some countries were allowed to join that should not have.

Politicians underestimated what it would mean to have a monetary union and what a country like Greece could cause, after all Greece only represents two per cent of the euro zone's GDP.

Who is to blame for it?

Saint-Etienne: The three main actors at Maastricht were Great Britain, Germany and France, all with divergent interests. Germany had no wish to have its strong Deutschmark economy weakened. The UK did not want to join the euro zone and was able to strengthen the principle of social and fiscal competition within Europe. So Germany and the UK got what they wanted and France in the end lost everything because it had no clear vision of what it wanted. They got a common currency on the basis of Germany's views … and competition within Europe is the toughest in the world.

The bankers? They came afterwards. Bankers are just like sharks. When they see blood, they come. But they didn't produce the blood.

Voth: Stupid politicians - if you just focus on symbolism and regard your own declarations as gospel truth while ignoring fundamental economic laws, you will inherit an economic disaster the like of which we haven't seen since the 1930s.

Sinn: The euro. Because it prevented crisis-hit countries from tackling their lack of competitiveness through currency devaluations.

Goossens: Many of those in a position of authority are to blame. When the euro was set up, that was maybe all that could be achieved but then later when discussions were held over a European constitution certainly the Germans and the British but also some others, such as the Dutch, blocked closer political union.

Later still, just recently when the magnitude of the Greek crisis became apparent, the European leadership became austerity obsessed. The financial crisis caused budgetary problems, particularly to rescue the banks, which caused cutbacks and they're still doing so obsessively, which causes a spiral into recession.

Where do we go from here?

Saint-Etienne: We just go from here to the fact that either France adjusts or there will be a tax on French debt before the end of this year. The major crisis is still to come ... we have seen nothing up to now. I am not the only one to be saying so but no one wants to hear it and that is why I believe this crisis is inevitable because everybody is pretending it is not there.

Voth: Europe urgently needs to abandon the euro project and return to a system of exchange rates like the one that existed in the time of the ERM [Exchange Rate Mechanism] - lots of currencies that fluctuate in narrow bands and can periodically be revalued or devalued.

Sinn: Some countries will have to quit to devalue, others can regain their competitiveness inside the euro zone. Others again will have to allow inflation to rise. The attempt to adjust exchange rates inside the euro zone is extremely difficult.

Goossens: All the talk now about stimulating growth is nonsense because they are talking about major investment programmes that will take years to start having an impact. What has to be done is to reduce the cutbacks and build a firewall so that the markets cannot strike again and for that you need the ECB [European Central Bank] and euro bonds. It is madness to put the whole burden of the adjustment on the poor, southern countries. Germany should stimulate domestic demand, after all it has profited from the euro.

You have to offer the populations of countries such as Greece and Spain better prospects, this kind of hardship could cause revolutions. What you have to do is act as a community in Europe, now you have 17 different countries with 17 different approaches.

If Greece exits the euro zone, will the European project disintegrate?

Saint-Etienne: Greece is technically already out because the banks have provisioned their debt. So the problem is not whether Greece gets out but what becomes of Portugal and Spain. There will come a moment when we will have to federalise the euro zone or, in my view, see a break-up between the north and south. I think this moment of choice will be within 18 months, possibly before the end of this year … Germany will not pay for French and Spanish deficits equal to twice its own gross domestic output (GDP), and will get out with two, three or five other countries … once Germany is out, if France realises it has to clean up its house and becomes the strong country of the south, then France can get out, too. It will at first be a two-tier zone, maybe more.

Technically, there is a very swift, coherent political and social solution: to federalise eight or nine countries to form a real monetary union. It could be done but I don't believe the present leadership in Europe has the will and foresight to act. Break-up is more likely.

Voth: There is a big danger of that; if Greece can't be saved despite all the vows of the political establishment, then things will get very difficult for Portugal, Italy, Spain. And if many market participants get worried, it turns into a self-fulfilling prophecy; then there will have to be a bailout for Spain, and it will all quickly become bigger than everything the Germans are able, or willing, to finance.

Sinn: No. The example of Ireland shows that the capital markets can very well distinguish between countries. Ireland has cut its prices by 15 per cent in the last five years, is competitive again now and has current account surpluses again. The capital markets have rewarded that by disconnecting Irish interest rates from the rates of other crisis-hit countries.

Goossens: It does not need to be fatal but I do think it will prove to be a very big setback because I doubt that it will be limited to Greece. People will say: what about Spain, and what about Portugal and then national politicians anywhere will no longer be able to defend the European project. You'd have such a setback that on many points people will say that Europe cannot work and that they should emphasise their national interest.

* Reporting by Colin Randall, Ferry Biedermann and David Crossland