Were the skeptics correct? Is economic crisis due to the Euro’s Adoption?

(Edited by Dave Kaiser – Questions by Jaime Ortega)

Before the Euro became European countries official currency of choice, skeptics, including nationalists, independents and provincials, speculated about the long-term effect of such a dramatic decision. They feared the wide-spread adoption of the Euro would deteriorate the economies of countries that accepted this currency and empower larger countries, like France and Germany, to easily manipulate the Euro’s puppet strings.

In the early 90’s, economic skeptics concluded the Euro was a failed copy, plagiarized from the US state system.  A few skeptics suggested the Euro had a built-in weakness because it is not the same as “trading from state to state in an already unified country, than country to country with a unified economy.”

Skeptics pointed out that basing an international currency like the Euro on a national currency like the dollar, would result in major international economic problems. They suggested the Euro would weaken, not strengthen the European economy. They argued that huge cultural difference separate trade between European countries like Portugal and Germany, compared to trade between US states, like Arizona and Virginia.

During the Euro’s golden years in the early 2000’s, skeptics were silenced by the progressive growth of the Euro, which easily rivaled the dollar in value.

Today, six years into the global recession it appears there was some truth in those skeptics hesitation, as the Euro has dramatically weakened. To short-cut the failure of the Euro, the IMF and the ECB, has bailed-out many businesses and countries in the union to restore confidence in the Euro and the market.

It seems like the anti-Euro skeptics’ prophecies have come true. German Chancellor Merkel, who was unwilling to bail out Greece, despite their participation in the union, showed that France and Germany are now the two heads of European economic hydra.

 This turnaround raises four key questions:

 1) Should countries with weaker economies like Spain, Portugal and even Ireland, have remained with their old currency instead joining the Euro?

2) If these countries had remained with their old currency, would they have been less affected by the global financial recession?  

3) Are France and Germany the true decision-makers in Europe?

4) Would Europe be in better financial condition today without the Euro?

While these four questions are useful conjecture, a more important question is whether or not, due to the current economic problems being encountered by the EEU, is there a way to reverse the decision to implement the Euro, and what would be the long-term results of such a move?”

Pierre-Antoine Klethi.

European citizen and federalist. Graduated from Sciences-Po Paris (Law department) and Sciences-Po Strasbourg (Public Administration). LL.M candidate in European Law at King’s College London. 

“Assessing the adequacy of Eurozone membership requires, first of all, recalling the benefits of the Euro for its users:

–          Price stability. Inflation in the Eurozone has been around 2-2.5% for most of the time since its creation. This was a positive change in some Southern European countries where the central bank’s commitment to limit inflation lacked credibility. Let us remember that inflation does not create real wealth!

–          Protection against currency speculation. Until the 1990s, many European countries (including France and the UK) had to devaluate every now and then their currency to maintain some competitiveness compared to Germany.

–          Protection against price volatility affecting oil and some other commodities. This advantage was particularly visible before the beginning of the financial and economic crisis, when the oil price and the price of some other important food commodities reached unprecedented peaks. A strong Euro mitigated the impact of the volatility of dollar-denominated price.

–          A size effect. Prices can be compared across the whole Eurozone, allowing companies to choose the most price-competitive suppliers. Moreover, a huge monetary zone facilitates trade, financial and touristic flows between its members.

–          Last but not least, the Euro is a political symbol marking a new step in an ever closer European integration (NB: an ever closer integration does not mean that everything is to be decided at central European level). Moreover, the Euro also continues to symbolise prosperity for a number of citizens in the poorer Member States in Central and Eastern Europe.

That being said, the Eurozone also has weaknesses due to the fact that it is not an optimal currency area.

The 5 main criteria defining the optimality are: labour mobility across the area; openness (free capital mobility, flexible wages and prices); similar economic cycles for all members; a redistribution mechanism to support the members adversely affected by the creation of the area; and similar/common political goals.

The Eurozone economies have a high degree of openness (though flexibility of wages is lacking in many Member States). Moreover, their economies are sufficiently linked to claim that they have similar economic cycles (or, at least, they had them before the beginning of the sovereign debt crisis; in the current situation, this assumption is challengeable). And it is also acceptable to say that Eurozone Member States have, to a certain extent, similar political goals based on common values and the European “Welfare State.”

However, the Eurozone still needs to significantly progress in matters of labour mobility (far too few European workers are active in another country) and in the setting up of a solidarity (redistribution) scheme, which is slowly underway.

The above-mentioned weaknesses in the Eurozone design have had some problematic consequences for Member States with economic structural weaknesses.

So, devaluation is not anymore possible to artificially regain competitiveness compared to countries like Germany. The consequence is that price-competitiveness can only be regained by making adjustments in the real economy, e.g., by cutting wages. Of course, these countries should also think about developing the quality and innovation of their products and services. Indeed, price is not the only factor of competitiveness!

Moreover, these Member States may try to delay hard choices with fiscal interventionism, thereby creating and deepening fiscal imbalances with the risk to eventually end up in a sovereign debt crisis like that experimented by the Eurozone.

So, would these Member States be better off outside the Eurozone, respectively should they never have become member of it? My answer is no.

First, while it is true that they could proceed to adjustments through devaluation and inflation rather than wage cuts, let us note that both methods have exactly the same effect on the spending power: a reduction in real wages.

Secondly, the positive effect on the balance of trade should not be taken for granted. Indeed, exports become more price-competitive, so that their amount shall increase, but as they are sold at a lower price, there is no guarantee that the total value of exports will rise. Furthermore, imports get costlier (leading to inflation) and shall thus decrease, but only within a certain limit since some imports (in particular, oil and some food commodities) are unavoidable, regardless of the price level. So, a positive general effect on the balance of trade is far from certain.

Thirdly, many weaker European economies would have suffered far more during the financial and economic crisis, had they not benefited from the credibility of the ECB and the solidity of the EU and the Euro.

As a closing remark, it may be worth remembering that monetary and fiscal policies have different purposes and origins, and consist in diverse instruments. The Euro is not responsible for tax cheating, housing bubbles (the ECB rates were not as low as those of the Fed), a disproportionate development of the financial sector in some financial centres, or a reckless fiscal policy. Of course, the Eurozone’s functioning can and must be perfected, but the Euro only created a constraining framework which makes structural weaknesses more visible, it did not create them!”

Claude Nougat.

4. There is NO way to reverse the adoption of the Euro and going back to national currencies without creating a much larger crisis than the one we have experienced since 2008. Such a move would effectively paralyze the banking system and make it crash. It would make the sovereign debt crisis of governments like Greece’s look like a Sunday ride.

Those countries leaving the Euro would find themselves totally unable to finance themselves. Which means good-bye to pension systems and health and other social safety network systems, like funds for the unemployed etc. The social mayhem this would cause is unimaginable. Do you want to try? Then explain to the unemployed why there are no longer getting any compensatory payments, to retirees why their pensions have vanished, to the sick and dying why the hospitals have closed down, to those trying to get to work why the bus and subway systems have stopped functioning etc etc. Have fun!

Steven Hansen.

Publisher and Co-founder of Econintersect. He consults to governments to optimize process flows; and provides economic indicator analysis based on unadjusted data and process limitations.

“As a pragmatist, I always start by looking at where we are – not rethinking the whole issue of the Euro. It involved integration of several economic cultures. However, a disciplined economic approach (Austrian school) like Germany is incompatible with the loose economic (and less disciplined) southern Europe.

Because of the mounting sovereign debt and money flows (southern Europe is net importers and north Europe are net exporters), at this point the Euro is destroying the southern economies (who have weak economies and cannot make adjustments necessary to monetary policy).

This may be the time to break the Euro into at least two separate currencies – and let them float against each other. The debts of each country will be re-denominated into the new currency. The Euro should be broken down into as many currency units as necessary to match the nature of each country.

It would be good if a common market has a common currency – but a currency has more functionality than simply payments for imports and exports. A country cannot control its economy unless it can control monetary policy. No country in the Eurozone can control its own monetary policy.

But Europe is incapable of making hard decisions – and this decision will have a lot of negative effects for northern Europe. The southern currency will devalue against the north. The beneficiary of this action will be the south at the beginning – but once the economies of the south strengthen – in the long term it will benefit all.

But the complexity in breaking the Euro into pieces (or even going back to each country having their own currency) maybe beyond the ability of all the Kings horses and all the king’s men. Any change of the Euro will have significant consequences – and there will be winners and losers. I cannot imagine Germany allowing themselves to be a loser – and the stronger Euro members must lose so the southern Euro states can win.

David J. Merkel.

CFA is Principal of the equity and bond asset management firm Aleph Investments, LLC, and writes The Aleph Blog. Previously, he was the Director of Research for Finacorp Securities. 

“The Euro is a political construct.  It was not a wise move economically to establish it.  It threw peripheral Europe into a boom then a bust.  This was necessary to realign the varying European economies into one economy.  Was it worth it?  Across the Eurozone, you would get different answers, but the powers that be felt that an “ever closer union” was the main goal, even if there would be a lot of hardship.

I think Europe would have been better off without the Euro.  Things may be getting better now in the Eurozone, but things would have been better still without the Euro.  The cultures of nations in the Eurozone are different, and without cultural unification, governmental and economic unification will still prove difficult.

The jury is out on the Euro.  It will be resolved when overly indebted countries delever.  I don’t see that anytime soon.  (Add in the entitlement crises…)

Mike Guillaume.

He is the co-founder and manager of e.com-ReportWatch and Author of “The Seven Deadly Sins of Capitalism” (www.mikeconomics.net)

“Were the skeptics correct? Is economic crisis due to the Euro’s Adoption?

 Much ink has been spilled over the euro and Eurozone troubles. First of all, it is fair to say that before and at the time of its inception skepticism about the new currency prevailed only in the U.S. and among a small number of political circles and economists in the E.U. (European Union), mainly from the fringes of the ultra-right and leftists. Personally, having studied the previous stages of the planned European monetary union (EMU) carefully, I was cautiously optimistic, yet a bit skeptical about a union based on a currency without unified economic, budgetary and fiscal policies. The euro crisis and the totally undemocratic practice of E.U. institutions have turned me into a Euroskeptic. As put in your introductory text, during the euro’s golden years in the early 2000s, skeptics were silenced by the progressive growth of the Euro, which easily rivaled the dollar in value.

To cut it short, and after the EMS, ECU and EMU phases –which, as many in Brussels seem to have forgotten did not prove very successful– the push for a single currency mostly (yet not only) came from French politicians and technocrats. These were both inspired by a desire for further economic union and by a fear of German reunification. Introduced in 1999 in a non-material form, it was launched as a real currency in 2002. That was about building up a monetary union through a currency but without the other components of a real union (i.e. budget, fiscal and economic policies). “A money too far,” as Paul Krugman wrote in the New York Times.

Eighteen months later, he added: “the European elite, in its arrogance, locked the continent into a monetary system that recreated the rigidities of the gold standard, and –like the gold standard in the 1930s– has turned into a deadly trap.”[1] Transmitted until now via member sStates –mainly through the Franco-German couple, as it is known in the E.U. –Eurocracy’s hubris is now working on its own. Between the two rounds of the 2012 French presidential campaign, the Euro Group’s president said it would be “a dream” to deeply modify the treaty proposed a few months before. Such interferences in member States’ politics were hardly imaginable ten or twenty years ago. The French economists André Orléan and Michel Aglietta once co-wrote a book titled “La Violence de la monnaie”. Though this could be correctly translated as “Violence of Money,” the Eurozone version of the book title would certainly go today as “The violence of a currency” or a shock therapy “à l’Européenne” (the European way).

If Greece –but we might as well take the other “PIIGS”, i.e. Ireland, Portugal, Spain and Italy as other examples– is not a case study for a shock capitalist therapy in disguise (really?), what is it then? Admittedly, Greek politics and economics stand as bad examples of profligacy and number-fudging; “Rhenish capitalism” is not comparable to tough Friedman-style monetarist economics; the Greek government was democratically elected (um, this is less sure); the political objectives are different (but what are they, really?); etc. Still… Early in 2012, Greece’s GDP was down by 13 percent compared to 2008. By comparison, Britain’s GDP never fell more than 10 percent during the Great Depression in the 1930s. More than a half of the decrease may be attributed to the last years’ Eurozone crisis. In 2014, it will be back to the GDP level before the country joined the euro, meaning that all supposed growth benefits of the adoption of the currency have been written off in a decade.

Adjusting the current-account deficit by spending less would require an additional 25 percent fall in GDP. Adjusting by raising exports would mean a 50 percent% increase of these. With a manufacturing export sector making up 7 percent of economic output and without devaluation (made impossible within the euro), the task is herculean. The E.U.’s cutback dogmatism is far from enabling even a small part of this hypothetical recovery track. In Great Recession style, the average worker’s pay decreased by 25 percent in the year 2011. 100,000 small businesses have gone bust these last two years, while the youth unemployment rate jumped from 25 percent to almost 50 percent.

As a condition to the second bailout package, international creditors and the “Troika” (a name much reminiscent of Soviet style) demanded a 22 percent (twenty-two!) cut in the minimum wage. In many areas, living conditions have become unbearable. “And the ‘rescue’ money often goes to bond investors rather than widows and orphans,” wrote BBC News economics editor Stephanie Flanders less than three weeks before knowing about another longer-term refinancing operation (LTRO) provided by the ECB to 800 European banks for an amount four times bigger than the second Greek bailout. To add insult to injury “the eurozone wants to impose its choice of government on Greece – the eurozone’s first colony,” added Financial Times commentator Wolfgang Münchau. The Greek colonels are long gone, but the results and realities are in Chile or Argentina generals’ policy style.[2]

This raises one of the big questions of our times: will the E.U. elites achieve through peace but at all cost the united Europe that Charlemagne, Charles V, Napoléon, and Hitler before them were not able to achieve by war? That would come at a high social price, and could even backfire in a populist and nationalist backlash.

The oddest thing is that, after four years of –sometimes harsh– austerity policies conducted in a context of global recession (bar the emerging markets) imposed on “weak” economies by Germany, whose leadership is now more undisputed than ever, the euro as a currency remains overvalued in comparison with the dollar and other currencies.

An answer to the four questions raised in your introduction.

1) Should countries with weaker economies like Spain, Portugal and even Ireland, have remained with their old currency instead joining the euro?

The answer is a straight yes. Greece would not have been much helped due to its industrial fabric (or the lack of), but economies like Ireland –yet hampered by the folly of its banks– and even more Spain or Italy (and even France) would have fared much more easily with a full control of their monetary policy. The new currency has helped Germany to hollow out large parts of E.U. developed economies. Thanks to a euro quite cheaper than the former deutsche mark, the powerful German export machine has beaten all value and volume records these last years. To take but one example, more than 60 percent of automobiles and trucks are now made in Germany.

2) If these countries had remained with their old currency, would they have been less affected by the global financial recession?

The answer is not as obvious here yet it is fair to say that both exports and reasonable deficit-spending policies would have helped.

3) Are France and Germany the true decision-makers in Europe?

Despite deceptive appearances, what the euro crisis has brought is the defeat of France as a co-leader. Though a “reluctant hegemon” as The Economist named it[3], Germany leads the way and France is now forced to follow. So much that the newly elected socialist president has had to shift to a more supply-side and austerity-driven policy, breaking his campaign promises.

4) Would Europe be in better financial condition today without the euro?

On the whole, the answer is probably yes here too. The German exporters and economy are almost the sole winners of the euro. Except a bit in northern and western areas, economies have slowed down, austerity policies are based on the low deficit-low debt German model and lead to deeper recession, unemployment (especially youth) is higher than it has ever been.

Moving forward with the euro is very risky, while getting backward would be very expensive. Another typical example of dilemmas E.U. politicians seem to be fond of.”