The euro: stuck in a burning house with no exit?
The launch of the euro in 1999 brought together eleven economies in a common currency zone and created a market of nearly 300 million people; expansion has added a further six member nations and an additional 30 million people.
When the euro was launched it was claimed that the eurozone would challenge the economic dominance of the US and that the new currency would challenge the pre-eminence of the dollar as a global reserve currency. Whilst the euro had established itself on the global markets, the original bold claims were already starting to look a bit fanciful before the financial crisis, given the emergence of China and India as economic powers.
The sovereign debt crises facing eurozone members such as Greece, Portugal and Ireland, has led many to ponder whether this will result in the collapse of the single currency. But is this talk of the euro’s early demise premature or is the euro really a currency on life support, with the doctors (ie Germany and France) ready to switch off the machine? Or could the currency (and the monetary union) actually emerge stronger following the current crisis?
The financial crises facing Greece, Portugal, Spain and Ireland are not the result of their euro membership. However, when one eurozone member faces difficulty, this puts a strain (economic and political) on other members. And any evidence that currency union is restricting individual nations’ ability to deal with their debt problems or is placing an unwanted financial burden on other members has the potential lead to calls for withdrawal from the eurozone. On the bright side, the €750 billion EU/IMF bailout package has given struggling eurozone members a large (if possibly not large enough) pot of funds to tackle the debt crisis in countries that, as part of a currency union, cannot now take the traditional currency devaluation option.
It is hard to say at this early stage whether the package has been critical to “saving the euro” as Nicolas Sarkozy and Angela Merkels have stated. However, if the bailout provides reassurance to voters in struggling countries, this may reduce any domestic pressure on governments to leave the euro in the event of severe fiscal problems. In any case, it is very unlikely that any government would choose to leave the common currency in the middle of a sovereign debt crisis, given the uncertainty and potential further economic difficulties this could generate through inflation, speculation, which could in turn lead to more debt.
So, will the euro survive the current crisis? I would say yes, although this is not to suggest that the eurozone policy framework is the optimal (or even an effective) one. As long as Germany and France remain committed to the euro the currency’s future is secure (and with the German economy currently growing strongly, there is little clamour for the country to reconsider eurozone membership). Even if, if the unlikely event that Greece or another struggling periphery member did decide to leave the euro, this would probably have a limited impact on the single currency. The key challenge will be faced if either France or Germany were beset with the kinds of difficulties facing Greece, Portugal etc, or if periodic crises meant that French or German residents started to directly link eurozone membership with bailouts of more profligate members.
Perhaps policy makers need to go back to the fundamental flaw in the design of the single currency. Amid all the Eurovision-type fanfare and balloons when the euro was launched, there was one key question that appeared to have slipped politicians’ minds (although it was uppermost in the minds of economists), namely “is the currency union sustainable with a central bank (monetary union), but no central Treasury (fiscal union)”? The eurozone cannot function properly as a single economy without a genuine single market across the EU. In the absence of significant fiscal transfers (ie a central fiscal policy), there is unlikely to be enough labour flexibility across the EU to make the eurozone work efficiently, and wide variations in performance are likely to be the norm.
However, the euro has been sold across Europe as an economic, not political venture. Will resident be happy to be part of a political union that fiscal union would entail? And do politicians have the honesty to say that the euro has always been more about politics than economics?
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