The Euro at 10: flawed from the start?

On New Year’s Day 2002, euro notes and coins hit the streets of 12 European countries for the first time, received with enthusiasm and optimism by some, and pure scepticism by others. 10 years on, the euro zone is facing an escalating sovereign debt crisis, along with credit downgrades, rising interest rates, spiralling unemployment and deep budget cuts. Euroasia Industry’s Gemma Carter asks the experts what went wrong with the euro and where it can go from here.

The initiation of the European single currency can be traced back more than half a century to 1957, when the Treaty of Rome suggested that a common European market could increase economic prosperity and foster closer ties among the people of Europe. A single currency became an official objective during the European Summit at The Hague in 1969, and in 1988, the Hannover European Council submitted plans leading to European Monetary Union (EMU). Three years later, proposals to establish a single currency for all EU states – except the UK and Denmark, which opted out – by January 1999, were agreed under the Maastricht Treaty.

In order to enter the third stage of EMU and adopt the euro as their currency, participating countries were required to fulfil strict criteria, including low inflation, long-term interest rates that remained close to the EU average, and a budget deficit of less than three percent of their GDP. While these provisions were put in place to ensure economic convergence and prevent financially unprepared nations from joining the single currency, many economists remained concerned that due to the distinct nature of the economies forming the euro zone, some would be incapable of competing in terms of production, exports and wages, eventually requiring subsidisation from stronger states.

The process forged ahead, nevertheless – 1998 saw the establishment of the European Central Bank (ECB) in Frankfurt, and in 1999 the euro was launched as an electronic currency used by banks, foreign exchange dealers and stock markets. Three years later, on 1st January 2002, millions of Europeans took to the streets at midnight to celebrate being able to hold euro notes and coins in their hands for the first time.

The euro’s hidden weakness

Today, the euro is used daily by more than 330 million people across 17 EU member states – five more countries having acceded to the euro zone since 2007. However, the sense of optimism that greeted the united currency at its inception appears to have evaporated, and Europe has become embroiled in a sovereign debt crisis that has threatened to deteriorate into an economic and banking crisis. Several euro-zone nations are experiencing severe downturns, while European banks are laden with debt and have reduced lending to consumers and businesses, creating a new credit crunch.

According to George Soros, the Hungarian-American business magnate at the helm of Soros Fund Management, the euro crisis is a direct consequence of the 2008 failure of Lehman Brothers and the crash that followed. “At a meeting of European finance ministers in November 2008, they guaranteed that no other financial institutions that are important to the workings of the financial system would be allowed to fail,” he writes in fortnightly magazine The New York Review of Books. “Angela Merkel then declared that the guarantee should be exercised by each European state individually, not by the EU or the euro zone acting as a whole. This sowed the seeds of the euro crisis because it revealed and activated a hidden weakness in the construction of the euro: the lack of a common treasury.”

‘The mistakes were always clear’

In order to find out whether other commentators share George Soros’ view, and to garner the latest professional opinion on the viability and future of the euro, Euroasia Industry spoke to three experts in political economy, banking and finance.

Dr Waltraud Schelkle is a Senior Lecturer in Political Economy at the London School of Economics (LSE) European Institute, and an Adjunct Professor of Economics at the Economics Department of the Free University of Berlin.

Euroasia Industry (EI): In your opinion, what mistakes were made in the construction of the euro?

Dr Waltraud Schelkle (WS): The mistakes that were made when the euro was introduced were always clear to macroeconomists. However, I do not agree with talk of Europe not being an optimal currency area, because which currency area in the world is? What we do know is that a common monetary policy needs backing from a fiscal authority – especially during a financial crisis. There were plans commissioned in the early 1990s for a fiscal mechanism that, in the event of shocks that hit some euro-zone countries but not others, could stabilise those regions. However, the European Council, especially the Germans, rejected these proposals. So, although the euro was a viable concept in the sense that it protected countries against currency crises like those we saw throughout the 1980s and ‘90s, in order to back up this common monetary policy in the long term, you need a form of fiscal unification that is, at a minimum, joint public debt management.

EI: What kind of impact do you think the lumping together of polar-opposite economies had on the creation of the euro zone?

WS: It was always a tall order, but consider this: although it is in bad shape today, Ireland enjoyed a so-called ‘economic miracle’ after joining the EU, in anticipation of the stability of the euro area. Indeed, one should not forget that the formation of the euro zone was a huge opportunity. Throughout the 2000s Europe was converging – in other words, the poorer regions grew considerably faster than the rich ones, so they were drawing closer – but the bubbles still have to be managed, and in the case of Greece, which was bound to run into an unsustainable situation at some point, this discipline was missing.

EI: What do you think needs to be done in order for the euro to survive as a viable unified currency?

WS: For Greece, the present reforms are probably right, but I am afraid they are not right for Spain, or even Italy and other such countries that really tried to live up to their obligations as a member of the euro zone. What might happen to them is quite disturbing. There are measures that would address the problems, such as a European financial stability mechanism, and that is what is required. However, ruling out the issuing of Eurobonds – which is the German position at the moment – is counter-productive. Many of the other measures, such as ever-more intrusive budgetary surveillance, are irrelevant, mostly, with the exception of Greece and perhaps Portugal. It is not public debt that is the problem but private debt, so we need to find ways of dealing with this debt, rather than focusing on budgetary surveillance that ignores the real problem with the euro zone. The markets need to be assured that there is someone who backs up the ECB in its ‘lender of last resort’ role, and that requires something like Eurobonds, which the German government does not want. However, the opposition is in favour, and it may be that the obstacle of Angela Merkel and her government is removed at some point – hopefully earlier rather than later, because they have blocked every sensible solution that has been suggested so far.

‘We are all in this together’

Dr Sascha Steffen joined Berlin’s European School of Management and Technology (ESMT) in January 2012 as an assistant professor and the first holder of the Karl-Heinz Kipp Chair in Research. Previously he was an assistant professor at the University of Mannheim in the department of Banking and Finance.

EI: The ECB claims that the euro is ‘a symbol of integration and co-operation’ – to what extent do you agree with this statement?

Dr Sascha Steffen (SS): I absolutely agree with this statement and I think the euro has a symbolic character. In the early days of the euro’s launch, most business executives had to agree that it was a massive success. However, the concept of a ‘united Europe’ and equality across euro-zone states is something that has never happened.

EI: Why do you think that is?

SS: One of the major problems is the fact that the EU created a monetary union without a fiscal union – it handed over monetary policy to one institution, the ECB, but it did not incorporate a mechanism that ensured the fiscal discipline of each country. Consequently, we are all in this together and there is no penalty for reckless spending, which left other countries powerless to ensure that Greece and Italy behaved correctly. Another problem is the different levels of competitiveness between each of the member states. Germany, France and the Netherlands were able to grow very quickly but the likes of Italy and Greece were unable to keep up, hence they had to resort to lax fiscal discipline in order to grow. If they were not part of a currency union, they would have simply devalued their currencies in order to remain competitive, but this was not possible.

EI: In your opinion, what measures need to be taken to address these problems, and what do you think of the reforms that have been made so far?

SS: One short-term problem is that we have to ensure the liquidity of the euro zone, as well as that of those countries and banks that have to refinance themselves. If we look at the kind of money that must be raised within the first quarter of 2012 alone, I think Italy and Spain have to raise around 150 billion euros. The medium-term problems include sovereign debt control and competitiveness among European countries, which is also reflected in the euro zone’s current account balance – Germany and France have huge current account surpluses, while the peripheral countries have very large current account deficits. These are matters that urgently need to be addressed, and I think the summit last December raised a couple of interesting points. For example, in terms of increasing sovereign debt control, euro-zone leaders agreed to more fiscal integration and a kind of automatic sanction mechanism that would be applied if there were a breach of the rules. The key question is how binding is this, because it is not much different from what has been included in the treaties already.

EI: What are your predictions for how the situation will develop during 2012?

SS: The euro is much more than an economic concept, it is a political concept, and I would assign a very high probability not only to the euro’s survival, but also to the fact that it will retain all of its member states. The ECB held its first three-year loan auction in December and it is scheduled to hold another one in February, so we will have to wait and see how much liquidity banks take up and how they invest it – a large part of it will probably go towards refinancing their existing debts, some of which are in the form of sovereign bonds, especially if this money is taken up by banks in the peripheral countries, like Italy.

‘Europe is a large patchwork’

André Thibeault is Professor of Finance and Risk Management at Vlerick Leuven Gent Management School, and Academic Director at Vlerick Centre for Financial Services. He also combines several additional academic and consultant positions in Europe, Canada and China.

EI: Given the current crisis in the euro zone, do you believe that the single currency was ever a viable concept?

Dr André Thibeault (AT): Yes, it was a viable concept at the time that it was launched, and as a way of continuing the integration of European states under certain laws and regulations. However, after the euro was introduced, the parties involved stopped there, as if their job was done, but it was not and that is why we are having such problems today. If Europe really wants to be integrated, its nations will have to make some big sacrifices, such as the loss of sovereignty and the transfer of jurisdiction to the central government. In Canada, for example, there are striking variations from one province to another, but they all live under the same monetary policy and use the same currency, which shows that it is possible to live in a vast area that has big differences, as long as each component of that area adheres to the same fiscal rules. Unfortunately, I am not sure that EU member states are ready to accept the changes that must be made.

EI: So, it is not a question of oversights made when the euro was created, but rather one of the errors that have been made since, in that the integration of Europe has not been pursued fully?

AT: Exactly. When the euro was introduced there was a roadmap for continuing the integration of Europe under a single fiscal policy, but this was not followed. From the outside it may look as though Europe exists, but from the inside, even with a single currency, it is certainly not acting as one country, and this is what needs to change. Europe is a large patchwork, and if it does not become better integrated then it is highly likely that it will break down into smaller pieces.

EI: Do you think recent reforms will be able to address these issues?

AT: They are not sufficient. Making the banks stronger so that they can absorb the losses of certain countries is something that will solve the problem temporarily, but in the long run we are still facing a moral hazard because there is nothing to oblige these countries to be stricter with regard to their budgets. Member states must relinquish some of their freedom and have faith in the central government’s ability to monitor what is going on – otherwise we may well see the euro zone implode.

EI: Is there still time for these changes to occur – or is it already too late?

AT: I am quite optimistic, so I believe we will see some kind of agreement that will facilitate stronger European integration. A step in the right direction was taken at the beginning of the year, and I am confident in people’s belief that greater integration is preferable to the implosion of the euro zone, which would be extremely damaging to all European economies.