End of the Euro as We Know It

December 13, 2011

The belief is gaining adherents that a break-up of the euro is a matter of when, not if.  The unthinkable is transforming into conventional wisdom of what will be.  Potentially catastrophic financial and economic consequences of any modification in the 17-nation configuration of EMU, however small, had been the basis for  the perceived impossibility of a split-up, and that fear has indeed not lessened.  The inevitability of a divorce is gaining traction, nonetheless, because politicians simply cannot find a way to consummate the marriage as it was intended, a fusion of monetary policy, fiscal policy and and many economies (initially eleven and now seventeen) under one tent.  The acronym EMU stands for Economic and Monetary Union, not European Monetary Union.

EMU was marketed to the public partly on the promise of great pan-Europe economies of scale, enabling the region to compete finally on a level playing field against the United States.  The eleven charter members had a population of 291 million, 8% greater than America.  They accounted for 12.3% of global exports, about 50% greater than the U.S. share at the time, and their GDP was a tad more than 80% of America’s.  Euroland’s current account was some four percentage points of GDP healthier than its U.S. counterpart.  The promise of a successful challenge by the euro to the dollar’s hegemony in international finance, and all the benefits that such would bestow, was never delivered, however.  The sole triumph of the currency union has been an enviable record of predictable, stable and low inflation, with well-anchored price expectations.  The founding principle of ECB central banking is that such anchoring is the main, and indeed only, contribution that monetary policy can make towards supporting economic growth and job creation throughout the currency union. 

Despite perfectly satisfying the precondition for reaching its true goal, Euroland has more times than not fallen far short of the ultimate prize of a decent rate of growth.  Moreover, the achievement of low inflation over the past dozen years is less extraordinary than generally realized because advanced economies in general have not been inflation-prone in the period.  Former ECB President Trichet often pointed out that German inflation on average had in fact been lower under the ECB’s stewardship than the Bundesbank’s, but that’s a misleading comparison to make.  One instead should compare the U.S.-German and Japanese-German inflation differential to historical benchmarks.  So while German consumer prices climbed 6.0% in the twelve months to June 1980, on-year U.S. and Japanese inflation then stood at 14.5% and 8.0%.  Relatively speaking, German inflation was better contained then than now.

The politicians, who conceived of a common European currency and engineered its passage, were motivated less by the economic merits of the plan than by geopolitical matters.  European economic integration, it was believe, would put an end to war in the region.  The continent had experienced 287 wars in the prior two millennia, including two world wars in the twentieth century.  From Germany’s standpoint, a currency union defended by a central bank conceived in the Bundesbank’s anti-inflationary mold offered a huge extra political benefit.  Hyper-inflations continue to be blamed incorrectly by many for Hitler’s rise to power and, implicitly, for the costliest war of all.  It is the tragedy of EMU and its architects like former German Chancellor Kohl that the experiment going badly has instead intensified animosities between European governments and their peoples rather than serve as an enduring firewall to end the need for war as a means of resolving regional conflict.  EMU has been no better at promoting peace than as a conduit to sustainable prosperity.

EMU might have worked if all its fine details had been worked out before 1999 and if the international monetary system had not misfired badly after mid-2007.  That’s now water under the bridge.  The framework of a common currency and many years of misaligned interest rates have taken the region to a place that can no longer be fixed within the straitjacket of automatic fiscal rules, a single shared currency, and one monetary policy.  The disparities of competitiveness are too great to heal so long as surplus nations like Germany also run tight fiscal stances.  The so-called peripheral economies face endless austerity, low-to-negative growth, and failed efforts to get their deficits below penalty-triggering standards.  For them, the status quo is unsustainable, but since decisions to abandon EMU are ultimately political ones, the timing of the departures cannot be pinpointed with precision. 

The greater confidence investors attach to a break-up, the harder it will become for Euroland politicians to kick the can further down the road.  Efforts to halt the euro debt crisis have so far been variations of the same basic theme, addressing symptoms but not causes.  And like a cancer that’s metastasized, solutions that could have worked six months, a year, or two years ago, no longer offer an answer.  The trap has closed.

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.


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