Holding on to the euro: the well-off and well-connected will manage
Although the euro was at heart a political project, there were some reasonable economic arguments for its adoption at first. There are the benefits from lower costs for tourists and businesses. Also, many in the south wanted monetary policy to be taken out of the hands of governments that had frequently been reckless. Put bluntly, many people trusted a German-style central bank at the heart of Europe more than they trusted their own governments. Indeed, it is worth noting that sound money has long been a principle of Catholic social thought since the late scholastics of the sixteenth century. In addition to this, the governments of the less prudent countries wished to be able borrow at lower interest rates. Thus was born a coalition of interests in favour of the euro.
It was generally felt by the euro’s proponents that, as long as the political will was there, the economic reform that would allow the euro to succeed would follow. So, what went wrong? Its opponents predicted the collapse of the euro from day one. Countries need to be able to respond to economic shocks. That is why exchange rates fluctuate. Fluctuating exchange rates enable countries to adjust when they are hit by shocks. If a country does not have an independent exchange rate then wages and internal prices must adjust instead. But the eurozone neither has flexible exchange rates nor flexible wages, hence the extraordinary levels of unemployment that have stalked much of our continent for several years.
This situation was made worse by the artificial economic booms in countries such as Spain and Ireland. If Ireland had had an independent currency, she could have raised interest rates as her economy was over-heating in the early 2000s. Instead, she was a member of a single currency zone and was able to finance an ever-bigger housing boom at interest rates set at levels that were wholly inappropriate for Ireland but appropriate for the eurozone as a whole. The banking crisis inevitably followed the boom and bust. For countries such as Ireland, Spain and Greece to restore competitiveness, wages and prices would probably have to fall by around 30 per cent relative to wages and prices in Germany. Wages go up quite readily when the economy is booming but, in most EU countries, they do not easily adjust downwards – although Ireland may be an exception.
On top of this, we have a sovereign debt crisis. When the euro was created it was made absolutely clear that the European Central Bank (ECB) would not bail out member nations and there were rules limiting government borrowing. However, everybody broke the rules from the start and now the creditworthiness of a number of countries is seriously in question.
So what is the solution? To the EU elites who created this mess, it is to socialise the debt at EU level. The problem is that, aside from Germany and some smaller countries, there is nobody to bear the bad debts. We have the European Financial Stability Facility (EFSF), the ECB, the European Financial Stabilisation Mechanism (EFSM) and European Stability Mechanism (ESM) all mutually guaranteeing everybody else’s debts – an alphabet soup of mechanisms designed to cloud the reality – and money is being poured into the southern European countries as their banking systems empty. EU governments act as the guarantor of the banking system and the banking system acts as the guarantor of the governments. But, in many countries, both are effectively bust! Meanwhile, the EU has kicked the can down the road while hoping things will improve. Time has been wasted and the opportunity for an orderly transition to new monetary arrangements lost – but transition there must be because the alternative to managing exits from the euro and recognising bad debts for what they are is indefinite chaos.
The first to go will be Greece. Exit will not be easy to manage technically, but currency unions have split up before. Indeed, some readers may remember the end of the Irish-UK currency union. However, the euro situation is made more complex by the fact that exit from the euro is legally prohibited.
What will happen after a Greek exit? The paradox is that, if a Greek exit is handled well in the technical sense and its economy starts to recover, there may well be overwhelming pressure for exit from a number of other EU countries – Portugal, Italy, Spain, perhaps even France and Ireland. The euro would then shrink to a number of core countries – Germany, the Netherlands and so on. This is not the most likely scenario but it is possible.
Interestingly, the euro may well circulate as an alternative currency in those countries which have left the euro. Businesses in particular would have the option of using the ‘new lira’ or ‘new drachma’ or the euro. Those countries may well adopt the euro again in time, when they are ready and when they meet the strict new criteria that will probably be developed for members of the reformed euro club.
In fact, this would take us back to the plan the British government proposed in the 1990s, as I proposed in the Wall Street Journal 18 months ago. A European currency might arise by evolution rather than by imposition from the centre. Of course, none of this suits the governing elites. They would prefer centralisation, fiscal transfers and the socialisation of debt at the EU level. Indeed, the elites would be prepared to see huge economic pain inflicted upon the people of the EU as long as the project of ever-closer union keeps on track.
This article was first published in The Tablet of 9 June 2012 and is reproduced with the permission of the publisher.