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WorldSeptember 3 2012

Why the euro cannot continue in its current form

The euro is no longer fit for purpose and must be dramatically rethought before it breaks up Europe.
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Why the euro cannot continue in its current form

Having been an early supporter of the euro, I now consider my engagement to be the biggest professional mistake I have ever made. Here are the reasons:

First, politicians broke all their promises made in the Maastricht agreement. Not only was Greece let into the EU for purely political reasons, the Maastricht Treaty was broken more than 60 times. Mandatory punitive charges provided for such cases were never applied. To top it all, in May 2010 the 'no-bail-out' clause, the firewall between the German taxpayer and politicians in other countries, was broken down in the wake of the first Greek rescue package.

Second, the 'one-size-fits-all' euro turned out to be a 'one-size-fits-none' currency. The euro itself caused some of the problems politicians are now trying to solve. With access to interest rates at much lower 'German' levels, Greek politicians were able to pile up huge debts. The Bank of Spain helplessly watched the build-up of a real-estate bubble without being able to raise interest rates. Without the ability to devalue their currencies, all countries in southern Europe lost their competitiveness.

Third, instead of uniting Europe, the euro increases friction in the continent. Students in Athens, the unemployed in Lisbon and protesters in Madrid not only complain about national austerity measures, they protest against German chancellor Angela Merkel. Today, French-German relations are at their lowest point in 60 years. Before the crisis of the euro, Germany was the most liked nation in Greece; today it is the most hated. No wonder, if the potential biggest creditor feels obliged to constantly lecture the potential debtors about their social and fiscal policies.

Moreover, the euro widens the rift between countries within the eurozone and those outside of it. According to the latest polls, of the nine non-euro countries in Europe, only the population of Romania still wants to join the currency. Some 91% of the Swedes and 94% of Czechs want to stay out. In the UK, a serious political debate has commenced on whether the country should stay in the EU. On the continent, the satisfaction with the European project is severely damaged. It takes a lot of ignorance not to admit that this is mostly the result of chaos created by the monetary union.

A bitter pill

Instead of addressing the true causes of the illness, politicians keep on prescribing pain killers to the euro patient every time another 'Greece', 'Portugal', 'Ireland', 'Spain' or 'Italy' pops up. The euro patient suffers from three discrete diseases: first, as a result of the financial crisis, many banks in the eurozone are still unstable; second, the negative effects an overvalued euro has on the competitiveness of the 'south', including Belgium and France, and third, the huge level of debt in some eurozone countries.

Treating a patient who suffers from three diseases simultaneously is indeed difficult, and it would be misleading to proclaim that there is an easy way out. But it is irresponsible to maintain there are no alternatives. Let’s look at them:

Plan A

'Defend the euro at all cost', as pronounced by European Commission president José Manuel Barroso and practically all governments in the eurozone. Mr Barroso should have added “...to the Germans, the Dutch, the Finns”. The end result will, however, be detrimental to all. Various rescue packages have led the eurozone down the slippery path towards the organised irresponsibility of a transfer union. If everybody is responsible for everybody’s debts, no one is. Competition between politicians in the euro-zone will focus on who gets most at the expense of the others. Instead of exploiting the advantages of diversity within the EU, the focus will be on harmonisation. Instead of relying on the principle of subsidiarity: ie. delegation of the authority to the lowest possible level, centralisation will become the order of the day.

The outlook is grim: less competitiveness for the entire eurozone, more debts, higher inflation, less wealth, but, and this will please a lot of politicians, whatever is left of it will be more evenly distributed. The competitiveness of the eurozone is bound to fall behind not only those of other regions, it will also fall behind those European countries which refuse to be part of it. The idea of a 'two-speed' Europe will materialise differently from what the inventors predict: the eurozone will become the slower of the two.

Plan B

'A Greek default or her departure from the eurozone' implies high risks. First in Athens, then in Lisbon, Madrid and perhaps Rome people may storm the banks as soon as word gets out. In my opinion, a very high risk to take. By the way, the 'hair cut' for Greece did not make that country more competitive either. There has never been a re-scheduling of a country’s debts without a concurrent devaluation. But that is not possible in a monetary union. In other words, soon, the Greeks will have to go to the barber again. In any case, should Greece leave, the principle is established once and for all. Why not Spain, Portugal, Italy and so on?

Plan C

That’s why we need a third option: Austria, Finland, Germany and the Netherlands get out of the eurozone and create a new monetary union modelled exactly on the original Maastricht agreement, leaving the euro for the remaining countries. This not only avoids the chaos of southern Europe storming their banks, if planned and executed carefully, for instance by first introducing a parallel currency (the northern euro), it could do the trick. A lower-valued euro would improve the competitiveness of the remaining countries, including France, and incite growth, employment and tax revenues, none of which they have today.

In contrast, exports out of the 'northern' countries will be impacted but their economies will enjoy less inflation and be spared from looking after the 'south' forever. Most likely, some non-euro countries such as Sweden, Denmark and the Czech Republic will join this 'northern euro' rather quickly. Depending on actual performance, a flexible membership between the two should be possible. Ireland may be able to join the northern club soon. Two central banks, each following a monetary philosophy appropriate to their respective economical environments, are to control the devaluation of the southern euro and the revaluation of the northern euro, much like the Swiss National Bank does today. And, who knows, maybe one day, once the economic convergence in the EU has really been achieved, we will be all together again.

Implementing Plan C requires that each of the three underlying problems is addressed separately.

  • We must rescue banks, not countries. Stabilisation of banks on a national level should replace current European umbrella proposals. In many cases, this requires temporary nationalisation of banks rather than the strategy of a European Banking Union. This was successfully done in Sweden, when the banks there were at the brink of collapse.
  • Germany and its partners in a new currency must forego a significant portion of their guarantees to help refinance the remaining countries of the eurozone. As most of these are practically lost anyway, this seems to be an acceptable price for a seemingly expensive 'exit ticket'.
  • The creation of a new central bank based on the policies of the Bundesbank but preferably not led by a German. The final name of the 'northern euro' must not be 'mark'.
  • The mechanics of the separation would be similar to those used for getting into the euro, eventually via the introduction of a parallel currency. In any case, if it was possible to form one currency out of 17 different ones, it should also be possible to form two from one. There have been many examples in the history of monetary unions coming to an end, the most recent being the Soviet rouble, the Yugoslav dinar and the Czechoslovakian crown.

A hard task

This will not be an easy task, both politically and mechanically, but it is time to focus on saving Europe and not the euro. Since Ms Merkel's spectacular turnabout agreeing to a special bail-out arrangement for Spanish banks, the mood in Germany has been changing. More than 200 economists voiced their protest against the European Stability Mechanism (ESM) in an open letter addressed to the German citizens. Even the German Constitutional Court believes that enough is enough. In an unprecedented move, the judges publically requested the president of the republic to withhold his signature under the ESM. Should the court rule that further shifts of power to Brussels are subjected to a referendum or should Finland, where the opposition to further financial aid for other countries is increasing fast, decide to leave the euro, Ms Merkel might face her second 'Fukushima'.

Remember, in the aftermath of a tsunami hitting Japan and the Fukushima nuclear power plant going into meltdown, it took Ms Merkel just a few days to abandon her energy policy completely and to announce the departure from nuclear energy altogether. After the German public became terrified by angst of something similar happening in Germany and opinion polls showed support of nuclear energy dropping to unprecedented levels, she executed the fastest and most dramatic policy change in recent German history. Despite her usual European rhetoric, she did not even consult with the French, although they were severely affected by her unilateral action. If a German referendum on Europe became one on the euro instead, she may face another Fukushima. That could result in another spectacular turn of German policy, this time on the euro. That is more likely to happen than a tsunami rolling up the Rhine.

Hans-Olaf Henkel is a professor of international management at the University of Mannheim. He was president of the Federation of German Industries (BDI) from 1995 to 2000 and is a former CEO of IBM Europe, Middle East and Africa.

 

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