Will the Euro survive?

Feb. 27, 2009 - PRLog -- This week saw the launch of David Marsh’s book on the history of the Euro. It makes a timely opportunity to review the currency’s progress, and to explore its role in the Credit Crunch.

In the UK much of the debate has been about whether the Euro will survive, with some of those hostile to UK membership extending their argument to suggest the Euro is too artificial a construct, a currency in search of a country. They have pointed to the lack of convergence of several of the Euroland economies with the German core of the system, forecasting the break up or at least the shrinking of the numbers of participants in the scheme.

As someone who has always been against UK membership of the Euro for a variety of economic and political reasons, I have never shared a wish to disparage the new currency, nor to exaggerate the forces that may seem to pull it apart. I have always wanted success for the new currency of the UK’s neighbours, and felt that the absence of UK membership would assist its chances, as the UK economy is divergent from the Franco-German one.  In this column as an independent commentator and analyst of the scene I am neutral over the political calls anyway.

It is important to understand that the Euro is essentially a political project. As David Marsh makes clear, its origins are deep in Franco-German history, with both sides seeing a common currency as an important part of political union between them to make future conflicts impossible. To the Germans it was the ultimate gift to France to let them have the excellence of the Bundesbank transferred to a wider area. To the French it was a way of trying to have influence over the German economy. It developed from that to a wish to create a common currency area throughout much of the continent, as part of the longer term aspiration of a united Europe.  If the economics get in the way, ways have to be found to get round the economics.

Until recently it was unthinkable on the continent that the currency might be under severe pressure or fall apart. It was fortunate that the countries which most diverged from the centre, Greece, Spain, Portugal and Ireland, in the early days benefitted from lower interest rates than they needed, and from faster growth than they might otherwise have achieved.  It was fortunate too that the economies that diverged most tended to be the smaller and more peripheral ones. The central core of France, Germany, the Low Countries and Austria had largely converged and anchored the system. Everyone knew there was huge political support for its maintenance, and an optimism abounded that a few years of some tensions and economic differences there would soon be a more harmonious converged whole.

Today I detect continued strong political will power to keep the currency together and deal with the tensions.  However, the Credit Crunch is now testing the mettle of the system, just as it is testing others.  In one sense it is increasing the determination of the founders to keep the Euro.  They see solidarity and strength in size.  At the gates of Euroland there are suddenly small countries being badly buffeted by their own policies and world events, wanting to join to gain the protection of the large grouping and the transfer of responsibility for maintaining a currency.

In another way the Credit Crunch is posing problems for the world of the Euro before its creators wanted to make some big decisions. There are two obvious signs of tension over support for banks, and the amount of debt a country can be allowed to run up in the common currency.

Austria, and to some extent Germany, has extended substantial credit to Eastern Europe (€230bn, equal to 70% of Austria’s GDP).   People are discussing whether the West needs to bail out the East, and if any of the liability is a pan-Euroland liability rather than the responsibility of the individual member states to support their own banks. In Austria’s case this could prove expensive.

Countries like Italy, Greece and Spain have larger public debts growing at fast rates. Should they continue to borrow at low rates suitable for Euroland as a whole?  Is this free-riding on the backs of the more prudent states?   As markets gradually increase the cost for the less well managed economies, are they being unfair in penalising what remain Euro sovereign debts, or are they not adjusting enough in case the country leaves the area?

The Germans are considering making payments or loans available to the harder-pressed states.  The relatively high level of the Euro reached during 2008 is making it more difficult for the high borrowing weaker economies to adjust, worsening their balance of payments.  There is a case to say that if you wish to have a flourishing single currency there has to be a mechanism to shift substantial funds from the more successful to less successful regions of the wider area.  There also becomes a case for a larger central budget, with tax raising powers at the Union level.

The EU has been keen to delay making such fundamental changes, knowing there would  be substantial public opposition in some parts of the EU to this, and knowing that it is not just the UK government that would oppose such a centralised vision. The EU will be hoping that it can use the crisis to increase the powers of the centre somewhat, but get by without large transfers of cash to the weaker places. The pressure in on countries like Italy to cut their costs drastically to live with the relatively high Euro from their point of view. After all, Germany may argue, that was what Germany had to do at the start of the scheme.

My cautious conclusion is that the Euro will survive this testing crisis, with all or most of its members intact.   There will be strong pressures on the high spenders and borrowers to rein back.   There will be periodic bouts of Euro weakness when markets worry about how feasible all this is.   At base it remains a political project.   Its creators will not necessarily be averse to strengthening the centre if that is what is takes to get through the crisis.

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