Time for Plan B: How the Euro Became Europe's Greatest Threat
Part 2: The Euro Is a Fair-Weather Construct
But the causes of the euro crisis are more deep-seated than that. The monetary union is a fair-weather construct, as a number of economists said from the beginning. American economist Milton Friedman, for example, predicted that the euro would not survive its first major crisis, and later, in 2002, he added: "Euroland will collapse in five to 15 years."
For these reasons, the euro crisis, as suddenly as it occurred, was expected. However, the warnings had been ignored and treated as a minor nuisance. More than anything, the euro was a political project. Its advocates, most notably then German Chancellor Helmut Kohl and then French President François Mitterrand, wanted to permanently unite the continent's core countries and embed Germany, which many neighboring countries perceived as a threat following reunification, in the European community.
Politicians hoped that as a result of the common currency, the underlying problem of the euro's design would resolve itself, namely that the member states would almost automatically settle in at the same pace of economic development.
It was a deceptive hope. In fact, it was only interest rates that converged, now that the European Central Bank (ECB) was setting uniform rates for strong and weak members alike throughout the entire economic zone. As a result, a great deal of capital flowed to Spain and Ireland, where a real estate bubble developed, while the Greeks and the Portuguese were able to live shamelessly beyond their means. They imported more than they exported and took on more new debt to pay for their consumption.
This behavior continued unabated until the financial crisis put an end to it. Suddenly money was scarce. The bubbles in Ireland and Spain burst, the economy in the euro zone collapsed, and the Greeks were forced to admit that their debts were much higher than they had ever disclosed before -- and that they had falsified their numbers from the beginning and should, in fact, never have been allowed to join the monetary union in the first place.
Has the Euro Pushed Europe Apart?
Since then, the monetary union has been on the brink of collapse. Far from growing together economically, Europe has in fact grown even further apart. As a result, the chances that the euro will survive in its current form are slimmer than ever. Politicians who ignore the laws of economics cannot go unpunished in the long run.
If national currencies still existed, countries like Greece and Portugal could resort to a proven means of reducing their lack of competitiveness. They would simply have to devalue their drachma or their escudo, and then the laws of supply and demand would see to it that the flow of commodities was diverted.
The prices of Greek and Portuguese products would go down to make them more marketable abroad. At the same time, money would be worth less in Athens or Lisbon, so that residents of those countries could afford to buy fewer imported goods. This would be beneficial for the trade balance. Exports would rise and so would the foreign currency revenues, allowing the countries to service their debts more effectively. Not the government but the markets would reduce economic imbalances.
But in a monetary union, the exchange rate is no longer available as an adjustment valve. Instead, the member countries must regain their competitiveness in different ways, namely by imposing tough austerity measures and reducing wages and prices. In a monetary union, it is up to the governments to enforce what the exchange rate would do in a system of competing currencies.
If this fails, the mountain of debt will continue to grow. In the end, a country with a large deficit has three options. First, it can declare itself insolvent and, after restructuring its debt, attempt to rebuild its economy. Second, it can also withdraw from the monetary union and reintroduce its national currency. Third, it can convince the creditor countries to keep issuing new loans, thereby providing it with permanent financing.
For more than a year now, European governments have been trying out a fourth option: muddling through.
And for just as long, politicians have been assuring the people that this approach is the alternative, and that it will end up costing taxpayers nothing at all, because the ailing countries will repay the debt, with interest and compound interest, once they've been bailed out. In fact, they argue, the whole thing is even a good business arrangement for the rescuers.
The truth is that governments and monetary watchdogs, despite all protestations to the contrary, have continually expanded their bailout programs, have built up massive risks that could significantly burden future generations and have violated both the European treaties and the iron-clad principles of the ECB.
To date, the history of the euro rescue program has not been a successful one. In fact, it is more of a history of mistakes and broken promises.
'There Will be No Budgetary Funds for Greece '
On March 1, 2010, Chancellor Merkel's spokeswoman said: "A clear no. There will be no budgetary funds for Greece." At that point, Athens was on the verge of bankruptcy, and politicians with Germany's center-right Christian Democratic Union (CDU) and pro-business Free Democratic Party (FDP) were suggesting that the country sell off a few islands.
On May 2, the euro countries and the International Monetary Fund (IMF) approved a 110 billion bailout package for the beleaguered country. Although the German portion of the loans was coming from the government-owned development bank KfW and not the budget, the federal government still served as guarantor. Every euro the Greeks do not repay will constitute a burden on the German taxpayer.
It was the first lapse, the first violation of the European treaties, which categorically rule out aid payments to needy euro countries. This so-called no-bailout clause was intended to guarantee that the monetary union didn't become a transfer union, and that the strong wouldn't have to pay for the weak. It was crucial to the acceptance of the treaty by the national parliaments; without it the German parliament, the Bundestag, would not have agreed to the monetary union.
The second lapse occurred soon afterwards. On May 9, 2010, the first euro bailout fund was launched. Although the volume of 440 billion alone made it clear that the opposite was the case, Merkel and Finance Minister Wolfgang Schäuble tried to downplay the importance of the European Financial Stability Facility (EFSF). They insisted that the fund was purely a precaution, would not be used and, most of all, was temporary.
"An extension of the current bailout funds will not happen on Germany's watch," Merkel said in Brussels on Sept. 16, 2010. This promise, too, lasted only a few months. On March 25, 2011, the leaders of the euro zone approved a new, constant crisis mechanism. Although it has a different name, the European Stability Mechanism (ESM), it will function on the basis of the same principle as its predecessor fund, the EFSF, beginning in mid-2013. The euro countries want to pry loose 700 billion for the fund, which will include a cash contribution for the first time. The Germans will be asked to pay at least 22 billion. To do so, Germany would have to take on additional debt.
'Outcome Is Very Close to a Transfer Union '
As if this weren't enough, in March the euro-zone member states also agreed that both the current bailout fund, the EFSF, and its successor, the ESM, would be authorized to buy government bonds from bankruptcy candidates with low credit ratings in the future. As a result, countries living beyond their means will no longer be punished with high interest rates, and market mechanisms will be eroded. Even the CDU's Michael Meister, one of the financial policy experts loyal to Merkel, says: "The outcome comes very close to a transfer union, which we reject."
All assurances aside, performance in return for Germany's willingness to play along would be absent again and again. Representatives of Merkel's government coalition government in Berlin have outdone each other in calling for strict penalties for countries that violate the euro-zone's deficit rules. There was talk of eliminating voting rights, of freezing EU subsidies like the bloated agriculture fund and, as a last-ditch solution, even of exclusion from the monetary union.
Most of all, however, the penalties were to be imposed automatically in the future when a country's budget deficit exceeded three percent of its gross domestic product. "We support the greatest amount of automatism possible," Merkel said in September 2010.
After taking a walk with French President Nicolas Sarkozy in the French seaside resort of Deauville, the chancellor abandoned the position that the deficit process was to be triggered automatically. Instead, the finance ministers in the euro zone must set it in motion first, meaning that any decision would be subject to the usual horsetrading in Brussels.
- Part 1: How the Euro Became Europe's Greatest Threat
- Part 2: The Euro Is a Fair-Weather Construct
- Part 3: A Clear Market Reaction
- Part 4: German Banks, Insurers Unload Greek Bonds
- Part 5: Berlin Expecting the Worst
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Euro zone members on Monday gave the green light to a permanent system to prop up ailing euro-zone economies after 2013. The new measure will take effect in mid-2013, replacing the current temporary bailout fund. The approved fund, called the Europe Stability Mechanism (ESM), will total some 500 billion ($713 billion). It was initially approved at an EU summit in March this year.
Jean-Claude Juncker, euro-group head, said the decision reflected the bloc's determination to shore up the currency's stability. The euro-bloc countries will, according to the plan, guarantee more than 620 billion and member states will pay 80 billion directly. Of that, Germany must pay almost 22 billion, payable in five annual installments of 4.3 billion starting in 2013.