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16/06/2019
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The €uro as the indispensable European building block

The European Union has 28 member countries and the €urozone counts 19 of them. Denmark, Sweden and the United Kingdom are among the most important member countries not participating in the single currency, in addition to six other new European Union members who still have to prove that they have taken measures for an ireversible progress toward a functioning free-market and competitive economy and some other requirements to build a lasting macro-economic stability. Within this continental stage, the €uro could have become the currency to consolidate the European Union, turning into a real international reserve currency if the European countries had followed in good faith the progressive course towards a stable Confederation of Nations, but the rejection by 2 of the 28 Union members of the draft Constitution previously approved by the other 26, which could have opened the way toward continental stability, served as fertilizer to the seed of discord. As anyone might expect, a common currency is unsustainable buffeted by a multitude of countries stubbornly clinging to independent monetary and fiscal policies. 

As it is highlighted in the following article, Europe is trying that the puzzle does not disassemble, but if the monetary union collapsed, the project of a United Europe will be dismantled from its own base.

Why the euro was created

by Michael Maibach

There are three reasons the euro was created. First, the euro aimed to deepen the EU single market by eliminating currency exchanges across national borders and creating transnational cost competition. Second, the currency was meant to become an alternative reserve currency to the U.S. dollar. And third, it could set the stage for a unified European superstate. Ironically, the euro has rapidly become a central cause of EU disunity.

While the euro is a single currency, the eurozone has 19 separate parliaments, heads of state, and national banks. These national banks, plus the European Central Bank (ECB), make up the Eurosystem – akin to the U.S. Federal Reserve system. As you might imagine, one airplane and 19 pilots is a formula for an economic plane crash. 

The significant challenge of one currency spanning 19 governments is that elected officials are disconnected from fiscal accountability. Additionally, the lost mission of national banks is to impose monetary discipline. The third failure here is that 19 nations have lost a vital economic tool, the appreciation or depreciation of their currency.

Currencies, by their nature, connect nations to global economic feedback and hold government leaders to account for the impact of their decisions. Nineteen EU nations have lost this vital tie to global economic forces. Today, Germany has four percent unemployment and 68 percent debt-to-GDP ratio, while Greece – using the same currency – has 22 percent unemployment and 170 percent debt-to-GDP ratio.

The creation of the euro temporarily papered over these economic disparities. The EU Stability and Growth Pact of 1997, the treaty nations sign to join the euro, requires that a nation’s budget deficit be no larger than three percent of GDP, and that the debt-to-GDP ratio to be no larger than 60 percent. Greece used false accounting in its 2001 application, and most eurozone nations no longer meet these requirements. In 1994, the 10-year interest rate on German government bonds was seven percent, while it was 24.5 percent for Greek bonds. These interest rates reflected the relative risks of buying German vs. Greek bonds. The euro was launched in 1999, and Greece became the twelfth euro member in 2002. From 2002 to 2008, there was little difference between German and Greek bond rates. But by 2011, due to the Great Recession, German government bond rates returned to 7 percent, and Greek bond rates returned to 24.5 percent. As Warren Buffett once said, “Only when the tide goes out do you discover who’s been swimming naked.” And yet despite these dramatic differences, the trading currency of both nations has the same strength, unaffected by the decisions of their leaders. And somehow, the ECB is expected to devise monetary policy advantageous to both extremes, and all 17 nations between them.

In summary, the eurozone has had the effect of undermining national fiscal accountability, monetary discipline, and the ability of 19 nations to benefit from the economic feedback of changes in the value of their currencies and what those say about their level of national competitiveness. When the Great Recession arrived, weak eurozone economies like Spain and Italy could not compete with Germany, Austria, and the Netherlands within the same currency union. By joining the euro, nations like Greece have lost internal fiscal disciplines, as well as the “release value” of currency depreciation and its competitive signals.

The question is, what is the right course going forward? President Macron would create eurobonds and a centralized Euro-fund to transfer wealth from northern to southern Europe in exchange for more centralized control over their national budgets. This would further remove those nations from market forces, the policies needed to restore their international competitiveness, and further dilute their national sovereignty by concentrating decisions in the hands of an inefficient bureaucracy. Creating more dependency is not the answer.

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