The Euro-Elephant in the Room

by Andrew Stuttaford

The Wall Street Journal runs an editorial today on Europe’s “phony” growth debate. The newspaper is quite right to argue in favor of a leaner state and labor market reform, and it correctly praises tax cutting and structural changes introduced by the Schroeder and Merkel governments in Germany since the late 1990s. Those were indeed both welcome and overdue. The WSJ argues that this is the example that the rest of the euro zone should follow. Oddly, however, for a newspaper that has historically been such an enthusiast for the EU’s single currency, it has nothing to say about the contribution that introduction of the euro made to Germany’s success over the last decade.

That’s strange, because it was crucial. Essentially, the switch from the euro  deutschmark to the deutschmark euro operated as a de facto devaluation of Germany’s currency both as against the outside world, and, critically, its competitors within the euro zone. That’s been great news for German industry (Germany was only recently overtaken by China as the world’s largest exporter), but it has been a disaster for a good number of euro-zone countries, doomed by the nutty one-size-fits-all logic of the single currency to restructure themselves at a pace that was neither economically realistic nor, it is becoming increasingly obvious, politically sustainable. The result has been an epic, continental-sized fail for which Germany too will pay a large chunk of the bill.

It is also worth remembering that the distortions set in motion by the euro played a large part in the speculative booms and subsequent busts that have proved so devastating for government finances in a number of today’s struggling PIIGS. These included the fact that (prior to the crash) interest rates tended to be held at levels that reflected somewhat sluggish conditions in the common currency’s Franco-German core rather than in the euro zone’s overheating periphery. Rates were kept far lower than was healthy for, say, Ireland and Spain, a fact that only inflated those countries’ real estate and construction bubbles still further.

#more#These unsuitably low rates also encouraged certain states to overspend, or in Italy’s case put off the day when it did something to reduce its huge government debt burden.

But weren’t there rules — the so called Maastricht criteria — designed to ensure that public-sector debts and deficits were kept under control within the currency union? Oh yes, there were, but they were defanged in 2005 at the insistence of various countries led by, uh, Germany.

Here’s (the inevitable) Ambrose Evans-Pritchard writing for the Daily Telegraph in 2004:

The European Commission bowed to political pressure from Paris and Berlin yesterday, proposing to replace the rigid spending rules of the Stability and Growth Pact with much laxer guidelines.

With Germany, France, Italy, Holland, Greece, Portugal all in or near breach of the pact – as well as Britain and six new member states – it had become impossible for the commission to keep up the fiction of maintaining discipline. It called for sanctions against France and Germany last year for repeated violations, but the big powers clubbed together in the Council of Ministers to let them off the hook. Mr Almunia admitted yesterday that the commission was powerless to hold the member states to account. “At the end the decisions are taken by the council,” he said.

The European Central Bank has fought hard to stop any weakening of the stability pact framework, which was first imposed by Germany to prevent heavily indebted states such as Italy reverting to inflationary deficits. While many economists have called for looser fiscal rules to allow eurozone states to support their economies through the current slowdown, the danger now is a “free-for-all” attitude that will damage monetary union in the long run.

The financial markets, already sniffing trouble, are starting to push up the interest rate spread between the bonds of the eurozone stronger and weaker economies. The banking firm Morgan Stanley warned earlier this year that this sort of divergence could ultimately pull the euro apart.

It said investors had bought eurozone bonds on the assumption that strict spending rules would prevent profligate relapses in southern Europe, only to discover that this implicit contract had been broken.

The WSJ’s editorialists can avoid the topic as much as they want, but it will not alter the fact that the root cause of the current crisis is the perversely constructed single currency that it has championed for so long. The question now is what to do about it.


Corrected to amend the transposed currencies in the second paragraph. Otherwise the sentence would be (to quote commenter DrJ) “huh”…

The Corner

The one and only.