Will the Euro Survive?

The Piper Must be Paid

The Euro is under considerable stress. There is now open debate about its survival. The stresses are pretty evident, and the causes plain. The euro is a federal currency; but individual European countries within the federation have been allowed to run monetary, economic, and fiscal policies virtually as they pleased. Now that about five countries, Greece being the worst, have run up huge debts to fund profligate entitlements they are turning to the European Community to bail them out (in the same way that California has turned to the US federal government to bail out its debts). This is something which the treaties and agreements surrounding the Euro explicitly forbid.

An article in Slate magazine, entitled Germany Is Tired of Paying Europe's Bills documents the palpable anger in Germany over the payout proposal.

The Germans are fed up with paying Europe's bills. They don't want to bail out the feckless Greeks with their flagrantly inaccurate official statistics; they resent being Europe's banker of last resort; they object to the universal demand that they plug the vast holes in the Greek budget deficit in the name of "European unity"; and for the first time in a long time they are saying it out loud. Not only are tabloids demanding the sale of the Acropolis, Frankfurter Allgemeine Zeitung, Germany's deeply serious paper of record, has pointed out that while the Greeks are out protesting the raising of the pension age from 61 to 63, Germany recently raised its pension age from 65 to 67: "Does that mean that the Germans should in future extend the working age from 67 to 69, so that Greeks can enjoy their retirement?'

The Euro and political treaties which undergirded it were deeply flawed from the start as a recent article in Spiegel points out.

It isn't just the culture of trickery that undermines the basis of the euro. It is also harmful that each country continues to pursue its own financial policy, lowering taxes or government spending as it pleases. As a result, a level economic playing field has not developed among the member states as hoped. In fact, they have drifted further apart.

On the one side are the EU's heavyweights, headed up by Germany. The new currency has made them more competitive, and they now produce far more than they consume. On the other side are countries like Spain and Ireland, which attracted large amounts of foreign capital, and where wages and asset prices rose rapidly. In the past, these countries' central banks would have promptly devalued the peseta or the Irish pound, thereby strengthening exports. But this safety valve has been sealed off by the common currency.

Another design flaw in the Maastricht Treaty is the no-bailout clause. Under this principle, each country must take responsibility for its own national debts. Of course, this rule has never been credible.

The current state of play is that Germany and France and others have been pressuring Greece to cut its fiscal deficit drastically. The Greek government has consequently entered an austerity programme, causing thousands to protest in the streets. It is an open question as to whether the austerity programme will survive the protests. The West hath no fury like an entitlement threatened.

If the austerity programme fails, the stronger economic nations are almost certain to step in and guarantee Greece's loans, public denials notwithstanding. The Spiegel writers claim that plans are already being made behind close doors. This is likely to generate a significant backlash in Germany's electorate. It will also mean far greater centralization of power in Brussels; nation states in Europe will become more like the United States of Europe. Either that, or the Euro will likely disintegrate.

A lot of smart money is on the latter. Large international hedge funds have been betting accordingly. Thankfully, were it to occur, it is an economic and political dislocation from which New Zealand should be fairly well insulated, although there will be some impacts to be sure. If the disintegration scenario were to play out, expect a rapid appreciation in the US dollar, and a consequent devaluation of our own currency. Global interests rates will likely rise. Global economic power will shift more rapidly to the East.

However, it is not yet clear which alternative will play out. Our inclination is to the greater centralisation scenario--since the overwhelming temper of the West is inclined in that direction. In the West, Government is god. Society will not easily tolerate the failure of its petty deities.