The euro’s failed experiment.
Policy making under the euro has failed because balancing the needs of stronger economies with weaker ones has been an impossible task.
David Brown From the South China Morning Post of 7 April 2014.
The euro-zone experiment is over. European Monetary Union should have carved out a brave new world for Europe. But it has all gone horribly wrong.
The fault lines have been in evidence for years. It is just a matter of time before the cracks turn into deeper fissures and weaker nations fall over the edge and crash out of the single currency. The writing is on the wall for EMU and the euro. It could happen within the next two years.
Critically, EMU has failed to deliver on the promised land of sustainable growth and job creation. The recovery is flagging and deflation threatens. Unemployment has soared to 12 per cent. Many weaker euro-zone nations remain saddled with crippling debts with little chance of repaying them. Euro zone policymakers remain paralysed with fear about what to do next.
Policy-making under the euro has failed spectacularly. The root cause has always been managing the euro zone’s economic diversity. Two-tiered Europe has never worked under the euro. The one-size-fits-all European Central Bank monetary policy that supposedly works for the euro zone’s 18 separate business cycles has been a complete myth.
Trying to balance the policy needs of Germany, Finland and the Netherlands on one side of EMU with Greece, Cyprus and Portugal at the other extreme has been an impossible task.
ECB thinking has always been dominated by Germany’s inflation-obsessed Bundesbank, with the needs of weaker euro-zone nations taking a poor second place. Hopes for a change had risen with the arrival of Italian Mario Draghi at the ECB’s helm.
But inertia to change still dominates. Last week’s ECB policy meeting failed to deliver the vital breakthrough expected for the next tranche of monetary stimulus. Policy was left on hold.
A shift to negative interest rates, the introduction of quantitative easing and the need for a weaker euro had all been hinted at. Critically, with deflation fears deepening, even Germany seemed to have thrown its hat into the ring for easing.
The ECB’s reluctance to adopt these radical new steps is because it knows they will cause even more economic distortions. Negative interest rates, QE and a weaker euro will be biased in favour of strong economies like Germany at the expense of the weaker ones like Italy and Spain.
German banks will be in a stronger market position to lend easy QE money to borrowers, boosting domestic growth. On the external front, German exporters have a strong competitive edge. A weaker euro will boost that export advantage even more.
The gravitational pull of Germany’s success means capital and resources will continue to be drawn towards the euro zone’s epicentre and away from the beleaguered southern countries.
A fully functioning fiscal union is now needed to bridge the gap. Resources from the wealthier northern nations need to be marshalled into helping development in the weaker euro-zone economies. In other words, channelling transfer payments to southern Europe, financed by higher taxes in Germany.
This would be complete anathema for the average German voter and Chancellor Dr Angela Merkel knows it. Germany has been prepared to lend just enough bail-out cash to keep the euro zone afloat, but no more. Agreeing to euro zone fiscal union is a political non-starter for Germany.
As long as national prejudices and self-interest persist in the euro zone, fuller economic integration is doomed to failure.
Countries will do what they can to survive. Some euro-zone economies are already looking to take the easy way out on budget reform and deficit reduction.
France is looking to ditch its austerity targets thanks to slower growth. Political pressures are mounting on the government to ease up on deficit cutting. Voter dissatisfaction is playing a strong part in the U-turn. Stronger growth and job creation are the new imperatives.
Italy remains on the brink, weighed down by a yawning budget deficit and mountainous public sector debt. There is no mandate for getting Italian public finances and the economy back on track.
Five euro zone nations – Greece, Ireland, Portugal, Spain and Cyprus – almost went to the wall during the contagion crisis. They were only spared financial Armageddon thanks to massive government rescues. The cost of paying these bail-outs back over the future is huge. Tax-payers in these countries will face tough austerity for decades.
The danger is that popular dissent is starting to fill the vacuum. Anti-austerity opposition parties are tapping into rising voter anger, especially in countries like Greece and Italy where unemployment is high.
There is an alternative. Countries can always junk the euro and leave EMU. As the groundswell of anti-austerity and euro scepticism builds to critical levels, the risks of a euro exit will escalate. The economic rationale would be irresistible. Economies would be free to exploit a full armoury of reflation tools.
The conjunct of easy money, easy fiscal policy and an easy currency could revitalise recovery prospects at a stroke. These policies have lifted the US and Britain into strong recoveries. They would work equally well for any country exiting the euro. If Europe has had enough of austerity it is time to bid the euro farewell.
David Brown is the chief executive of New View Economic