The euro's bitter-sweet triumph at 10

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/4045210/The-euros-bitter-sweet-triumph-at-10.html

The euro's bitter-sweet triumph at 10
If the purpose of the euro is to confront US dollar hegemony and turn the European Union into a monetary superpower, it is a signal triumph. But politicians should be careful what they wish for.
By Ambrose Evans-Pritchard
01 Jan 2009

On its tenth birthday, the single currency is an unquestioned part of daily life for 330m people in sixteen states (Slovakia joins on January 1st), spreading almost as widely as Rome's denarius -- the first truly Pan-European coin.

There has been no "tissue rejection" by the public, even if Eurobarometer data shows that the euro is more accepted than loved. Shoppers blame it - unfairly -- for inflation. Half the French still think in francs. Oddly, a slew of regional currencies have begun to circulate in German regions since the launch of EMU. Sociologists are baffled.

Market eagerness to push the euro to sterling parity, and to defiant highs against the dollar, yuan, rouble, and rupee, is an undeniable stamp of confidence. But success is bitter-sweet. The eurozone itself is in deep recession. A currency surge at this juncture is a cruel blow for export industry. The full damage will hit in late 2009 as the time-lag effects work their curse.

The point of monetary union -- at least for Paris -- was to stop this happening. EMU was supposed to shield Europe against the fall-out from Anglo-Saxon "casino capitalism" and to ensure a stable currency.

Stable it is not. The Élysée never imagined that it would be a currency on steroids, spiking so high that it hollows out the French industrial core and drives Airbus to the brink. As President Nicolas Sarkozy put it in a moment of fury, "we didn't create the euro so that we could no longer build a single aircraft in Europe".

Otmar Issing, ex-High priest of the European Central Bank, says half the states of West Europe would now be facing currency storms akin to the early 1990s were it not for the fortress strength of EMU.

The yield spreads on Italian, Greek, Portuguese, Spanish, Austrian, and Irish debt would be even higher than they are already, amplifying the effects of the credit crunch and probably making it too dangerous for governments even to think of fiscal rescue plans. "People do not seem aware of this. They are now taking the advantages of the euro for granted," he said.

This is true in one sense, although the 1990s ructions stemmed from a fixed link to the D-Mark, a recipe for disaster. But such claims and counter-claims hardly touch on the deeper question of whether EMU is a viable undertaking over the long run -- or an "optimal currency area" (OCA) in economic jargon. Ten years on, the controversy rages. Both sides have enough evidence to say with equal vehemence, "I told you so". It all depends which part of the picture you look at.

Let us not forget that the euro is a revolutionary construct. Never before have sovereign states of equal weight agreed to abolish their currencies -- some dating back to the Middle Ages -- and tied their destiny to a supranational bank.

The franc -- minted in 1360 to celebrate the end of Jean Le Bon's captivity in England -- evoked France itself, and French voters were not easily persuaded to give it up. The Maastricht Treaty passed by a wafer-thin margin in September 1992. We will never know how the German people would have voted if allowed to decide on the fate of their beloved D-Mark, the symbol of national renewal.

Currency unions come and go, typically revolving around one dominant power. The euro is a different animal. It has no political anchor. It is a leap into the unknown without a state, treasury, debt union, or EU social security net to back it up.

For arch-critics at Germany's universities, the decision to press ahead with the euro before the creation of a full-fledged EU state was to put the cart before the horse. America had forged its union before issuing a currency, as had 19th century Germany.

This is the bigger question to be tested over the euro's second decade. Currency unions can mask risk for a while. They shield sinners long enough to let imbalances get out of hand, storing up trouble for a more traumatic crisis later.

Eurosceptics say this is exactly what is happening. The gap between North and South has grown ever wider as Europe's nations hold true to type, and as the ECB's one-size-fits-all policy has vastly different effects on different cultures. Italy has lost 40pc in labour cost competitiveness against Germany since the currencies were fixed in 1995, and Spain has lost about 35pc.

The reasons are complex, rooted in the wage-bargaining structures, the protected guilds, and the banking systems of countries refusing to give up their traditions. In Spain, 70pc of wages are indexed to inflation, and over 98pc of mortgages are linked to floating Euribor. Is it any wonder that Spain's property boom mushroomed out of control when the ECB held rates at 2pc (to help Germany, then in trouble)?

Latin Bloc states could have taken drastic steps to make their economies more compatible with Germany. They failed to do -- despite heroic efforts by officials, especially at the Bank of Spain -- because the political class never understood the implications of EMU. Nor did Germany's leaders, for that matter. The shining exception is Finland.

Current accounts tell the sorry tale. Germany has a surplus near 7pc of GDP, while deficits have reached 10pc in Spain and Portugal, and 14pc in Greece. Club Med extravagance can continue only as long as foreign investors are willing to plug the gaps with fresh capital. Italy's debt headache is different, but no less serious. As Europe's most indebted state, it must roll over €200bn of bonds this year in hostile markets.

It will not be easy for victims to claw back competitiveness within the constraints of monetary union. They will have to "deflate" wages relative to Northern Europe, but there lies the risk of a self-feeding debt trap.

We are shifting into the political realm in any case. Spain's unemployment has jumped from 8pc to 13pc in little over a year, and some analysts are predicting 18pc by 2010. When does civic patience snap? Nobody knows, but the ferocity of last month's riots in Greece is a warning.

As Europe's slump deepens this year we may find out if it matters whether or not the euro is a stateless currency. In dollar land, Washington disburses a fifth of GDP. A system of "fiscal transfers" automatically shifts stimulus from healthy regions to bust zones. This is how an 'OCA' self-adjusts. We may find out too whether euroland enjoys the solidarity of a nation, "all for one and one for all", when the chips are down. German body-language so far does not suggest that it does.

For now, the eurozone is basking in glory as the world's ultimate safe-haven. Icelanders are eyeing the currency longingly, and Denmark has paid a high price (two rate rises into the crisis) for its semi-detached role in the Exchange Rate Mechanism. The Poles are trying to rid themselves of the zloty as fast they can.

Berkeley Professor Barry Eichengreen says the euro is the "great winner" of this financial crisis, confounding those in the Milton Friedman camp who thought EMU would blow apart in the first bad storm. The nature of this banking drama has played -- unexpectedly -- to EMU's strengths, he argues.

Banks in European states outside EMU mostly lack a domestic currency used for international dealings, so they have borrowed in euros (and dollars). This has proved to be an Achilles Heel. "The implication is clear. National banking systems need a lender of last resort. In small countries, where a significant share of bank liabilities is in someone else's currency, the national central bank lacks this capacity. The only options are then to slap draconian controls on the banking system or join the euro area," he says.

His verdict is that every country except perhaps Britain will have to join Euroland. "The writing is on the wall", he said.

So the debate goes on. For defenders of sterling - and the Swedish and Norwegian crowns -- the precipitous slide against the euro over recent months is broadly a boon, unless you work in the travel industry, or ski a lot. It acts as a shock absorber at a crucial moment, helping to cushion the economy against debt deflation.

Export profits may hold up long enough to give a lifeline to UK manufacturing and service firms as banks shut off credit lines. It is the difference between survival and failure for thousands of healthy companies. This is what an independent currency is for. It preserved social stability in 1931 when Britain left the Gold Standard, and again in 1992 on leaving the ERM (from which the pound later roared back to a higher level, at the appropriate time).

We are too close to events to draw any definitive conclusions about the workings of EMU or the crash in sterling. There will be many twists and turns before this great debacle has played itself out across the world.

When the Chinese leader Chou-en-Lai was asked what he thought about the French Revolution, he replied "too soon to tell". To judge the euro revolution on just a decade is frivolous.