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Double or nothing: the euro solution

Published in Business Spectator (Melbourne), 11 April 2013

In early March, we were worried about Italy after the Italians had elected a parliament with no clear majorities. In late March, we got concerned about Cyprus because the European Union’s misguided crisis management undermined confidence in the safety of bank deposits across the eurozone.

Now, in early April, we have to be nervous about Portugal as the country’s Constitutional Court declared large parts of the government’s 2013 budget unconstitutional. We also have to be anxious about France as President François Hollande’s administration, mired in political scandals, proves unable to implement any meaningful reforms.

If that’s not enough to rob you of your sleep, you may wonder whether Malta may be one of the next victims of the eurozone. Former Deutsche Bank chief economist Thomas Mayer just pointed out that the Maltese banking sector was even larger relative to the size of the economy than the financial sector of Cyprus, and Malta ran substantial trade, current account and budget deficits. Admittedly, Malta is even smaller than Cyprus. But lack of size has never stopped the Europeans from causing a major policy disaster.

So is Malta the next Cyprus? Is Italy the next Greece? Is France the next Portugal? Or was it all the other way around?

Looking across the eurozone, you do not need to be a doomster to be pessimistic about its economic and political prospects. Being a realist is entirely sufficient to feel gloomy. Three years of bungled crisis management, of explicit and covert bailouts, and of imposed austerity budgets to enforce ‘internal devaluation’ have not managed to end the euro crisis.

The only thing that has slowed down somewhat is acute market panic over Europe – if only because we have all become used to a constant flow of bad news from Europe. Europe’s crisis is the new normal, and everybody seems to be accepting it. At least, European policymakers do by proclaiming current policies to be “without alternative”.

How hopelessly stubborn and arrogant Europe’s ruling elite have become was demonstrated nicely in the European Commission’s media release following the Portuguese court’s decision. The court had explained why Portugal’s austerity budget, imposed by the EU-ECB-IMF troika, was incompatible with the Portuguese constitution. ‘Never mind’, was the EU Commission’s answer:

“The Commission reiterates that a strong consensus around the program will contribute to its successful implementation. In this respect, it is essential that Portugal’s key political institutions are united in their support.”

In other, less diplomatic words, the Commission reminded the Portuguese government to ensure that judges must be brought into line so they can no longer interfere with fiscal policy. This reveals a questionable understanding of the separation of powers and national sovereignty. It also shows how unwilling Brussels is to listen to legitimate concerns of its member states and their populations.

If something seems to be without alternative, it usually only demonstrates that you have not thought hard enough. In fact, there is an alternative to spending the foreseeable future in a vicious policy circle. There is an alternative to spending endless time and money on saving Europe’s common currency from collapsing.

The alternative is not to have a common currency.

It was a mistake to introduce the euro before Europe was ready for it. Even some of the euro’s most ardent supporters now admit that. But it is an even sillier mistake to pretend that this badly designed monetary union must now be defended at all cost. It would be far better for the Europeans to cut their losses and give up on the euro.

If Europe just continued its current policies, the result would be disastrous for everyone involved. Forcing the crisis country to continue devaluing internally by cutting wages, pensions and prices would increase their already high unemployment rates. It would condemn their young generations to misery, destabilise their political systems – and there is no guarantee that this recipe would actually turn their economic fortunes around and ultimately make their products competitive internationally. Meanwhile, for those countries underwriting the bailout guarantees, their financial commitments will soon exceed their ability, let alone their willingness to pay for their neighbours.

Of course, any exit path from monetary union is painful. But at least there is hope that once Europe’s countries return to currencies suited to their respective economies they would be able to generate growth and employment. A breakup of the eurozone would also help to deal with the persistent trade imbalances in Europe. It would help crisis countries to export more and make the others, most notably Germany, to import more.

Previously, such equilibrations happened by adjustments in the exchange rates of Europe’s many currencies. The euro crisis does not leave any doubt that such a mechanism of exchange rate flexibility between European countries is still badly needed.

The end of the euro could happen by a return to national currencies. For political reasons, this is highly unlikely to happen. Europe’s political leaders would lose face if, after decades of propagating the benefits of monetary union, they would allow a new monetary diversity of Europe – as desirable as it may be.

As a second-best solution, the eurozone may be split into two parts: A weaker currency for the struggling periphery and a stronger one for a bloc of countries led by Germany. This is not a new division of Europe because this division is already visible in Europe today. Europe is clearly divided between euro core and euro crisis countries. Splitting the euro into two currencies, a move long suggested by former chairman of Federation of German Industry, Hans-Olaf Henkel, would only acknowledge an economic and political reality.

It is high time for the Europeans to make a choice. Do they prefer a painful end to euro, or do they want endless euro pain?

If they are happy to move from one crisis symptom to the next – yesterday Greece and Portugal, today Spain and Cyprus, tomorrow maybe Italy, France and not to forget Malta – then they should keep the euro. If they ever want to return to more normal economic circumstances, they should seriously explore ways to end the disastrous euro experiment.

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