The real coins and banknotes currency
euro was born on 1 January 2002. The launch was
accompanied by high political and economic hopes,
not to forget dollops of fanfare. Led by the German
Chancellor Helmut Kohl and the French President
Francois Mitterrand, it reflected the political
belief that the time for a unified Europe had come.
What could be a better symbol of unification than a
powerful common currency? One that could
successfully challenge the post-war monopoly of the
US dollar?
The European technocrats and economists had done
their homework well. Led by outstanding civil
servants like Jacques Delors and macroeconomists
like Wim Duisenberg and Bob Mundell, the European
Commission (EC) had realised that a common currency
across vastly different geographies and economies is
easier said than done. So, they hammered out the
Maastricht Treaty in February 1992 — well before the
euro actually came into play.
The core of the Maastricht Treaty was simple. When
countries give up their right to print and manage
their individual currencies, they lose a very
critical choice parameter. Thus, they need to be
more disciplined than ever in the conduct of their
fiscal policy — particularly deficits and public
debt. The hub of Maastricht, therefore, was the
mechanics of macroeconomic convergence, which then
led to the so-called ‘stability and growth pact’ (SGP)
that any euro currency country had to strictly abide
by.
Adopted in 1997, there were six complementary
elements of the SGP. Of these, the two critical ones
were:
• No member country of the monetary union could have
an annual budget deficit higher than 3 per cent of
its GDP, which was the aggregate all public budgets,
including municipalities and regions and off-balance
sheet items.
• All member countries needed to have their national
public debt at less than 60 per cent of GDP, or
close enough and approaching that ratio.
Here lay the rub. Beautiful in theory, the success
of the SGP and, hence, the euro, depended upon
discipline and enforcement. You could hypothetically
argue that among the big four euro nations, Germany
would tend to be fiscally more disciplined. But
would that extend to Italy? Or France? Or even
Spain? If countries deviated from the SCB, who could
punish? And would it be credible, severe and
sufficient?
Even among the original 12 members of the euro in
2002 — I’m being impolitic and ignoring Monaco, the
Vatican and San Marino — deviations started before
the ink dried on the SGP. Forget about the world
after Lehman Brothers. Between 2002 and 2007, Italy
breached the public debt to GDP ratio for every year
since 2003; France from 2003 to 2007; and Germany,
still reeling under its unification costs, from 2003
to 2006.
After 2007, the story is far worse. Every country
has breached the deficit condition. For 2010,
Germany’s deficit to GDP ratio is the most
parsimonious at 3.7 per cent. Italy’s is 5 per cent.
France’s 7.8 per cent. Spain’s 9.7 per cent;
Greece’s 8.5 per cent; and for the euro zone as a
whole, it is 6.5 per cent. Worse still, after
dealing with a bleeding Greece and all the political
and economic pains that it incurred, the European
Commission deserved some peace. That was not to be.
Ireland tanked this November, leading to a bailout
of €85 billion. The money markets believe this to be
wholly inadequate. The result is a huge widening of
the spread on 10-year government bond yields between
the disciplined and frugal (German bunds) versus the
lax and profligate — Greece, Ireland, Portugal,
Spain and Belgium.
Can the euro survive? First, it requires huge
political will. Germany is not only surging ahead,
but is openly irritated by the lack of discipline
across much of Europe. It no longer wants to bail
out the euro zone, and has to be cajoled and coaxed
to open its purse strings. Moreover, in the face of
over 10 per cent unemployment across the euro zone,
and prospects of no more than 1.5 per cent GDP
growth, the bigger nations don’t want to tighten
their deficits. But want the beggars to, i.e. Greece
and now Ireland. Second, it requires understanding
that some countries may not be able to repay their
debts. Third, it needs far greater, hard-nosed
financial and fiscal discipline, including forcing
debilitating haircuts on debt-holders — never an
easy thing to do. And fourth, it requires the net
creditor countries to aid the deficit nations.
None of these is easy to comprehend, leave aside
execute. Especially in an artificial entity beset by
different cultures. The success of the euro is in
deep doubt; but its failure will be catastrophic.
That’s the uncertainty for the next few years.
Unless the euro zone’s GDP grows at over 3 per cent
per year, and prosperity takes over as of yesterday.
Ave Maria to that!
Published: Business World, December 2010