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Damned Either Way

Omkar Goswami


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


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