On January 1st, the euro closed a circle of 20 years. The reality is that it remains a significant threat to European integration. The eurozone muddles along from crisis to crisis and the euro is one of the most important causes for that. By pushing countries into a monetary union without having a fiscal union and an optimal currency area, the euro has contributed to the crises, has been magnifying productivity divergence, and has created imbalances, while advancing mediocre growth. The euro’s problem is fundamental: it took away the exchange rate adjustment mechanism and replaced it with nothing.
The euro was and is a political project. The problem is that in the political design of the European monetary mechanism, they forgot a crucial factor: the banks. Hence, a system of equilibrium was designed without taking into account that banks collateralize assets, inflate assets, lend against those assets, securitize assets, and participate in financial markets, especially the debt markets.
The European project is too important and the euro is too dysfunctional to accommodate it, especially when the ECB’s monolithic and myopic perspective converts the euro and the debt denominated in it into an end in itself rather than a means to an end (e.g. higher standards of living, low unemployment, financial stability, etc.). The consequences of bad design (where needed institutional support was neglected), horrible execution, and even worse management of the crises – at a time when sovereignty has been erased and substituted by sclerotic benchmarks designed by Eurocrats – not only has no end in sight, but also has been creating a black hole where everything goes in but nothing comes out. Here is an example: With the exception of 2-3 countries, no eurozone country can afford normalized interest rates. Therefore, if normal rates cannot be afforded, subsidization of rates becomes a permanent feature of the system which by default could lead to declining standards of living since debt becomes unsustainable at normal rates.
The net international investment position (asset minus liabilities) of France, Italy, Belgium and many other eurozone countries has deteriorated significantly since the inception of the euro. As for countries like Spain, Italy, and Greece their position has deteriorated (relative to their GDP) on average by about 70%. I understand the notion of Chancellor Kohl that “nations with a common currency never went to war against each other”, however, the Latin Union (of the late 19th /early 20th centuries) in Europe became so dysfunctional to the point that it was finally dissolved through a war!
We live in an age of asymmetric downturns (e.g., non-performing loans in one country and unsustainable current account deficits in another). Those asymmetric downturns require asymmetric policy responses that the euro design does not allow. At the same time the system of federal transfers is nonexistent in order to stabilize demand. In the midst of rising populism, the reforms required will be very difficult to implement. Twenty years later, the lack of deep integration inhibits the flow of capital and the result has been a loop of doom that leads to lower mobility and stagnation.
And then comes the question of all those unfunded liabilities from pensions to healthcare, let alone the debt repayments. Kicking the can down the road is a scheme that works as long as there is a road. Another crisis is inevitable for the EU. The question is if Draghi’s determination of saving the euro with “whatever it takes” will be accompanied by needed reforms so that the engine of finance will not be called upon.
The Euro at 20: Cheating Death but Still Dysfunctional
Author : John E. Charalambakis
Date : January 10, 2019
On January 1st, the euro closed a circle of 20 years. The reality is that it remains a significant threat to European integration. The eurozone muddles along from crisis to crisis and the euro is one of the most important causes for that. By pushing countries into a monetary union without having a fiscal union and an optimal currency area, the euro has contributed to the crises, has been magnifying productivity divergence, and has created imbalances, while advancing mediocre growth. The euro’s problem is fundamental: it took away the exchange rate adjustment mechanism and replaced it with nothing.
The euro was and is a political project. The problem is that in the political design of the European monetary mechanism, they forgot a crucial factor: the banks. Hence, a system of equilibrium was designed without taking into account that banks collateralize assets, inflate assets, lend against those assets, securitize assets, and participate in financial markets, especially the debt markets.
The European project is too important and the euro is too dysfunctional to accommodate it, especially when the ECB’s monolithic and myopic perspective converts the euro and the debt denominated in it into an end in itself rather than a means to an end (e.g. higher standards of living, low unemployment, financial stability, etc.). The consequences of bad design (where needed institutional support was neglected), horrible execution, and even worse management of the crises – at a time when sovereignty has been erased and substituted by sclerotic benchmarks designed by Eurocrats – not only has no end in sight, but also has been creating a black hole where everything goes in but nothing comes out. Here is an example: With the exception of 2-3 countries, no eurozone country can afford normalized interest rates. Therefore, if normal rates cannot be afforded, subsidization of rates becomes a permanent feature of the system which by default could lead to declining standards of living since debt becomes unsustainable at normal rates.
The net international investment position (asset minus liabilities) of France, Italy, Belgium and many other eurozone countries has deteriorated significantly since the inception of the euro. As for countries like Spain, Italy, and Greece their position has deteriorated (relative to their GDP) on average by about 70%. I understand the notion of Chancellor Kohl that “nations with a common currency never went to war against each other”, however, the Latin Union (of the late 19th /early 20th centuries) in Europe became so dysfunctional to the point that it was finally dissolved through a war!
We live in an age of asymmetric downturns (e.g., non-performing loans in one country and unsustainable current account deficits in another). Those asymmetric downturns require asymmetric policy responses that the euro design does not allow. At the same time the system of federal transfers is nonexistent in order to stabilize demand. In the midst of rising populism, the reforms required will be very difficult to implement. Twenty years later, the lack of deep integration inhibits the flow of capital and the result has been a loop of doom that leads to lower mobility and stagnation.
And then comes the question of all those unfunded liabilities from pensions to healthcare, let alone the debt repayments. Kicking the can down the road is a scheme that works as long as there is a road. Another crisis is inevitable for the EU. The question is if Draghi’s determination of saving the euro with “whatever it takes” will be accompanied by needed reforms so that the engine of finance will not be called upon.