The continued uncertainty over the future of the euro is doing little to enhance the prospects of any kind of economic recovery in Europe. The single currency threatens to take not just entire countries, but global economic prospects with it into the abyss
What do experts think should be done to save the euro?
Thus far, the approach has been to lurch from one crisis to the next, with banking bailouts on a regional or even national level. Traders, meanwhile, are quick to speculate on increasingly volatile markets, creating a further threat to recovery that is as dangerous as it is unwelcome. Out of this, one thing is becoming increasingly clear: the euro cannot continue to function in its current state.
What do the experts – politicians, economists and those from the financial industry – think should be done to help the euro either work in practice or successfully evolve into a new format?
Roger Bootle, managing director, Capital Economics
The most likely and probably the most sensible way for things to break is through the departure of one or more countries. As things stand the departure of a weaker country – most likely Greece – is the most probable way. But it’s not the only way. Various people have talked about the idea of Germany leaving and that’s actually a very sensible idea. Finland leaving is a distinct possibility as it is getting increasingly frustrated, but it could end up being Spain, Italy or Portugal.
The issue then is how successful that country is outside of the euro. If it is successful, which I would expect, then I don’t think it will be possible to hold the eurozone together because the weaker members will be under enormous pressure to leave. You would then get some members remaining with a currency that might still be called the euro. Those countries would be Germany, the Netherlands, Luxembourg, Austria, Finland, probably Belgium and there’s an interesting question mark about France.
When the euro goes, the weaker and more peripheral countries of southern Europe will have a more competitive exchange rate and will stage some sort of net export-led recovery. Germany and the northern core would undoubtedly suffer from the loss of net exports and would find themselves under enormous pressure if their currencies went up to expand domestic demand, which is the healthy thing to do. What comes out of all this is a much healthier European economy.
Martin Koehring, European economist, Economist Intelligence Unit
For the European single currency to work the euro area will have to move closer to becoming an “optimum currency area”. Economic theory looks at four factors in this regard: the extent of intra-regional trade; the extent of labour mobility; the similarity of economic structures; and the degree of fiscal federalism.
First, intra-regional trade has not been significantly boosted by the introduction of the euro. Members now trade more with countries outside the eurozone than countries within it. With trade in goods already liberalised, a full implementation of the Services Directive could help boost services trade in the euro area.
Second, in practice labour is not moving as freely as it should. Differences in languages, cultures and pension systems deter many people from seeking employment in other euro area countries. Much stronger efforts will have to be made to encourage labour mobility.
Third, there are huge differences in economic structure. The German-led focus on structural reforms could help to bridge these gaps but the process will be far too long for some countries, unless Germany erodes some of its competitive advantage by boosting domestic demand.
Finally, the eurozone has to move closer to a fiscal union, allowing for fiscal transfers from prospering regions to suffering ones. The fiscal compact is a first step in that direction. But fully- fledged fiscal union will require the eurozone to obtain politically sensitive powers such as the power to raise taxes and a banking union with supranational supervision.
Douglas McWilliams, Gresham professor of commerce and chief executive at the Centre for Economics and Business research
Break-up of the euro is near inevitable. There are many ways in which this might happen, but it looks likely the process will be forced by a crisis. The Germans might pull out after the next election, as might the Finns, who now seem to be the hardest of the hardliners on refusing to bail out the southern states. Or the Greeks or Italians might revolt from austerity. If the process happens piecemeal, a return to the old currencies is likely.
The practical difficulties of breaking up the system are considerable. There will be major costs to the banking system, which will have to be bailed out from its losses as some of the new currencies devalue against the euro. These banks will probably have to be nationalised.
The extreme estimate of the impact of the end of the euro comes from the German government, which estimates a loss of 10% of GDP for Germany alone. I think this is exaggerated; my number is about 5% of GDP for Europe on average. But these figures do not take into account that there will be a basis for European countries to start to revive their economies again.
Charles Kennedy, MP and president of the European Movement UK
The eurozone must invest politically and financially in coupling economic and monetary union with fiscal and political integration. It needs to collectively guarantee the banking sector, mutualise eurozone debt and put in place a system of fiscal transfers that can assist the weaker parts of the eurozone.
This needs to take place in parallel with more pooling of sovereignty and closer co-operation when drafting budgetary and fiscal policies.
The EU budget must support growth and promote initiatives that help the EU achieve economies of scale. Investment in information and telecommunication technologies, green energy, and research and development can produce better results when co-ordinated at the European level. Investing in such areas can help the EU as a whole to regain its competitiveness at the global level.
Last but not least, all the above institutional innovations must involve EU citizens. The directly elected European parliaments must be part of the decision- making process that affects economic and fiscal policies and it must be central to greater democratic input at all levels. At the same time national parliaments must be empowered further to scrutinise common EU economic policies.
Bob Lyddon, managing director, IBoS (International Banking – One Solution)
Sorting out the euro requires a proper central bank. The eurozone national central banks should be merged into the European Central Bank, with member states as the ECB’s direct shareholders, and joint and several guarantors. Currency and bullion reserves would become directly owned and controlled by the ECB. Non-eurozone member states should drop out of the ECB structure until they join the euro.
This would give the ECB more firepower and autonomy. And it should carry out real banking: public ministries and public sector entities would hold their bank accounts at the ECB, allowing a central overview on public sector payments. To complement that move, the public sector debts of eurozone countries need to be recorded and published using a consistent methodology.
That would shore up the currency and give it a proper foundation: stability. How to create growth is another matter. It means eliminating the gap between aspiration and economic performance. For 20 years, rising public debt has supported the gap, and it is very tough to turn the tide on that habit with the French president paddling in the opposite direction entirely.
Geraint Johnes, professor of economics, Lancaster University Management School
There are two issues. The first is whether the economies that currently comprise the eurozone constitute an economically sensible currency area. There are structural issues that affect the south differently from the north, and it is likely that southern economies in Europe would have fared better had they enjoyed the flexibility afforded by their own separate currencies.
That said, moving the southern economies onto their own currencies now represents a daunting prospect and would lead to speculation against the new currency and enforced devaluation that would result in stagflation. The alternative for these countries is to tough things out within the single currency, adopting structural reforms that go well beyond short-term tinkering with budget deficits.
The second issue concerns the need to impose fiscal discipline, whether the eurozone remains as it is or not. The idea of European bonds is attractive since, by averaging out the risk attached to states with vulnerable fiscal positions with the relative security of stronger states, these would allow the high interest rates faced by southern economies to fall. But Germany is understandably sceptical, since such a solution does not deter profligacy.
The answer is to issue conditional bonds, so that states with weaker fiscal positions pay interest rate penalties if they fail to strengthen their public finances. A credible scheme of this kind should reduce interest rate spreads, thereby considerably easing the position for Italy and Spain.
Ian Stewart, chief economist, Deloitte
Europe’s plan A involves a long process of adjustment. Countries like Greece and Italy need to grind down costs, shake up their economies and curb public spending. Europe needs to create the infrastructure of a durable monetary union, especially ways of avoiding and managing banking and debt crises in weaker economies. This will be a slow and challenging process.
Many fear the alternative would be a chaotic and hugely damaging break up of the eurozone. However, it is possible to imagine a more ordered process of restructuring. There are many options, from creating two or more new currency zones to a return to a free trade zone of 17 national currencies.
What is clear is that a successful solution would need to be meticulously planned, largely under conditions of utmost secrecy, to avoid the destabilising effects of uncertainty. It would also require excellent co-ordination, execution and political assent to work. It would be a hugely demanding venture and, as with plan A, there would be no certainty of success.
There are no true historic parallels. But big currency devaluations, as would be seen in a break up of the euro, often do kickstart growth. The experience of past financial crises, such as Iceland in 2008-09, shows that, with good management and good luck, even deep financial crises can pass.
Dr Constantinos Alexiou, senior lecturer in economics, Cranfield School of Management
If there is a way to be envisaged out of this crisis, it is imperative that the ECB acts as a lender of last resort in the euro area bond market, easing off the ever-so- volatile environment dominating the bond markets across the globe.
Further steps should be taken to ensure that the uncontrollable activities of the monstrous financial edifice are closely monitored and effectively regulated. In particular, there has to be a separation between commercial and investment banking. Public investment projects should be actively pursued by means of co-operative and non-profit banking. An imposition of a financial transactions tax (a Tobin-type tax) should also be introduced to restrain the ill-driven speculative behaviour of investors.
It is of paramount importance to prevent speculation, especially against struggling economies, by swapping any remaining government bonds for jointly guaranteed euro bonds. A right policy mix of both common monetary and fiscal policies should be pursued to ensure that full employment is set as the ultimate target.
Finally, a co-ordinated European wage policy should top the policymakers’ agenda so that the current dwindling trend of the share of wages in national income is reversed, ensuring that countries with relatively lower incomes converge towards those with higher incomes.
Glenn Uniacke, senior dealer, Moneycorp
In any discussion of how to manage the euro crisis, a sensible place to start is by asking whether it is worth saving. There are, of course, advantages to the euro, albeit fewer than were promised. Price transparency has been achieved, along with the reduction of transaction costs. Yet advantages such as increasing cross-border employment have never materialised and many of the key benefits envisaged at the inception of the euro – financial market stability and macroeconomic stability – are clearly nonsense.
My roadmap to recovery is for the euro to split in two, with a stronger northern euro and weaker southern version. This retains the euro project as well as its combined institutions. Lower transaction charges are retained (two is surely better than 17) and crucially it provides an immediate credible boost to growth where it is most needed, in the struggling periphery. The southern euro could plausibly weaken off 10-15%, making its constituents immediately more competitive and able to stage an export-led recovery.
Andrew Smith, chief economist, KPMG
The financial bust has left unsupportable debt burdens and uncompetitive economies in the periphery of the eurozone. Eventually one of two impossible things will have to happen.
First, the eurozone could make a dash for full union. Aggregate government debt to GDP is around the same as for the US, which is having no trouble funding at record low bond yields, and the annual budget deficit is lower. But the stronger economies are unwilling to write a blank cheque, certainly not without both political and banking union.
Second, break up. One or more countries could decide to exit the euro and devalue to restore competitiveness. But that would compound their debt problems and widespread defaults would be unavoidable. The practical complications would be horrendous: preparations for a new currency, capital controls, recapitalisation of the banking system and rewriting of contracts would have to be conducted in secret. To prevent cross-border panic and contagion, firewalls would need to be built in advance.
Or is there a third way? Rather than austerity, the adoption of expansionary policies in the core would give the periphery a chance to adjust through growth, but only if export-led Germany, for example, was prepared to allow higher inflation to erode its own competitiveness and undermine its trade performance. That sounds like an impossibility as well.
How to give the euro a fightIng chance
- The ECB acts as a lender of last resort to both countries and banks
- National banks are merged into the ECB, which owns and controls currency and bullion reserves. Fiscal transfers are undertaken to assist the weaker parts
- Eurozone debt is mutualised and European bonds issued to average out the risk attached to states. Those with weaker fiscal positions would face interest rate penalties if they fail to strengthen their public finances
- A separation of commercial and investment banking should be imposed along with a financial transactions tax to deter speculation against struggling economies
- Closer economic union is accompanied by moves towards greater social and political union, with a European parliament having the power to raise taxes and supervise the banking system, and barriers to labour mobility eased
- More prosperous nations that have benefited from greater exporting power allow higher inflation to erode their own strength and enable struggling nations to grow their way out of trouble
And how to successfully manage a transition
- An ordered and highly secret operation is put in place to oversee a restructuring of the euro, with the aim of creating a number of currencies or a looser free-trade zone
- Alternatively, a number of weaker countries leave the euro, either reverting to national currencies or to a “euro lite” currency. This is likely to divide along north/south lines
- Countries leaving the euro can devalue their new currencies to go on and stage an export-led recovery
- Remaining members of the euro suffer from a fall in exports and focus on building domestic demand
- Governments face up to the possibility of more banks needing to be nationalised
PDF of ‘Future of the Euro’ article’, Economia, October 2012