When EMU dissolves, real political capacity retrieves

Tthe dissolution of  the EMU is not the end of EU – quite the contrary. If that recognition is understood, some necessary changes of the currency system might bring a kind of euro-realism into the collaboration of the EU. 

Probably, before long Germany is tired of supporting the shaky southern European economies. EMU will, like all previous currency unions in history, be dissolved. It looks like a tragedy, which it is not in the hands of the ECB to change; but in reality it could be changed into an opportunity – a new beginning of a more realistic and workable EU. For once the European politicians have become accustomed to a post-EMU era, they might be able to use the new reality constructively.

The 15th August 2011 it was forty years since US President Richard Nixon pulled the dollar out of the then international monetary cooperation – the so-called Bretton Woods system. The decision apparently came as a lightning from a clear sky. This event is mentioned in history books as nothing less than the Nixon-shock[1].Policy-makers in Europe acted as if they were totally unprepared. In many ways it became a psychological shock similar to the one that hit the world economy, when the United Kingdom left the gold standard in 1931 and thus broke with the contemporary currency system with fixed rates. The question is whether there are quite a number of striking parallels from 70/40 years ago and the actual situation, where the European Monetary Union is in the middle of the dissolving process. And we could prepare ourselves for an EMU-shock by looking at history.

This should be done notwithstanding that it is a frequently used phrase that ' history is not repeated ', but similarities are striking. In any case, I have my theoretical doubts when it comes to the existence of exchange rate systems based on the idea of fixed and unchanging exchange rates. History has told us that the fixed exchange rates between sovereign States don't last one day longer, than there is the political will to pay the economic and social costs associated with such a monetary/currency system. This also applies to a monetary union, regardless of whether there is in practice used a common currency or not.

Politically, it is still just a fixed exchange rate system, which can be changed with few days’ notice. In this EMU perspective the Nixon-shock from 40 years ago is chillingly topical. A number of EMU countries reeling on the edge of an economic and social collapse, a Germany that in many ways has a role in EMU system which the United States had in the Bretton Woods system. It is the German taxpayers, who in the end will have to pay the biggest part of the bill, which the EU writes out in an attempt to keep the southern European countries from a State bankruptcy. This bill will grow year by year as imbalances are growing and more countries will need aid packages.
Until 40 years ago the United States and the dollar were guarantor for the post-war currency system functioning. There was a permanent and unbreakable (thought most people) exchange rate relationship between the dollar and gold. But the dollar came increasingly under pressure, as the participating countries in the Bretton Woods system actually changed their dollars for gold. It became too expensive for the United States, so the 15th August 1971 Nixon said stop. From that day, the dollar was no longer exchangeable with gold. The dollar's value was made floating, freed from the gold anchor. From the day the dollar exchange rate was determined by supply and demand in the international currency markets. There was from the day no longer something that could be called the dollar exchange standard.

This decision came as a shock to most European politicians, for until the 15th August had Americans, of course, denied that such a thing at all could be considered. But, seemingly it could and one of the post-war international pillars broke as a stick. Then, the Europeans had to fend for themselves without direct support from the dollar. This created considerable problems in Europe. After a somewhat tumultuous Aryan period with lots of currency crises, the idea of a single European currency got momentum. It was argued that a single currency would make it impossible to speculate against national currencies, if they ceased to exist – such was the political argument, which several economists supported, see for instance, the Delors-report of 1989.

History does not repeat itself

 Now, we could wish that the politicians (and economists) had learned from history. [3] For no fixed exchange rate system between sovereign states has so far been able to survive – even if the national currencies, like the case of the euro, was replaced by a common currency. EMU is a reality today, as the Bretton Woods system were 40 years ago. The parallels are striking. All politicians deny with one mouth, that it can happen that the EMU is dissolved and replaced by a less rigid and less ambitious European currency cooperation. But it cannot be denied that Germany in many ways have the same position within the EMU, which the United States had 40 years ago. The only fundamental difference is the psychological, which lies in the fact that 17 countries in practice have substituted the name of the currency from 'D-mark ' into ‘euro’.

The German problem consists in that it has become too expensive to make cheap loans available to all deficit countries. On the other hand the uncertainty with regard to the future of the EMU has become a cost for all the participating countries. A German exporter will today be hesitant to accept payments in euro issued by a Greek, Portuguese, Spanish and Italian bank, simply because the uncertainty is increasing nearly day by day. Admittedly, the southern European banks are supported by their respective Governments; but these Governments is now due to their own debt problems so rickety that they cannot provide national banks the aid necessary in order to eliminate the difference between, inter alia, a Greek bank-euro and a German bank-euro.

This means that a ' euro ' is no longer a ' euro '-the quality depends on what country and what bank, which stands as a guarantor of issue. This difference of quality is hardly realized when a tourist go into a EMU-bank to get some euro-banknotes, because they are still the same. On the other hand, there is a growing difference of having a bank account in a Greek bank and in a German bank. Safety behind the euro-deposits in a Greek bank is simply inferior to safety behind the deposits in a German bank.

ECB has become a weak link

At least a great threat to the entire EMU design lies in The European Central Bank (ECB) activities. It has pumped hundreds of billions of euros to private banks in distress. These banks have so far been allowed to borrow unlimited at the ECB, at a very low interest, and should only provide collateral in the kind of government bonds. This, however, were not sufficient to prevent the continuous increase in interest rates on the southern European government bonds. The ECB will now seek to remedy this rise in the interest through direct purchases in the market of needy Government bonds. This opens up a very high risk activity; for the ECB is at the core of the EMU system and its future activities will be challenged by the financial markets. In the coming weeks and months, speculators will test whether the ECB has sufficient strength to prevent a continuing rise in interest rates. The situation is becoming quite similar to the currency crisis in 1992, when the Bank of England eventually had to throw in the towel and leave the European Monetary System.

The question therefore frequently is asked, for how long the European Central bank (ECB) will give Greek (or other southern European) banks euro-loan with collateral in Government bonds or directly buy these very devaluated bonds in the market. If these States go bankrupt, then the ECB is insolvent with huge inventory of highly insecure Government bonds. This scenario of threaten solvency of the ECB is scary. It may therefore rather be that in the nearer future the ECB closes the credit facility and executes the decision, which the politicians postpone, of excluding the southern European countries from the EMU. This will happen the day ECB directors announce that some of the EMU-countries’ banks no longer can borrow at the ECB, because it is under siege by the financial markets. In that case the decision by the ECB is a kind of self-defence to protect what is left of the EMU system’s credibility.

An EMU-shock could be a part of the solution

The EMU-shock will hit European economy on the day on which either the ECB or the German Chancellor says stop – and closes the credit window to the indebted countries' banks and stop buying Governments bonds in the market. In this situation, it is extremely important to recall the history of 40 years ago: in that case the world economy was in fact NOT stalled by Nixon pulling the dollar out of the international monetary system. The European economy does not have to grind to a halt if the Germans (perhaps along with the other northern European countries of EMU) drag their currency out of EMU cooperation.

Trade has to go on across national borders financed one way or another; practical men (and bankers) will find a number of needed solutions although the surroundings will be turbulent. The Financial Times-editor Martin Wolf was, at least, not in doubt at a conference in Copenhagen in May 2011, where he as a matter of historical fact noted ' there will always be an out-come of a financial crisis – it is only money'. He spoke from experience of Britain having a national debt through out the last 200 years of on average 150 percent of GDP and two dramatic exits from, respectively the Gold Standard in 1931 and the European Monetary System in 1992.

When the shock has subsided, and confusion has settled there will appear out of the chaotic conditions a number of national euro-currencies – not one but several with different national prefix[4]. In that case there will be traded Greek, Spanish, Italian and perhaps also French euro’s on international currency markets and presumably one North European euro will be left. This is a pragmatic solution to a very acute financial problem. Then there will be some weak euro’s perhaps fluctuation within a newly defined EMS with a wide band of say +/- 15 percent, as we knew before the EMU was established.

Some European economies will continue to fight with a large national debt. Here, a key issue is the future value of the government debt – i.e. whether this debt will follow the value of the national euro currencies or the value of the North European euro. Regardless of the answer to this question, the individual countries would regain an extra degree of freedom in economic policy, when the value of national currency can reflect the country's productivity and competitiveness, which is a fundamental prerequisite in order to be able to initiate a restructuring of the economy.

This monetary conversion process within Emu will not of course be easy to implement – and will be experienced as a political defeat for Emu’s fathers. But it doesn't have to mean that European cooperation will collapse in other areas. On the contrary, if only it could be acknowledged that the EMU has been created on false arguments of convergence within Europe. It is not a matter of changing minor inconsistencies within the existing system; but a recognition that the EU consists of economic very uneven sovereign countries.

In that respect the story from 40 years can be useful to achieve this insight that the dissolution of (parts of) the EMU is not the end of EU – quite the contrary. If that recognition is understood, some necessary changes of the currency system might bring a kind of euro-realism into the collaboration of the EU. Of course, a number of European politicians need some time to get familiar with such a post-EMU era; but once it has happened, then national politicians, as well as EU Commission could much better concentrate on the real problems of the EU: to create jobs for the 25 million. unemployed people and to initiate transition into a post-carbon development of a sustainable economy. Challenges which have been set on stand-by until the EMU-crisis was solved – in practice, postponed into an unknown future, because the EU-system has paralysed itself by the much premature monetary union.

The lesson could be learned that history does not repeat itself; but sometimes similarities are striking.  

[1] The Nixon Shock was a series of economic measures taken by Richard Nixon U.S. President in 1971 including unilaterally cancelling the direct convertibility of the United States dollars two gold that essentially ended the the Bretton Woods system of existing international financial exchange . (http://en.wikipedia.org/wiki/Nixon_Shock)
[2] Committee on the Study of Economic and Monetary Union (1989) Report on Economic and Monetary Union in the European Community, Luxembourg: Office for Official Publications of the European Communities (the Delors report)
[3] Here it should be shown Justice noted that professor Christen Sorensen was one of the few Danish economists who at an early stage pointed out these in fixed exchange rate systems inherent problems when it includes sovereign States: Denmark-State in Europe? Copenhagen: Forward, 1992
[4] The pending establishment of the EMU currencies existing in the form of a French, a Belgian and a Swiss frank was just testimony to the defunct roman monetary union (1865-1927), where also Italy and Greece was member. The Danish, Swedish and Norwegian krone has also concluded in a monetary union, 1875-1914. The phenomenon of dissolution of monetary unions is not unknown from modern history (the Soviet Union, Yugoslavia, UK and Ireland, Czechoslovakia and many more).

Jesper Jespersen

Jesper Jespersen is professor of economics at Roskilde University.(jesperj@ruc.dk).
Member of the EMU committee appointed by the Council for European policy,2000, He has contributed at several Parliamentary hearings on EMU respectively in Januar 2009 and Februar 2012. Together with Dr. Bruno Amoroso published L’Europa oltre l’Euro, by RX-CastelVecchi, Roma, Settembre 2012, info@castelvecchieditore.com