The fundamental problem within the European Monetary Union is that member-countries have different preferences with regard to growth, employment and inflation. EMU cannot proceed on its current course: Alternatives are possible possible.
The European economic crises lasting for more than two years has made it clear that the European Monetary Union (EMU) is not flawless. In fact, there is an increasing feeling of uneasiness that a disaster is looming somewhere in the future. We know that social sciences are not predictive, that history does not repeat itself. But having said that, we cannot free ourselves from the number of parallels, that we see between the optimistically political atmosphere, which surrounded the launch of the euro 10 years ago and the launch of the ‘unsinkable’ transatlantic ship Titanic 100 years ago. It is scaring to think of the denials, at that time, of any risk related to the voyage of Titanic and the similar lack of acknowledgment of the risks related to the Euro.
Although the EMU has a number a build-in weaknesses the order of the captain is to go full speed forward. Prominent passengers are dancing in the ball-room as though nothing really dramatic is happening. We see a dancing couple of Angela Merkel and Nicolas Sarkozy taking the leading position in a classical waltz with other heads of euro-states following closely suit and with special invited bankers applauding. On-board safeties and the speed of the engines are entrusted to the captain Mario Draghi, a former Goldman-Sachs employee. The luxus-liner, now called ‘ Euro’, is said to be invincible and nobody dare associates it to the destiny of the other proclaimed invincible construction, which sank tragically. Any talk about a monetary disaster is considered, in the ball-room, as disgraceful and inappropriate. The turbulence of the chandelier makes some of the dancing couples nervous; but any problem related to the functioning of the ship is denied. Of course, a quick glance through the window would tell a story of an arctic sea filled with icebergs. Hence, the risk of a collision could quickly be a dramatic reality; but like the fairytale of the new clothes of the Emperor no one dared to tell the truth until it had become too late.
The observations made by the crew and recorded by the navigation instruments should have caused concern. The economic data of the EU-zone countries showed for a long period that the macroeconomic machinery was not working the way the euro-economists had said it would work inside a monetary union. Growth was lacking behind compared with countries outside the EMU. The main reason for this is a rift within the Euro-zone between the countries of northern Europe and those of southern Europe with France somewhere in between. The Euro-zone is falling apart due to the German neo-mercantilist export-led model based on wage cuts and internal market constraints. This very unilateral policy creates tensions within the Euro-zone – the weaker countries are becoming more and more indebted towards German and French banks and other euro-countries with a substantial balance of trade surplus. This dispersion is growing larger and larger, year by year – there is no mechanism within the EMU construction which can stop the disastrous course towards mounting debt in Southern Europe.
The balance of payments figures have for years reflected and confirmed an unequal distribution of these trends among the euro-zone countries. The growing balance of payments deficit has become a widespread problem in Southern Europe and is becoming a problem of particular weight and concern within a common currency area. In fact, the weakening of the export industries in Greece, Spain and Portugal has caused a “vicious circle” to develop. We see in these countries growing unemployment followed closely by decreasing tax revenues, increasing budget deficit mounting public debt and rising rate of interest.
However, the orchestra goes on playing undisturbed and with a few minor corrections to the rules of the games the ball goes on. But underneath the deck one can see that the ship is already leaking, and the crew activates the pumps and asks the question: Is the European flagship ‘Euro’ truly unsinkable? Are the proposals put forward by the EU-commission really sufficient to avoid a collision with an iceberg? And if this not possible, what to do to make the captain understand?
Originally, there were hypothetical questions on the advantages and disadvantages for the passengers of embarking on this new and untested ship. To step on board would give some immediate advantages: reduces transaction costs, removed uncertainty related to nominal exchange rates turbulence and a German rate of interest. But euro-zone countries have to give up some of their macroeconomic instruments; and the government had to give up its privileged right to print money. In case of a financial crisis within the EMU governments of a deficit country could risk to suspend payments of wages to civil servants and old age pensions because of lack of money. A member country could be denied euro-liquidity and be forced to go bankrupt, if it will not accept the conditions set by IMF and other euro-member states. This lack of access to euro-liquidity would also prevent deficit countries from kick-starting a renewed growth process.
The fundamental problem within the EMU is that member-countries have different preferences with regard to growth, employment and inflation. Governments of the relatively poor eastern and southern European countries consider economic growth as the most important goal in order to increase employment and real income. Germany and a number of other northern European countries have another preference. They give highest priority to price stability, where growth seems to be less important. The leading couple in the ball-room has no doubt. They proclaim that the other euro-zone countries should just do what Germany did for many years: wage restraint and public sector discipline.
It is not discussed that the balance of payments imbalances are the underlying cause of EMU difficulties. The focus is entirely on the public sector deficits and debt. No one seems to pay attention to the fact, that public sector cuts are a secure recipe for increased unemployment and further fall of GDP, which reinforces the “vicious circle” set in motion by the weakening of the competitive position of private enterprise. Hence, the course is set for rising unemployment in Southern Europe followed by a reduction in tax revenue, persistent balance of payments deficit, increased indebtedness to foreign banks, weakening of the financial sector with an unsustainable increase in long term interest rates. An interest rate at a level higher than the rates of real economic growth is known as the ‘interest trap’ that at the end pushes the economy toward the financial collapse. These phenomena are not inevitable or unavoidable outcomes of the actual economic crises but due to the lack of understanding that a single currency for countries with such different aspirations is premature. The leading politician should realize that they do not want to dance following the same rhythm. The southern countries want to go for a quick-step rather than the classic waltz. They have to leave the ball-room, if they want to change the course in direction of their preferred priorities by re-starting the growth engines, re-establish the international competitive positions and quickly re-balance the balance of payments.
On the other hand, it is not yet too late to change the course of the entire EMU. In fact, there is a possible way out of the crisis. By now it is clear, for many people outside the ball-room, that the single currency has become a problem, rather than a solution. Germany and its associated countries have a 30 percentage competitive advantage in terms of costs which give a dominate position for German manufactures at the expense of the countries of southern Europe. The Northern economic hegemony is possible because the Southern countries are chained by the single currency and therefore unable to improve the competitiveness of private enterprises at the foreign markets. Sothern Europe is caught in a trap of high unemployment and continued rising foreign and public debt, which cannot be broken – like Great Britain, Sweden, and Poland did by lowering the exchange rate. The paradox is that the countries that generate this imbalance in the European economic system (Germany), by exporting unemployment and deficit to other countries, is threatening the weaker countries with expulsion from the ‘ball-room’, if they do not start to behave like the Germans and accept draconic budget cuts.
Does it in the middle of a deep recession make any sense to implement this “German model” in other euro-countries, as demanded by Merkel and applauded by Sarkozy? Is it really a right policy to pursue the classical dogma of a balanced budget in all euro-countries before 2015 in an attempt to ‘save the euro’? Balancing the budget could be a rather easy task for Germany, Netherland and Austria, where unemployment is falling; but what about those countries where the competitive position is deteriorated to such an extent that unemployment is rising month by month, tax revenues are shrinking, balance of payments heavily in deficit? As we know from the national accounting system – a surplus of one country will always be matched by a deficit of an exactly equal size by one (or more) countries. Hence, as long as Germany pursue its neo-mercantilist policy of running huge balance of payments surpluses – the matching deficit countries have no chance to break the vicious cycle of increasing indebtedness, higher rates of interest and low (if any) growth. A change of this situation requires cooperation by all participating countries – especially the surplus countries. As long as Germany denies that such a shared responsibility should be a part of the plan to ‘save the euro’ – it is difficult to see how an economic catastrophe in the coming years can be avoided.
Are there alternatives to the Merkel-Sarkozy finance pact in this situation? Yes, fortunately it is not too late to change the course. Many constructive plans have been submitted from academics and politicians outside the inner cycle of ball-room. The preferred one is a cooperative solution building on European solidarity. This model requires that countries with balance of payments surplus should increase their domestic consumption and make their wage policy less restrictive. Furthermore, surplus countries should share a proportion of the risk related to financing the debt owned by the deficit countries. This process of joined risk taking could be organized by issuing Eurobonds with a shared EU-collateral for, say, 60 percent of the total public debt of any member country. Finally, the strongly needed restarted growth process could be kicked off by a European ‘Marshall Plan’ where surplus-countries pay, say, 10 percent of their foreign wealth into a European Clearing Bank with the specific purpose that these money should be used for projects which would improve deficit countries competitiveness.
On the other hand if heads of states, while waltzing in the ballroom, cannot agree on a changed course following the ideas of cooperation mentioned above, then the only option left for the deficit countries is to leave the ball-room. And they better do it sooner rather than later and enter the rescue boats, while Titanic is still floating. EMU-countries with high unemployment and an unhelpful competitive position will have no other choice to avoid a bankruptcy: because further public sector cuts are self defeating.
Hence, in this case of member countries entering the rescue boats we are back to the pre-EMU situation with nearly as many European currencies as the numer of member countries. Hopefully, it is not too late to re-establish the old European Monetary System (EMS), where the re-introduced national currencies (they may be called Greek-euro, Italian-euro, etc. ) could form a fixed, but adjustable exchange rate system. In fact, this the EMS(II) with rather broad margins (+/- 15 percent) worked quite well in the period from 1993-99 without any major currency crises.
While summing up the present situation there seems only to be one rather certain option: the European Monetary Union cannot proceed on its current course. In that case a collision is inevitable. On the other hand pursuing the German model would not be a helpful solution. It would probably only mean a prolongation of a period of stagnation without reducing the mountain of debt significantly. For good reasons, one should not overdo the metaphor of making the course of the ‘Euro’ to the fate of ‘Titanic’. Having said that it is a fact of history, that Titanic did sink on the April 15, 1912, it took only 4 hours from the ship hit the iceberg until it laid at the bottom of the sea. Only 1/3 of the passengers and crew were saved. Translated into the norms of the European Monetary Union this would mean that only six countries will retain the Euro (probably Germany, France, Benelux, Austria and, perhaps, Finland).
In order to avoid this immanent catastrophe, we would wish that heads of government waltzing in the ball-room would stop the music, go to the captain and ask him to make the Titanic come to a stand still, and then negotiate the cooperative change of course. This might end up with a reduction of the number of member of the Euro-zone. This is not a catastrophe if handled with mutual understanding. Fortunately, history has quite a number of examples that dissolution of a monetary union can take place in an orderly way. In the present situation countries leaving the euro-zone should be given a generous compensation for the economic damages the membership has caused.
Hence, there is a way forward where economic growth in Europe can be resumed; this could be reality if political pride and prejudice were left aside and economic realism appreciated. But, time is scarce, because we can see icebergs approaching!