Issue 4 - March 2011
Will The Euro Survive?
Critics point to a growing gap between eurozone nations. But supporters warn of dire consequences if the center does not hold.
POINT
VICKY PRYCE, Senior Managing Director, Economic Consulting, FTI consulting
In 2002, when euro notes and coins entered circulation, the dominant view among the 15 (now 23) member states using the currency was that it represented a big step toward ensuring peace and prosperity for the Continent. What people in individual European countries tended to overlook was that a single currency brings greater interference by members of the union in each state’s monetary, fiscal and political affairs. Tension over such intrusions, coming to the fore in the wake of sovereign debt crises in Greece, Ireland and elsewhere, casts serious doubt on the survival of the euro as the single currency for most of Europe. During the next few years, member states will do whatever they can to avoid a split because the practical inconveniences would be enormous. Weaker countries, such as Greece, would face a radical devaluation of their currency and essentially would have to close their fiscal borders to prevent a flight of money. Stronger nations, such as Germany, would suffer as well. The inevitable rise in a German-dominated currency would make exports — a cornerstone of the German economy — far less competitive on the world market.
That’s why leaders of financially robust member nations will continue to support bailouts despite grumbling from their citizens about shouldering the lion’s share of the cost; it’s also why weaker nations, such as Greece and Ireland, will continue to accept austerity measures despite protests from their citizens about cuts in government services. But over the longer term, say, a decade or so, the survival of the euro in its current form will become much more problematic. In order for the bailouts to succeed and the single currency to remain viable, the productivity gap between weaker and stronger countries must close significantly.
Yet during the past decade, technological advances and wage moderation have helped Germany widen the gap with southern Europe in terms of manufacturing unit labor costs, a standard measure of export competitiveness. Since 2001, when Greece locked in its exchange rate with the euro, its unit labor costs have increased by more than 240%, according to the Organisation for Economic Co-operation and Development, while Germany’s costs have risen less than 70%.
COUNTERPOINT
GRAHAM BISHOP, an economic consultant specializing in european financial markets and former adviser on european financial affairs at citigroup in London
Amid a serious and worsening European debt crisis, the euro this year is likely to face the greatest challenges to its survival since the inception of the unified currency a decade ago. The eurozone’s collective decision to offer massive support to Greece in 2010 was merely a prelude to what lies ahead — with no fewer than six states (Greece, Ireland, Spain, Portugal, Italy and Belgium) now deemed at risk of defaulting on their obligations and thus probably needing new infusions of eurozone assistance.
Yet most eurozone leaders seem not to have realized the magnitude of the challenges ahead — or to have grasped the consequences of failure. Consider, for example, the likely result if the financially stronger European states offer anything less than full financial commitment to euro preservation by continuing to help the weaker states. In June 2010, banks in Austria, France, Germany and the Netherlands had nearly one-quarter of their overall loans tied up in those weaker economies. Should the countries drop the euro and default on those loans, worth an estimated €1.9 trillion, the impact would be catastrophic for both the banks and their home countries. And what of the countries that desert the euro and attempt to reinstate their old currencies? Those currencies inevitably would face rapid, severe devaluation.
If Greeks, for example, caught wind of such a change, fearing the disastrous consequences of a return to the drachma on their personal accounts, they would naturally transfer their assets to Germany or another eurozone state. Try as Greece might to close its economic borders, this flight of capital, made simple and inexpensive by technology and the euro, would be almost impossible to prevent. The result would be an immediate liquidity crisis crippling those countries’ banking systems. For all of its troubles, the euro — and a financial system that enables its daily use by 330 million people — is a major component of the region’s single market, which lets residents purchase goods and services seamlessly across borders.
Though some observers contend that European unity could survive a split in the currency, it’s more likely that any sense of political oneness would be destroyed amid waves of recriminations over ruined economies.