The debate continues as experts give their counterarguments:
Avinash Persaud, global head of research for State Street bank
Graham Bishop, advisor on European financial affairs at Salomon Smith Barney
Why has the euro fallen so much since its birth? The euro, of course, is a bad currency: it is structurally incapable of providing stable economic conditions in its area as a whole, and still less so in each of its member economies simultaneously.
The structural faults in its architecture, combined with the imperialistic political motives that underlie the idea of "Europe", will within a few years create a financial crisis that will allow its progenitors to push for the creation of a European financial area run by democratically unaccountable bureaucratic agencies, such as a beefed-up Euro-11 Council. But that is not why the euro has been weak this year. The reasons for this year's relatively benign weakness, as opposed to the malignant weakness its structure will make inevitable, are to be found in the past, not the future. But the link between the past and the future can be discerned, by those who look closely enough, in the travails of the German economy.
On May 2 1998, the European Council took the formal decision to institute a single currency, the euro, in 11 EU countries as of January 1 1999. Commenting on the decision that day, the leader of the main German opposition party, Gerhard Schröder (now chancellor), said that the euro was coming too soon and would cost Germany jobs. What did he mean? And how does his comment throw light on the weakness of the euro since its inception?
Germany is a structurally uncompetitive country with high unemployment, high costs and sclerotic markets. Everyone knows that, and most people have known it for the past 15 years. Worse, German reunification, by reducing the average productivity and real-income levels of the Deutschmark zone, depreciated the long-run equilibrium exchange rate. But the demand consequences of the eastern, transfer-financed bonanza meant that the short-term equilibrium rate had to appreciate. There was nothing wrong or problematic about this short-term/long-term divergence in itself. But the perversities of the exchange rate mechanism (ERM) and of the drive to economic & monetary union (Emu) meant that movements in the Deutschmark were of intense political significance. It was made almost impossible for the Deutschmark to be "right" for the German economy, either in the short term or long term.
By 1995, the Deutschmark was hopelessly overvalued. It subsequently retraced part, but only part, of its appreciation against the Anglo-Saxon and European peripheral countries. But it remained far too strong. The response of Helmut Kohl's government, which was essentially to shift the distribution of income away from labour and towards capital, did quite a lot for the DAX stock index but nothing for the economy. In part, it was that contrast that led to Kohl's downfall last September.
Former Bundesbank president Karl-Otto Pöhl said about a year ago that Emu would be run not by the German government but by German firms. It certainly seems, in the wake of the Lafontaine debacle (the forced resignation of finance minister Oskar Lafontaine in March this year), that Germany is not run by the German government but by big business: Lafontaine was proposing fresh taxes and the linking of wages to productivity; he also tried to force rate cuts on the supposedly independent ECB.
The pressures of globalization, as they impinge on Germany, have so far meant mergers and acquisitions, outsourcing of operations overseas, and falling employment at home. No-one would be pessimistic enough to say that the rate of return on capital employed within Germany will never improve, appreciating the equilibrium real exchange rate with it. But, certainly as viewed from May 1998, it would have been wildly optimistic to think it was going to improve soon enough and significantly enough to help Germany's employment problem. And if it was not going to happen soon enough to help employment, it would also be too late to avoid difficult dilemmas on government spending, on the pension system and on taxation. This did not paint a pretty picture for an incoming government.
When the Schröder/Lafontaine team took office, the need was to get the Deutschmark down. But they faced a double problem.
The first aspect of it was historical. Ever since about September 1997, when it finally became clear that the single currency was going to go ahead on schedule - that had been very much in doubt during the summer of 1997 - and that 11 countries would be in it, exchange rates among the 11 were set firmly on the "Emu glidepath", determined by expectations of the euro conversion rate and by short-term interest rate differentials. For most countries, since differentials were by then very small, exchange rates were close to the expected conversion rate. But for Ireland, Italy, Spain and Portugal, the glidepath actually implied currency depreciation. So Germany was faced not only with essentially fixed exchange rates against its nearest neighbours, but with a worsening of its competitiveness - at least in the short term - against four other countries, of which Spain and Italy were far from insignificant trading partners. From September 1997 onwards, this had been a worrying prospect for the Kohl government, which, with support from Bundesbank president Hans Tietmeyer, began lobbying for realignments within the ERM.
The initial target was Ireland. Why? The country was totally insignificant in German trade. Part of the answer was that the Irish pound was, in late 1997, trading far above its ERM central rate and the economy was booming. A plausible economic case for an Irish realignment could thus be made, one the Irish central bank would be intellectually, if not politically, happy to support. More important, it was thought, Ireland had no political weight in Europe and, unlike Italy and Spain, could be forced into a realignment even if it didn't want one. Once Ireland had been dealt with, the markets might smell further realignments, pushing up the value of the peseta and the lira within their ERM bands and providing an excuse for Germany to ask for those currencies, too, to be revalued before it was too late.
