The problem with the euro: it’s working too well
The narrative over the eurozone crisis is blindsided by venom over the single currency's supposed ills, but that shouldn't detract attention away from the need for structural reforms.
It has become quite fashionable to blame the euro for anything that goes wrong, be it in the eurozone member states or outside, or in developed as well as emerging markets. It is so fashionable that writing an article in defence of the euro makes one feel... well... German.
Earlier this week, Moody’s downgraded France by one notch – the second ratings agency to deprive the country of its AAA status this year. In the statement accompanying the announcement, the rating agency kept reminding readers that: “France does not have access to a national central bank for the financing of its debt in the event of a market disruption.”
However, that is exactly the point of the euro. It was designed so that those who get in correct their economies by doing structural reforms rather than by taking the easy way of currency devaluation.
Yes, in the case of a crisis, the quickest way to return to growth is by devaluing your currency to gain relative competitiveness – but that would not be real competitiveness, as in the race to the bottom your neighbours will soon be playing the same game.
In the statement, Moody’s listed some of the reforms France must do – such as making its labour market more flexible, encouraging innovation and relaxing the regulation of the services market, which is more restrictive than in other countries.
However, it also implied the country’s euro membership was harmful, leading analysts to conclude that, had it not been a member of the single currency, France would not have been downgraded.
The problem with this way of thinking penetrating all levels, from ordinary people to academics and economists, is that it erodes confidence in the single currency without replacing it with a coherent alternative.
Many pundits have urged Greece to leave the euro rather than go through the painful adjustment that its economy is undergoing now – but the truth is that Greece had over-extended itself and would have never been able to repay its debts, inside or outside the eurozone.
The same argument can be used for the other sick members of the single currency – Portugal, Ireland, or Spain – even though in their case the disease is not as advanced as in Greece.
It is not the euro’s fault that for a long time investors believed a single currency would magically erase the structural differences between the economies that make it up – and consequently mispriced risk.
It also isn’t the euro’s fault that governments in these countries postponed or simply gave up on unpopular structural reforms once they got into the single currency area, as the incentive had disappeared.
The debt crisis could easily have been avoided, if structural reforms had been implemented on time and if the single currency’s principles had been respected.
However, before the crisis, not many eurozone members kept their public debt below 60% of GDP and their budget deficit below 3%, as required by the Maastricht criteria for eurozone members; adjusting during a downturn was always going to be painful.
Those outside the eurozone did not escape the pain – it just largely went unnoticed because it happened in small, eastern European countries. In some of those, civil servants suffered salary cuts of up to 75% –bonuses, which made up around half of their salaries in some cases, completely vanished – property prices collapsed by more than 50% and unemployment shot up to the double-digits.
The flexible currencies were not much help, as devaluation brought a rise in inflation, eroding even more of the people’s buying power. However, the painful structural reforms helped most of the eastern European countries shake off the excesses of the boom years and realign their economies on a more sustainable path.
Other emerging markets went through the same pain – in Asia, during the crisis at the end of the 1990s.
The eurozone debt crisis is no different. Having a single currency rather than 17 different ones does not change the fact that painful structural reforms are needed in some of the member states – and the recent French downgrade shows that not even the core members are spared.
Granted, structural reforms will not magically sort out the present crisis, but they will help the eurozone slowly dig itself out of the hole – and avoid the next crisis.
Antonia Oprita is managing editor at Emerging Markets.