Against the tide: Reports of the euro’s death are greatly exaggerated


David Roche
Published on:

The eurozone’s advantages for both strong and weak members far outweigh any disadvantages that might incline countries to walk away.

There is an increasing body of opinion that thinks the eurozone will break up. The evidence of increased tension is expressed in the spreads of bond yields to German government debt of the weaker periphery countries. These have widened dramatically, reflecting the poorer fundamentals of these countries. However, the absolute cost of their government debt has hardly shifted, because of declining long rates globally. The weaker eurozone governments are paying now much the same as they paid before.

The reasons why the euro is structurally as solid as a rock surpass feelings that are often prejudiced for or against the single currency

The one exception is Greece. But with all due respect to this cradle of European civilization and coffin of good macro-management, the Greeks do not matter much for the euro. Their GDP is 2.5% of the eurozone’s, while Spain’s is 11%. And it is Germany’s 27% share that really matters.

Had the cost of financing periphery countries’ debt risen, coupled with their over-high levels of debt to GDP, this could indeed have caused their budget deficits to blow out. Even then, the cost should really be compared with the enormous cost of being outside the eurozone.

Convergence with the eurozone gives the periphery countries of Europe a cost of capital way below that dictated by their weaker fundamentals (such as government debts and deficits). If they left the euro, with what would their cost of capital converge?

Here are the guesses: Greece to Turkey, Italy to Libya, Spain to some place such as Uruguay, Portugal to Brazil. That would spell bankruptcy in months rather than years for countries with debt levels like those of Italy, Greece and Portugal. That’s not a very attractive alternative, even for a sub-zero-IQ populist politician.

The euro (together with the other EU institutions) is all about history, not economics. It is the instrument that consummated the dilution of German nationalism into the European identity. By reverse osmosis, the EU and the euro are guarantors that keep Italian politics mildly clean-handed and assured the Portuguese, Spanish and Greeks that their regimes would remain democratic. The cement of history is a lot stronger than that of economics. Even in times of recession, popular support for the euro is unlikely to fall to a level at which populist politicians could muster enough support to leave.

Second, currency unions only break up when the strong core backers, not the weak peripheral dependants, walk out and stop paying. For reasons of history, Germany is about as likely to walk as it is to invade Poland again (with anything but BMWs).

Third, the eurozone works. Its haphazard structure, which makes trying to get things done rather like kicking a jellyfish to make it hurry, seems to eschew the political and economic excesses of more focused regimes. The EU is wealthy, civilized and secular. So, like families of similar condition, it is well able to withstand shocks and the odd black sheep.

It is sad, particularly for those of us who are from Ireland, to see worthy countries like that Celtic tiger transformed into a squashed Celtic cat by the pile-up of the credit crisis. But the reasons why the euro is structurally as solid as a rock surpass feelings that are often prejudiced for or against the single currency.

Keeping the family together

Eurozone yield spread with bunds

Source: Datastream 

In the present credit crisis, Iceland and the central European states were either bankrupted or bailed out before they became so. Ireland, which had the credit bubble to end all credit bubbles, survives more or less intact because it has no currency for speculators to murder.

By complete accident, Europe has the right structure to deal with credit crises: subsidiarity of decision-making to the national level when dealing with financial restructuring, and a single currency that protects individual states from speculative attack. This advantage has been spotted by the European states that are not members of the eurozone. Hence the mad rush by central European states to get into the euro.

In contrast, the ill-focused and profligate policies of the US authorities in dealing with the credit crisis will eventually undermine the dollar. And post-credit crunch, the US national savings deficit will rise through incurring unsustainable budget deficits. This will increase US dependence on foreign financing at a time when the US economic model is no longer seen to be an attractive investment destination.