Will The European Monetary Union Lose Members?
February 19, 2009
This question to Currency Thoughts from Bgin2end is sure timely. George Soros addresses one element of the issue in an Op-Ed piece of today’s Financial Times. He touts some big benefits of having the eurozone but argues that the present crisis has revealed a flaw in its construction, the lack of a bloc-wide government bond market. Difficult compromises would have to be ironed out to establish how the market would be administered. Soros favors EMU and expects it to survive but doesn’t exactly say how strongly contingent those views are on officials agreeing on a bond market that helps unify fiscal policy.
I was skeptical after the 1992 Maastricht Treaty that a common currency would be embraced by the people and beneficial on balance, coexisting with 11 different fiscal and foreign policies for the original 11 governments. I doubted that EMU would force those dimensions of integration to get done. I was glad to see Britain opt out, believing that would enhanced prospects for EMU’s success. 1992 had not been the first time speculation forced the U.K. to float the pound away from a European joint float. Twenty years earlier, Britain had joined the European “Snake,” which limited members to +/-2.25% margins of movement against one another, on May 1st but was forced to leave less than 8 weeks later on June 23rd. I was also skeptical that the Stability and Growth Pact would impose the fiscal discipline that its designers intended. Most importantly, I felt that EMU lacked the constitutional legitimacy that such a ceding of monetary sovereignty ought to embody. To me, a shift of such importance ought to have been subjected to referendums in all of the joining countries or at least a process as difficult as passing a constitutional amendment in the United States.
My initial assumptions were mostly correct, but I underestimated the political impetus from several European leaders to launch the project come what may. After that happened at the beginning of 1999, the euro had a rocky first 22 months, depreciating some 30% against the dollar by October 26, 2000. But even during that time, it became apparent that the costs of leaving EMU would be greater than the costs of staying for anybody that tried to secede. Once euro coins and paper money began to circulate, voters endorsed the new money with increasing enthusiasm and, in several cases, associated better economic performances than before with the common currency. Significantly, Europe was not victimized by periodic currency crises.
European Monetary Union now faces its greatest crisis yet — by far. As badly as the zone’s economy has performed, contracting 5.9% at a seasonally adjusted annual rate last quarter and heading for a drop of easily over 2% in 2009 as a whole, conditions probably would have been much worse for many participants without EMU. As Soros observes, just look at the economies in Eastern Europe, whose leaders wish they were inside the euro area. If an EMU member now left the group, its currency would tumble, and its mostly foreign currency-denominated debt would soar. Enhanced export competitiveness, unlike Britain’s circumstances after 1992, would mean little in a world of shrinking, not expanding, trade flows. To answer Bgin2end’s main question (is secession by some members possible?), the answer is yes because the decision is essentially a political one. But such a development still appears very unlikely, because it would entail pain in the form of higher interest rates, greater debt service costs, and rising inflation to the countries that leave. It would also be a blow to EMU’s image, which would be a problem for the remaining members.
Bgin2end’s question is also timely because I’m off tomorrow to a conference at Columbia on the global financial crisis, where such luminaries as Bob Mundell, a pioneer in research on optimal currency areas, Paul Volcker, Will McDonough, Joseph Stiglitz, and George Soros will be speaking. On a question as central as the future of the euro, it’s important to keep an open mind, always challenging one’s predisposition. Perhaps I’ll hear things that change my view. Loyal readers of this site will be the first to know.
Copyright 2009 Larry Greenberg. All rights reserved. No secondary distribution without express permission.
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Thanks Larry, I appreciate the detailed response. I must say however that this was not wholly thought up on my own, I had some help discussing this topic with Jay at his blog The Lonely Trader.
Excited to see what comes out of the conference. Thanks for keeping us updated.