When the EU introduced the euro in 2002 it did so to great fanfare, with the whole world watching. Why? Because this represented the official formation of the world’s biggest economic entity. Five years later, in 2007, the member states celebrated the 50th anniversary of the European project, officially created with the Treaty of Rome in 1957 in its former guise of the European Economic Community. At the same time, the Economist published a special report — “Fit at 50?” — about the EU’s mid-life crisis and its internal contradictions, detailing all of the economic problems of the various member states that are proving so hard to solve.
Then, last year, the Greek debt crisis hit the headlines, and the five weaker economies of Portugal, Italy, Ireland, Greece and Spain (PIIGS) lurched into debt. The EU has lumbered from one financial crisis to another. These crises have reverberated throughout the global financial markets and continue to do so. Experts are now saying that the euro is not robust enough to withstand this battering and looks close to collapse. Some are even saying the end of the EU is in sight, that there is a distinct possibility it could collapse. If this does happen, what will it mean for the global economy?
When the Greek debt crisis first started, the press initially blamed the Greeks for not only covering up the fact that government debt was running at 12.7 percent of GDP, but also of misleading the EU at the time of its entry in 2004. The next round of accusations was leveled at the Greeks themselves, for having an “all take” and “no give’ attitude, and the officials who increased government debt to fund populist policies, pushing the country into a hole it couldn’t dig itself out of. This was followed by anger internationally and street demonstrations domestically.
Shortly after this, Italy found itself facing a debt crisis of its own, and the alarmingly high exposure of European banks holding toxic assets threatened to spread the contagion further afield, affecting international markets overnight. Things got pretty ugly within the EU, with members at each others’ throats. It seemed that there was no solution in sight, and little has changed since then.
People are asking what lies at the root of this mess. When different member states joined the euro they did so at different exchange rates. Germany entered at a rate of 1.9558 deutsche marks to one euro, Greece at 340.75 drachma. Germany’s exchange rate was relatively low, so it ran quite a high trade surplus after joining the euro. Not so the PIIGS, whose comparatively high exchange rate pushed their trade balances into the red, where they stayed.
However, it was only when their economies went into a downturn that the constraints on their control over monetary policy really hit home. With no control over the exchange rate, they couldn’t revalue to address the problem. Unable to adjust interest rates, they could not lower the rate to stimulate investment. Powerless to print money, they were unable to print their way back into the black. The only option available to them was to raise government debt, and this is what has led to the current mess. The culprit, in other words, is the euro.
Some analysts are saying that the lack of investor confidence and the problems of increasing government debt all point to the need to issue a common eurozone bond. This, however, would be difficult because it would involve asking governments to effectively underwrite the debt of other countries. Others have suggested moving toward financial integration, but given the current political climate in the eurozone further integration is unlikely to happen any time soon.
There are also many voices calling for Greece to declare itself bankrupt and withdraw from the EU, but this could have an undesirable domino effect that might conceivably result in the collapse and disintegration of the EU. Fears of this outcome have led others to conclude the answer lies in the creation of a two-tier economy, pushing the problematic states into the second tier, but this idea was vetoed at a meeting of finance ministers because of the potential aftereffects of such a course of action.
The focus then returned to the euro, with some saying that a Greek default and exit from the euro, returning to the drachma, remains a viable option as there are 10 members of the EU yet to join the common currency. Unfortunately, according to initial estimates by the Economist, the cost of withdrawing could be as much as 50 percent of Greece’s GDP in the first year, and 15 percent for several years thereafter and this doesn’t even include the costs incurred by European banks writing off Greek debt.
Others are saying that southern Europe has come off worse after joining the euro and that it should be Germany that pulls out, returning to the deutsche mark and allowing for a devaluation of the euro. The costs of this move would only be 20 percent to 25 percent of Germany’s GDP and half that the following year.
The euro was hastily rolled out before the design glitches had been smoothed over. These faults were too significant to be eliminated with the introduction of the European Financial Stability Facility. If the problems are allowed to continue to exist and not tackled directly, the euro could well collapse.
At this point in time, in addition to 17 EU member states, nine non-member states also use the euro, and 23 peg their currency to it. Central banks the world over have euros as part of their foreign currency reserves, and there are countless international financial instruments and international trade in euros.
If the euro disintegrates, the consequences do not bear thinking about, and if the survival of the EU is threatened, the entire world economy would be effected. Asian leaders are right now planning a single Asian currency. I hope they are taking note of what is happening in Europe.
Norman Yin is a professor of financial studies at National Chengchi University.
Translated by Paul Cooper
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