The Euro’s Original Sin

By Mar 26, 2013, 10:08 AM Author's Blog  

All along Europe’s Mediterranean coast, grumbling about German domination of Europe, and especially of the eurozone, is getting louder and angrier.

The irony is that the euro was created largely to prevent Germany from dominating Europe.

Though they don’t often mention it, the governments of Britain and France were aghast at the thought of a powerful, reunited Germany emerging in the center of Europe when the Berlin Wall came down in 1989. The Times of London reported in 2009 that then-Prime Minister Margaret Thatcher asked Soviet leader Mikhail Gorbachev, two months before the wall was breached, to do whatever he could to prevent reunification.

West Germany was a NATO ally of Britain and France, not to mention the United States. Official NATO policy favored Germany’s peaceful reunification. Yet Thatcher told Gorbachev to pay no attention to the public pronouncements.

But reunification proceeded faster than anyone, probably including even the Germans, imagined. A deal soon emerged in which France accepted the enlarged Germany in return for Germany’s commitment to European integration – which, to France, meant expanded French influence as a leader in a united continent that could compete with the two superpowers of the time, America and the Soviet Union. (Nobody was paying much attention to China then.)

Money exists for economic reasons. But currencies, as we are discovering with the euro, are as much about political considerations as about economic ones.

Eleven nations formally adopted the euro when it launched as a tangible currency at the start of 2002, after existing in electronic form since 1999. The agreements establishing the common currency called for participating nations to harmonize their economies by taking down trade and labor barriers and by bringing their government budgets under tight control. The euro’s founders knew perfectly well that, without these steps, centrifugal forces could tear the new union apart. Less-productive economies would be unable to devalue to make themselves competitive, and profligate governments would be unable to get hold of enough euros to service their debts.

But politics overrode sound economics. Even as his countrymen fretted about abandoning their beloved and strong currency, the mark, German Chancellor Helmut Kohl realized that Italy – a founding member of the euro club – did not qualify. But he was not willing to exclude the continent’s third-largest economy and sacrifice the illusion that European integration was unstoppable. Germany turned a blind eye to Italy’s shortcomings in 2002, and then to Greece’s lack of credentials in 2004.

The euro brought many benefits to its participants, for a while. While France strutted on the global economic stage, Germany and its productive northern European neighbors enjoyed expanding export markets in the eurozone nations to the south. Meanwhile, southern nations such as Spain, Portugal, Greece and Italy could tap currency and credit strength that their relatively backward economies could never have supported on their own. Spain experienced a huge building boom. Greece employed a huge share of its workforce in government jobs, even as its tax system failed to collect much revenue. And tiny Cyprus, which did not join the currency union until 2008, quickly built a huge banking industry, attracting vast deposits from Russia and other former Soviet constituents. Those deposits would never have come to the island nation if the banks there had been offering Cypriot pounds rather than euros.

Once Greece’s true financial condition exploded into the headlines in 2009, the illusion of parity melted away. Various governments’ borrowing costs have diverged wildly. Creditworthy Germany pays next to nothing to borrow cash – and lenders occasionally pay Germany just to take it – while, without extensive support from the European Central Bank and other institutions underwritten largely by the Germans, credit costs have soared for governments on the periphery.

The crisis on Cyprus that was resolved – at least for now – by a revised deal early yesterday was mainly a byproduct of the earlier Greek bailout. European officials insisted that “private” lenders take substantial losses on Greek government bonds, even as official agencies like the ECB and the International Monetary Fund were made whole. But those private lenders included the Cypriot banks insured, and in some cases mostly owned, by the government in Nicosia. The bailout of Athens exported its financial woes to Cyprus.

In a truly integrated eurozone economy, a single cross-border bank regulator, akin to our Federal Reserve, would have taken note of the Greek-Cypriot fallout at the time the Greek rescue package was being negotiated. But Cyprus had no effective voice in the talks about Greece.

Now the 800,000 or so residents of government-controlled Cyprus face the prospect of their economy shrinking by perhaps a quarter during the next two years. Greece alternates between rage and despair, and anger is building in Spain at prolonged unemployment north of 20 percent. Meanwhile the Germans feel besieged by impoverished neighbors seeking handouts.

The Cyprus rescue package avoids setting the precedent of a nation leaving the eurozone, for now. Whether it had stayed in the euro or departed, Cyprus faced economic disaster, mostly as a result of being treated as a “private” creditor for buying the bonds of a fellow eurozone state. Germans justify this by portraying Cypriot banks as being unreasonably large and excessively convenient as a waypoint for Russian money of questionable lineage.

This is probably not a wonderful moment to be a German tourist or business executive visiting Cyprus. Or Greece. Or Spain. Or Portugal. Or Italy. In all these places, Germany’s role as the eurozone’s paymaster is not breaking down national barriers, as it was originally envisioned to do; it is rebuilding them, after a brief era in which the gates were opened with the lubrication of easy money.

A common currency can only survive long-term in a closely integrated economy. Europe does not yet have one. Whether it can be created in time to save the euro is an open question. But the German-led abandonment of Cyprus and its banks does not bode well, either for the currency or for the continent that it was envisioned to unite in prosperity and strength.

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