Is the Euro-zone headed for a break up ? (1/3)

Since late 2009, it has become fashionable for pundits and financial commentators to argue that the euro is headed for a breakup – partial or total. It started to be taken seriously when one of founding fathers of the euro (Otmar Issing) said in Feb. 2010 that “starting monetary union without having established a political union was putting the cart before the horse.  Now the question is whether monetary union can survive without such a political union.”

How likely is the eurozone to really break-up ? How to analyze european policies’ impact on a potential break-up ?

Previous monetary unions

“Before long, all Europe, save England, will have one money”. This was not written by a financial commentator of the 90’s, but by Walter Bagehot, the famous The Economist editor, over 150 years ago. He was referring to the Latin Monetary Union (LMU), which survived more than 50 years – longer than the still young euro. A quick review and an analysis of the LMU could lead to interesting conclusion for the current conundrum.

The LMU was dreamt up by the French, worried by their declining geopolitical standing, as a natural extension of the franc zone started with Belgium in 1830. It was formed in 1865 by France, Belgium, Italy and Switzerland. At the peak of the LMU, eighteen countries were pegged to the Gold franc. The main purpose of the LMU was to facilitate trade among members by setting standards by which gold and silver currency could be minted and exchanged. Traders could accept another member’s currency with confidence, as he could convert back to a comparable amount of his home currency – for a reasonable 1.25% commission. The LMU therefore had no single currency, but the national currencies of its member countries were at parity with each other. The LMU was officially disbanded in 1927, but it is the first world war – and the government spending that went with it – that killed it. It lacked a common monetary policy monitored and enforced by a common Central Bank – and these deficiencies proved fatal.

The most famous of the successful monetary unions is the Zollverein (German Customs Union). At the beginning of the 19th century, the German Federation was composed of 39 independent political units. The Zollverein was established in 1834 to facilitate trade, and the Prussian central bank became the effective central bank of the Federation. When Bismarck united Germany in 1871, the new Reichsbank issued the Reichsmark, effectively transforming the Zollverein into a monetary union. It survived two World Wars and their aftermaths. This is the only case in history of a successful monetary union not preceded by a political one. Prussia possessed 70% of the land mass and population of the German Federation, therefore it was easy to enforce a strict compliance on the other members of the Federation. It understood the paramount importance of a stable currency and sought to preserve it by introducing various consistent metallic standards, probably the first example of modern monetary management.

The simple fact that a European monetary union has been tried and failed should be a warning to those who dismiss a potential break-up of the Euro too casually. Germany’s success in its Zollverein is not really a soothing fact, as they don’t enjoy the same hegemony in the euro-zone as they did in the German Federation (despite being it’s most influential member). The euro does have a common monetary policy, but as the LMU, it is not resilient to destabilizing events

Euro Creation and its implications for today

One of the major reason for the creation of the Euro was to get rid of the repeated devaluations from different European countries during the 70s and the 80’s. Other often quoted reasons are reduced interest rates, inflation control and elimination of currency transaction costs.

Inflation and low interest rates were not goals that attracted Germany, as the Deutsche Mark and the Bundesbank could attain them. However, preventing their European trading counterparts to use competitive devaluations was certainly of interest to support Germany’s neo-mercantilist strategy, and was certainly a major reason for Germany’s participation in the euro-zone. French state owned enterprises and Italian SME also aspired to follow that model, although they had less success. The euro, divorced from fiscal policy, does not contribute to stability; rather it only serves to safeguard oligopolistic competition within Europe through wage deflation.The results of this strategy have met Germany’s expectations, as from 2000 to 2008, external demand generated around 2/3 of the growth in Germany’s GDP growth. The euro-zone helps Germany’s export machine by delivering to them captive markets at a fixed exchange rate. Another reason explaining Germany’s participation in the euro is that the Deutsche Mark couldn’t achieve the status of reserve currency on its own, whereas the euro might become if properly managed. Reserve status could bring interest rates even below those achieved by the Mark.

Finally, the Euro is first and foremost a political construct, and it has to be analyzed and understood as such. As the economic advantages and disadvantages of a single currency are indeterminate, support and opposition to EMU in Britain, France and Germany vary with regard to visions of European integration rather than economic considerations. If economic ideologies were all that mattered, we would have had a strong support for EMU among British, French, and German right parties. But the opposite is the case. In those three countries, the left-wing parties were among the strongest supporters of EMU, while conservative parties were more divided. Indeed, strong supporters of the Euro in all three countries share a common vision of European integration as overcoming the historical divisions of the continent. While they might not agree on everything, they do shared the belief that the times of national solutions to economic, political, and social problems in Europe are definitely over, and view the Euro as a symbol of a collective European identity.

 

Next : Part 2 : The Fundamentals

 

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