Don't write off the euro - well, not just yet anyway
In economics nothing is for ever and the euro will eventually go the way of the gold standard
Thursday 27 May 1999
We have reached the stage where Wim Duisenberg, president of the European Central Bank, is today reported in a German business weekly as saying that there is no danger of the euro becoming a weak currency. When central bankers say there is no danger of something happening, you know this is precisely the outcome worrying people in the financial markets. It certainly will do little to check the string of stories about the sickly nature of the euro.
At this stage I can make a prediction with total confidence. The euro- zone will not last. What I cannot predict is when it will end - whether it will break up within the next couple of years before national currencies are finally abolished, or whether it will be abandoned (maybe even as part of a movement to a single world currency) in a generation or so, say some time about 2030. An early collapse is in fact rather unlikely, given the political commitment to the euro. But in economics nothing is for ever, and the euro will eventually go the way of the gold standard and the Bretton Woods fixed exchange rate system, and be replaced by something else.
However, to focus on the sickly euro is to focus on the wrong side of the story. The problem is not the euro itself, but the European economy. The weakness of the euro is more a reflection of European economic under- performance than a cause of it, though having a single currency and a single interest rate for a very diverse economic area does to some extent make the problem harder to fix.
The euro is weak because the European economy is weak. Not all of it, but at least half. The half is Germany and Italy. Both countries have many wonderful companies - global giants in Germany, medium-sized powerhouses in Italy - but in both cases demand has only been inching forward for several years. Both countries need lower interest rates to push their economies forward.
France, the other economy that really matters, has done rather better and will manage reasonable growth this year. It can manage with the present interest rate structure - but in an ideal world, it too could do with another interest rate cut. The ECB did cut interest rates by half a per cent last month (one of the main reasons for the euro's continued weakness). But it has been assumed by the markets that this would be the last cut in the cycle. Whether that will prove right is not at all clear.
The president of the ECB been vague about interest rate expectations, doubtless intentionally. The problem is that while Germany and Italy could do with lower rates and France could live with them, other countries such as Spain and Ireland really need higher rates to stop their booms whizzing out of control. The "one-size-fits-all" interest rate self-evidently doesn't fit all.
But if the euro is part of the problem, rather than part of the solution, it is by no means the whole problem. Indeed it is tending to catch the blame for troubles that have nothing to do with it and long pre-date its inception. It is both unfair and incorrect to declare the euro a failure on the basis of five months' experience. The lags in economics are far longer than that.
So what should we look for in the months ahead, as clues to whether the euro is a serious hindrance to European economy recovery, or a relatively minor complicating factor? Here are three tests.
Test one will be whether European consumers decide to dip into their bank accounts and spend rather more in the next couple of years. What Europe desperately needs is a consumption-led recovery. It needs people to behave less responsibly, splash a bit of money about, have some more fun. Europe cannot rely on America to pull along the whole world economy year after year, and America cannot do so anyway. Look around the world and there is no other candidate to be a locomotive.
Test two will be whether European governments start to tackle the string of detailed regulatory and taxation blockages which currently inhibit growth. They are lumped together in expressions such as "structural polices" and they differ from country to country. But the common theme is that most euro-bloc countries require public sector reforms which will bring them into line with US and UK practice.
The awful truth is that the big three European economies, Germany, France and Italy, have created no new net jobs in the last 20 years, whereas here we have increased employment by 8 per cent and in the US employment is up 32 per cent. Could the single currency become a spur to structural reform?
Test three is whether European companies will embrace the opportunities that the euro, in theory, presents. In theory the larger currency zone should force greater efficiency on companies. The advantage is not so much that they will have the opportunity of selling to a larger market, for they have that already. The advantage is that both they and their customers will be able to compare prices directly. So they will be under the whip to extract more efficiency out of their plants and their offices.
If the European economy as a whole does become more efficient that will be a powerful argument for the single currency. Or put the other way, if the single currency does not force more efficiency, there is not much point in having it.
So distrust the inevitable headlines about the supposed failure of the euro. Distrust the equally inevitable headlines about the incompetence/ inflexibility/ inexperience of the European Central Bank. The mood of euphoria may have changed, but that was always going to happen. The fundamentals of the euro have not.
Of course, moods do matter. I learnt something new the other day. I was talking with an American banker. He told me the view of their bank now was that Britain would not join the euro after all. It had concluded as the months passed that there simply was not much advantage and there were a lot of potential disadvantages. But that decision, like any judgement on the ultimate success or otherwise of the euro, seems to be a long way off.
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