There has been plenty of speculation about the dollar and poor old sterling recently – but how has the euro fared in its first big test?
Two years after the onset of the credit crunch, and a decade on from its establishment as a single (though not universal) currency for the European Union, it has survived in better shape than most of its critics predicted.
Its biggest economies – Germany and France – are already out of recession. It is humiliating the dollar. It covers the biggest economic zone in the world. Yet, when it started out it was labelled, by some typically indelicate London forex traders, as a "toilet currency", compromised by fundamental weaknesses in the sclerotic European economies. Even the bank-notes were derided as being too easy to forge. A wave of counterfeits was predicted – that never arrived.
To many even five years ago, the dynamic Anglo-Saxon model still looked a better bet, and the euro languished against sterling and the dollar for a long time. Today, the euro is being talked up as possible replacement for the greenback as a reserve currency for the world.
Nor has the governance of the euro been noticeably inferior to that of its principal rivals. The European Central Bank was designed on the highly successful template provided by the German Bundesbank, a central bank that, alone in the G7 powers, enjoyed a reputation for monetary rectitude. It has not yet been chaired by a German, but the Dutch Wim Duisenberg and, still more conspicuously, the former French central bank governor Jean-Claude Trichet have shown themselves Germanic in mind-set.
The ECB, almost alone among the institutions of the European Union, has a proper job to do and gets on with it unfussily. Indeed many critics say, with the benefit of hindsight, that at least the ECB managed the early stages of the credit crunch more effectively than the Federal Reserve or the Bank of England. Leastways, nothing was done to damage the euro itself, even though the anchor of the Maastricht criteria – low budget deficits and modest national debts – has had to be jettisoned.
Sooner or later, as with our own "golden" fiscal rules, the governments of the eurozone will have to reinstate some sort of credible fiscal framework. The German constitutional amendment to restrict structural annual budget deficits to 0.35 per cent of GDP might be a good pointer.
But those euro successes are only part of the story. One of its main, if often undeclared, aims was to accelerate convergence among European economies. Let us recall here that after half a century of free trade, and another 10 years or so of a single market, the eurozone economies were already pretty integrated – or at least seemed to be. Some of the smaller nations around Germany had been Deutschemark satellite zones long before the euro was dreamt up. The euro should have followed the usual economic logic and made the eurozone nations economies still more integrated and convergent. So did it?
Crude as it is, I've tried to test this by looking at the course of two broad indicators: inflation and unemployment. (Only some nations are shown in the charts, for the sake of clarity). The evidence is a little surprising.
First, as the charts suggest and simple measures of standard deviation confirm, the eurozone economies didn't converge that much even in the good years, when intra-zone trade was expanding. Let's take inflation.
Looking at the difference between the best and worst performers, and the variability of the economies from each other, they did indeed broadly get closer over the first seven years of the euro's existence. Indeed the maximum convergence occurred, eerily, in July 2007, just when the credit crunch was about to bite: the difference between the best and worst inflation performances among the original members of the euro was 1.2 per cent. Spooky. Now the divergence is more severe – around 4 per cent, close to where the eurozone started out.
More telling still, and more dangerous because of its far more destructive impact on social cohesion and politics, is the increasingly alarming disparity in the eurozone's "real" economies. Nowhere is this more apparent than in the unemployment numbers, with Spain in particular registering a disastrous increase. Almost always the worst performer in the western European Union, Spain is now even further from away from the mainstream, with youth unemployment now in excess of 30 per cent. Ireland has joined Spain as an outlier, but the rest of the pack is more spread out than ever before in the euro's history. A decade ago there were 10 percentage points separating the best and worst performers – the Netherlands and Spain. Now there are 15, and between the same two states. So what does this tell us?
Well, it does underline that, although we occupy such a tiny corner of the globe, trading so much with one another, we Europeans have far less in common than we might think. We are very structurally divergent, and it has taken this crisis to show us quite how much.
The reasons are obvious: differences in property, labour, product and capital markets, all far from uniform. The real-estate scenes in Ireland and Germany, for example, might as well be on different planets. The labour markets of the Netherlands and Belgium are bizarrely different, and the differential impact of the credit crunch on different countries' banking systems has also exaggerated differences (though in that respect the Spanish have come off relatively well).
Add to that the many languages, and separate political cultures, and you can see why the eurosceptic case is so persistent. Had the UK joined the euro in 1999, the chances are that we would have converged with the rest of the eurozone no more than Spain has done. This might well have left us too with the wrong level of interest rates for the state of our domestic economy – and the Exchange Rate Mechanism (ERM) experience writ large. Indeed it is perfectly possible that sterling might have dropped out of the euro by now.
Still, the euro is hanging together. The higher yields demanded by the markets on government bonds issued by weaker brethren such as Portugal are evidence enough that the central political problem of the euro has not been expunged.
It is still possible – although the moment of greatest peril has prob-ably passed – for one of the eurozone's members to re-establish its national currency. When some nations manage to control costs more effectively than others, and unemployment and social pain mount elsewhere, the traditional method of adjustment has been currency deprecation. With that safety valve removed, it is difficult to see how nations such as Italy will be able to solve their growth problem, or Spain to dissolve its jobless queues. That isn't an argument for them to leave the euro: merely to note that, as long as they retain their own governments, that option will always exist.
Additional research by Beth Admanson