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How to keep the euro project alive
By Gerard Lyons |
July 29, 2011, Friday
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Print Edition
Print Edition
EDITOR'S note: This is the second and final part of an article on the euro zone crisis.
I wrote as long ago as 1997 that a historical analysis shows that no monetary union of large sovereign nations has survived without becoming a political union. That may be what is necessary for the euro to survive.
But this is not going to happen yet. The challenge is that in the core economies such as Germany, things are seen differently. In terms of the Economic and Monetary Union (EMU), the view there is that the MU part, or monetary union, has worked well.
In contrast the E, or the economic aspect, has failed. Thus the core sees the need for the periphery to make the economic adjustment needed. Hence, the tough conditionality asked of the likes of Greece and Portugal, among others, in return for any help from the center. The central aspect of this are the measures to make the periphery more competitive, through austerity and supply side policies. In short, the Greek economy needs to become like Germany's - an almost impossible task.
Austerity is the last thing the periphery economies need now. They are already in a hole, and are being asked to dig deeper. What is the solution?
Under the present set-up it is for the public and the politicians in the core to decide whether to sustain huge fiscal transfers to the periphery. Where the boundary between the core and periphery is has never been clear, but in recent weeks Italy has moved towards the periphery.
The euro's current problems justify completely the UK's decision to stay outside, and set policy to suit its own domestic needs. In contrast, countries in the euro area don't have this flexibility.
I doubt very much that the periphery will be able to sustain the economic pain under the present set-up. Facing recession and already high youth unemployment, they are being expected to adopt austerity measures. It will not work and, instead, it will impart a further deflationary bias into their economies. Debt figures will stay high, not justifying the economic pain being inflicted upon domestic populations.
A two-speed system may provide the solution. The core can stay in the fast lane. Their economies are in better shape. They could form an optimal currency area, where the costs of staying in a monetary union are minimized, and the benefits of the European free-trade area maximized. They also will not need to go on writing blank checks for the periphery.
There are clear benefits for the periphery from being in a slower lane.
The periphery needs a competitive boost, in much the same way the UK benefited in recent years from the sterling's massive devaluation. They need this in a way in which they can stay realistically committed to the euro project. Going at their own speed is necessary and safer for their own populations.
How would it work? With a two-speed euro, the European Central Bank would remain in place. There would be two currencies and two rates, one at a discount to the other. Over a realistic period, say 50 years, the aim may be for achieving parity between the two currencies.
Interest rates would be different, with higher policy rates now for the fast-speed zone, based on present conditions, and lower policy rates for the slow-speed zone.
Run on banks
Every scenario for the euro faces huge obstacles. There is a genuine possibility it will not survive in its present format. Trouble is: leaving the euro is hard even if a country wanted to. Replacing the euro with your own currency cannot happen overnight. And if people and the markets thought this was imminent there would likely be a rush of money out of the country and a run on banks.
In some respects, the periphery are damned if they stay in the euro. Thus the disruption caused by moving to any new set-up, while painful, may be seen as a necessary step towards eventual economic recovery.
The immediate benefit to the periphery is that the member countries would receive an immediate competitive boost from a weaker currency.
Initially the market might view this as an admission of defeat and demand higher rates, but over time these would be expected to fall, particularly if the European Central Bank gave support to the slow-lane's currency. Such lower rates would help the economies in the periphery.
The fear of default would be replaced by the reality of growth. After some initial uncertainty, yields in the slow-speed zone would likely fall as economies start to recover and debt dynamics improve.
Of course, some say this can't happen as treaties would need re-writing. But that would seem the least difficult thing to do in the current circumstances. The question for the euro zone is whether any new approach taken can reignite growth while still keeping the euro project alive.
A multi-speed euro, with different countries going their separate ways would not achieve that objective; a two-speed system might.
(The author is chief economist and group head of global research at Standard Chartered Bank. Shanghai Daily condensed the article.)
I wrote as long ago as 1997 that a historical analysis shows that no monetary union of large sovereign nations has survived without becoming a political union. That may be what is necessary for the euro to survive.
But this is not going to happen yet. The challenge is that in the core economies such as Germany, things are seen differently. In terms of the Economic and Monetary Union (EMU), the view there is that the MU part, or monetary union, has worked well.
In contrast the E, or the economic aspect, has failed. Thus the core sees the need for the periphery to make the economic adjustment needed. Hence, the tough conditionality asked of the likes of Greece and Portugal, among others, in return for any help from the center. The central aspect of this are the measures to make the periphery more competitive, through austerity and supply side policies. In short, the Greek economy needs to become like Germany's - an almost impossible task.
Austerity is the last thing the periphery economies need now. They are already in a hole, and are being asked to dig deeper. What is the solution?
Under the present set-up it is for the public and the politicians in the core to decide whether to sustain huge fiscal transfers to the periphery. Where the boundary between the core and periphery is has never been clear, but in recent weeks Italy has moved towards the periphery.
The euro's current problems justify completely the UK's decision to stay outside, and set policy to suit its own domestic needs. In contrast, countries in the euro area don't have this flexibility.
I doubt very much that the periphery will be able to sustain the economic pain under the present set-up. Facing recession and already high youth unemployment, they are being expected to adopt austerity measures. It will not work and, instead, it will impart a further deflationary bias into their economies. Debt figures will stay high, not justifying the economic pain being inflicted upon domestic populations.
A two-speed system may provide the solution. The core can stay in the fast lane. Their economies are in better shape. They could form an optimal currency area, where the costs of staying in a monetary union are minimized, and the benefits of the European free-trade area maximized. They also will not need to go on writing blank checks for the periphery.
There are clear benefits for the periphery from being in a slower lane.
The periphery needs a competitive boost, in much the same way the UK benefited in recent years from the sterling's massive devaluation. They need this in a way in which they can stay realistically committed to the euro project. Going at their own speed is necessary and safer for their own populations.
How would it work? With a two-speed euro, the European Central Bank would remain in place. There would be two currencies and two rates, one at a discount to the other. Over a realistic period, say 50 years, the aim may be for achieving parity between the two currencies.
Interest rates would be different, with higher policy rates now for the fast-speed zone, based on present conditions, and lower policy rates for the slow-speed zone.
Run on banks
Every scenario for the euro faces huge obstacles. There is a genuine possibility it will not survive in its present format. Trouble is: leaving the euro is hard even if a country wanted to. Replacing the euro with your own currency cannot happen overnight. And if people and the markets thought this was imminent there would likely be a rush of money out of the country and a run on banks.
In some respects, the periphery are damned if they stay in the euro. Thus the disruption caused by moving to any new set-up, while painful, may be seen as a necessary step towards eventual economic recovery.
The immediate benefit to the periphery is that the member countries would receive an immediate competitive boost from a weaker currency.
Initially the market might view this as an admission of defeat and demand higher rates, but over time these would be expected to fall, particularly if the European Central Bank gave support to the slow-lane's currency. Such lower rates would help the economies in the periphery.
The fear of default would be replaced by the reality of growth. After some initial uncertainty, yields in the slow-speed zone would likely fall as economies start to recover and debt dynamics improve.
Of course, some say this can't happen as treaties would need re-writing. But that would seem the least difficult thing to do in the current circumstances. The question for the euro zone is whether any new approach taken can reignite growth while still keeping the euro project alive.
A multi-speed euro, with different countries going their separate ways would not achieve that objective; a two-speed system might.
(The author is chief economist and group head of global research at Standard Chartered Bank. Shanghai Daily condensed the article.)
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