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Opinion: Eurozone must muddle through

A noted euroskeptic argues it is too late now for the EU to turn back

Posted: March 7, 2012

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Opinion: Eurozone must muddle through

By Josef Joffe

As one of the early skeptics of the European monetary union, events are now proving me and other critics right. But I am not going to take a cheap, I-told-you-so shot at the most ambitious integration project in the history of Europe - especially since I hardly have an impressive record on predictions. I am right exactly half of the time, which means my forecasts are just as good as flipping a coin. My purpose in saying so is to make the larger point that the common currency was always a political project, not an economic one.

Fourteen years ago, in an article in The New York Review of Books, I started with a fictitious movie scene set in the library of the Elysée Palace in March 1990. Present are France's Francois Mitterrand and Germany's Helmut Kohl.

"Mitterrand is in a melancholy mood. During the last few months, ever since the collapse of the Berlin Wall in November 1989, he has tried every conceivable diplomatic stratagem to stop, or at least break, the quickening pace of German reunification. But to no avail. Glumly, he stares into the fireplace, as his friend Helmut pleads. 'Look Francois, this time reunification won't be like Versailles in 1871, when the new Reich was proclaimed on the ruins of French pride. We have Franco-German friendship, we have the European Union, our forces are completely integrated in NATO.'

"Mitterrand remains glum. So Kohl continues to wheedle: 'My dear friend, this is 1990 - not 1914 or 1939. These days, my countrymen are polishing their BMWs, not their jackboots. This time, German unification will not bring down Europe. Come on, Francois, what do you say?' Mitterrand continues to stare into the fire. At last, he bursts out, 'Bon, Helmut, c'est ce qu'on va faire. You get all of Deutschland, if I get half of the Deutschmark.' "

The point of this imaginary scene is that the euro was born out of the abrupt transformation of world politics: Moscow's capitulation in the Cold War, which suddenly revealed the true power relationships on the Continent. Germany would be united and would shed the ancient dependencies that had tied it to the West, and to France in particular.

Helmut Kohl understood the precarious position of a reunified Germany. The Deutschmark was the very symbol of German primacy, so what better way to soften the blow than by more integration?

This was a wise but not entirely selfless move. The euro was good for Germany, as it would relieve the relentless revaluation pressure on the Deutschmark and protect Germany's export-led growth. The euro would be the D-mark writ large, administered by a European Central Bank that would be the Bundesbank writ large, totally independent of political control and the guardian of strict monetary discipline.

In the run-up to the European Monetary Fund, would-be members had to live up to the so-called "convergence criteria" of low national debts, low deficits and stable parities. In 1997, Germany bound the rest through the Stability Pact with its penalties to enforce fiscal discipline now and for ever more. In other words, Germany would not so much sacrifice its currency as extend its sway beyond the informal zone that encompassed Austria, Denmark and the Benelux countries.

So with all this "Germanization" of the common currency, why are we in trouble now? The answer is that good politics do not necessarily make for good economics. Or bad economics will always trump the best of political intentions.

Perhaps we should think about monetary union without political union as a train of as many locomotives as there are member states, all running under their own steam. Without a lead engine - political union - each has to maintain exactly the same speed in terms of fiscal policy. If not, the couplings would break and the train would go off the rails.

There are only three ways to avoid this. First, those who put too much coal into their locomotives by spending too much and running up deficits, are forced by the virtuous rest of the train to mend their ways. They will impose fiscal discipline on themselves and balance their budgets. This would be the collective dictatorship of virtue. The second way is for those locomotives that run out of coal to be helped out by others that have fuel to spare. As good Europeans they share the wealth. This is what's being called a "transfer union." The third solution, being neither common virtue nor an "all for one" wealth sharing, is the decoupling of the locomotives that make up the train. The wastrels either withdraw from the euro or are forced out, but alas the Maastricht treaty that in 1992 set out the rules of monetary union has no proviso for either of these decoupling options.

So once secession and expulsion are ruled out, the choice is between transfers from the outside or adjustment on the inside. This is the logic of a monetary union without fiscal or political union; either the sinners reform, or their companions keep them on some form of permanent dole. Failing that, the eurozone train leaves the rails.

Today we think of Portugal, Ireland, Italy, Greece and Spain - the PIIGS - as the great sinners, yet by the middle of the last decade as many as nine eurozone members had breached the deficit criterion, among them France and Germany - France five times and Germany six. So the moral is that when it comes to the crunch, national egotism always trumps communal virtue. The drivers of those national locomotives don't observe the common good but rather their domestic electorates or the business cycle.

The euro's birth defect was that monetary union encompassed two incompatible cultures. There's "Club Med" - France, Italy, Spain, Portugal, Greece and Ireland -

and then there is "Club North" - Germany, the Netherlands, Finland and Austria. Club Med is largely Catholic and Club North is generally Protestant, give or take the Austrians. And Club Med spent while Club North saved, so while the northerners' expenditures stayed more or less in line with their revenues, Club Med was always shoveling coal at a faster rate than its tenders were being replenished.

In economic parlance, too, this is called overheating, and its logical consequence is rising debt and inflation. How, then, did these countries stay competitive, given rising nominal prices for goods and wages? Before the euro, they did so by devaluing just a little faster than they were inflating, but once in the euro they could no longer use that safety valve, so inflation at home translated one-to-one into rising prices on the world market - not good for countries that sell about one-third of their GDP abroad.

Thus the Club Med countries began to price themselves out of world markets. And instead of converging economically, the eurozone's members were moving farther apart. As German exports soared to 47 percent of GDP - a ratio that dwarfs even China's - those of the Club Med countries fell. And not only did the euro impose virtue, it even made vice easier. Before the euro, high-spending countries were forced to pay a devaluation premium on the interest of their debt. With it, they no longer had to issue bonds denominated in devaluation-prone liras, francs and drachmas as they could issue debt in solid-gold euros. As their interest charges went down, their borrowing went up.

But of course the dream of a Germanized euro has turned into a nightmare. Instead of forcing internal reforms to make the wayward more cost-efficient and productive by liberalizing labor markets and leveling privilege, the euro encouraged extravagance. Why should Club Med countries save if they can borrow, and borrow cheaply? Put in economic parlance, if you can't devalue on the outside, you have to devalue on the inside by lowering the rent-seeking of privileged groups, driving down costs, extending working weeks and working lives.

Where does the eurozone go from here? Rescue mechanisms like the EFSF and the ESM worked until March, when Greece has to pay out 14.5 billion euros in interest and redemption. So there won't be a default until the spring, I presume. But Greece is insolvent, so nobody knows what will happen after March. Shrinking the Greek economy by about 5 percent through painful reforms may be a road to solvency, but not to growth.

Everybody wants to save the euro, of course, but saving it means a transfer union, and that will only last as long as the Germans are willing and able to pay. The theory of public goods says those who have the most, and the greatest interest in preserving public good, will pay most for it, so it looks like "transfer union" as far as the eye can see.

The alternatives are either a breakup of the eurozone, or the leap into political union with a common fiscal policy and mandated revenue sharing. Because the Utopian state looks impossible for the eurozone's 17 members, let alone the EU's 27, it's probably going to have to be a case of muddling through. And I myself would not recommend anything else. Europe can't afford to let the euro train run off the rails, yet I'm very doubtful about a great leap forward into a more "perfect union." Europe's closer integration since 1950 has been like a slow walk through the foothills, but now we are facing the Alps of core sovereignty. The EU's easy past doesn't necessarily lead to the shiny future that is a United States of Europe.

- The author is publisher-editor of the German weekly Die Zeit, senior fellow at the Freeman-Spogli Institute for International Studies and Abramowitz Fellow at the Hoover Institution, both at Stanford. This text comes courtesy of Europe's World (

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