As an old saying goes, “Fate is not without a sense of irony.”
The same is true for our single currency.
The Euro was certainly conceived as a political rather than as an economic project, since when the project was launched, the strictly economic reasons to create a single currency area were far from being uncontroversial. Beyond the rhetoric about the advantages that a major critical mass would have given to the European economy, the founding fathers’ main aim was to unify a continent which had always been war-torn, a primarily political goal. Germany, on the contrary, had resolved to overcome its uncertainties and to swallow the bitter pill of the end of German mark only through the “sweetener” of German reunification, another political goal.
Consequently, it is certainly ironic that the Euro has now turned into the greatest bone of contention between the main European countries since the end of the war. It was introduced to reconcile but it risks to die after little more than 10 years, fuelling dissensions and prejudices which seemed to be soothed. But that’s and old story.
Indeed, the new scenario which is outlining around the Euro in a dramatically much more ironic way, is the so called generational conflict.
According to founders’ intentions and statements, the Euro had to be the pass which would have opened the door of well-being wide for European young people, mainly through the single market and the increased mobility of job flows. In reality, it is killing the progress and development aspirations of many European young people. Why?
A single currency area, where temporary advantages mainly stay in controlling inflation expectations and thus in the trend of domestic interest rates, is based on the improbable assumption that a not so efficient country will be able during time to keep pace with a very efficient country to which it is linked by the currency. In the 90’s, during the so called Tequila Crisis, the many of the most important South American countries which had adopted fixed exchange rate regimes compared to the American dollar, found out to their own detriment how much the choice to renounce the control of their monetary and exchange rate policy (and thus automatically their fiscal policy), had turned into a very reduced ability to react to external shocks, determining the inevitable insolvency of already fragile systems. Since then, the greater part of the key countries in Latin America has adopted mobile exchange rate regimes, also thanks to the influence of some South American young and brilliant graduates who, during those years, came back from Yale, Princeton, and Wharton to find a job in the Ministry of Economy and in local central banks; those countries who did not follow this example paid their consequences in the following years (Argentina, Ecuador, Uruguay, etc).
Similarly, when a country like Italy, which in the 80’s and 90’s used to regularly devalue its currency to close the competitiveness gap with more efficient partners, joined the European project, passing over the fact that its public debt stock was almost double the amount generally accepted by the Treaty of Maastricht, the implicit assumption was that Italy would have been able to open a new season in terms of productivity, efficiency and innovation. Once in the Euro, it wouldn’t have been possible to devalue any more and thus it would have been necessary to struggle for competitiveness day by day.
It’s useless to say that this assumption was unlikely to be true.
Since the adoption of the Euro, Germany has constantly limited the increase in its unit labour costs (<10%), thanks to the considerable productivity of its firms and thanks to an efficient bargaining mechanism between social partners. Meanwhile, these costs have soared in Euro zone periphery (+30/40%), creating gradual disproportions first in the commercial field, then in the balance of payments and finally, as a consequence, in public finance. These disproportions have started to deeply influence development trends within the Euro zone and gradually, in an increasingly incisive way, within the European financial system where German, Dutch and Finnish banks, worried about the concentration of bonds in the periphery, have gradually begun to reduce the exposure to their Spanish, Italian, Portuguese, Irish and Greek counter-parties to such an extent that today European interbank market does not really exist any more and has been replaced by a market between European central banks.
Measures such as LTRO 1 and LTRO 2 have further worsened this climate of distrust, since once again they essentially ended up in a carry trade of periphery banks in favour of domestic bonds rather than supporting domestic economies, as hypocritically flaunted by Mario Draghi and the most part of the European establishment.
The European authorities’ erroneous approach to the crisis, which I believe is based on an intentional misunderstanding of its deepest causes, has resulted in the failure. The roots of the crisis are going deeper and deeper into the system, shaking its foundations. They are economic roots and are connected to competitiveness gaps.
When such important gaps in competitiveness come to the surface, there are two possible ways to bridge them, both of which lead in one direction: a massive loss of spending power of the most inefficient countries; in this case, of the Euro zone periphery.
The first path, the one which is usually taken first and never works, is keeping fixed exchange rates and recovering competitiveness through austerity and structural reforms. It’s very suggestive from a theoretical point of view, since the idea of avoiding devaluation as a first step and recovering the ability to compete through the elimination of wasting and inefficiencies is generally preferred. However, in reality, carrying out this approach takes aeons, if we consider the vicious circles that are created around the economic activity. Therefore political forces hardly ever manage to keep the necessary level of consent till the end. Citizens observe their representatives repeatedly cutting salaries and pensions, taxing incomes and properties, without obtaining any noticeable benefit in terms of development. After a while, initial consent completely vanishes and a gradual social anarchy spreads, which leads to the inevitable end of adjustment programs.
The second path, which follows the failure of the first, is that of devaluation. The advantage for local politics is that the job is done by the market and the tragedy takes place in a few weeks at most. Consequently, times are rapid and there is the real possibility to shift the responsibility to someone else. Let’s take for example Greek case: at present Syriza, the coalition of the radical left party, takes the lead in the survey with about 30%. Its apparently contradictory message to the voters is that of keeping the Euro and rejecting austerity. If Europe should decide to be inflexible in respecting the adjustment program agreed during the second package, in case of its abandonment by a new government, there could be a collapse of the Greek financial system, and Europe would stop allocating rescue funds. Consequently, Greek government, being unable to pay wages and pensions and in light of the possibility of a total emptying of local banks, would be obliged to reintroduce the drachma, freeze bank accounts, and introduce very heavy restrictions on capital transfer abroad. Who would be blamed for all this? Europe, obviously.
In my fifteen years of experience gained through various crises in developing countries, only this second path, although initially devastating, has proved to deeply remove the problem at the root and lay the foundation for a return to sustainable development. All the countries which followed the path of austerity under the conditions the Euro zone periphery is experiencing today, came to give it up and resign to the inevitable devaluation. But they were obliged by the markets, since it is economic reasons and not “speculation” that is stronger than politics in a market economy.
European young people who today have nothing and must shape their own future, should paradoxically follow this second path. The old generations who have acquired their rights, such as wage, pension, income and real estate, have much to lose from this way of reasoning. Thus, it’s not by chance that more and more frequently, in Euro zone periphery, there are technical governments whose members’ average age is very high, with a bipartisan support where the centre-right tends to defend properties and incomes and the centre-left tends to defend wage-earners and retired people, pestered by millions of young people who need an answer about their future.
There’s no doubt it’s time for Europe to take a decisive leap towards a complete fiscal, financial and, finally also political, union. Otherwise, there will be a break-up, caused by the centrifugal forces activated by competitiveness gaps. If they do not take a resolute step forward, there will be an even more resolute step backward, independently from the huge costs and uncertainties associated to the end of the Euro. And there will be plenty of time for recriminations.
The common citizen already wonders if entering the Euro was good or evil. I can only answer by saying that the entry into a single currency area by itself is not an absolute good or evil but only a game-changer, a change to the rules of the game. A traditionally not very competitive and efficient country, like Italy in the 90’s, needs strong reforms concerning different sectors (work, law, tax authorities, university etc), independently from the exchange rate regime adopted. Actually, without the above mentioned reforms, the country will continue losing ground against its competitors at a global level, independently from the exchange rate, and especially in a fixed exchange rate regime. Therefore, the currency regime influences the way such competitiveness gaps can be bridged ex post, either through competitive devaluations or through domestic deflation and/or relative wage trends. From this perspective, the entry into the Euro has been, for countries like Italy, a time slot which should have been exploited to implement the necessary reforms, sheltered from market perturbations. This missed opportunity has had a boomerang effect. Gaps have become more marked and the system does not currently offer any realistic way to close them in reasonable times.
From this perspective, it is important to remember that when a markets’ distrust is able to vent through exchange rates, it temporarily improves the country’s ability to compete, especially when its export sector is important. Thus problems mechanically contribute to part of the solution, although in a temporary way and with collateral costs. On the contrary, when this distrust can be released only through interest rates, this is a one way negative element which depresses the economic activity in the vicious circles of the debt trap.