In 1952, when the smokes of the Second World war had not settled yet, France, Italy, Germany, Holland, Belgium and Luxemburg signed the Treaty of Paris, the first post-war European inter-nation organization. These same countries in 1958 signed the Treaty of Rome, formally giving birth to the European Community system. In 1973, England joined the system. Twenty years ago, in Maastricht, some European Union countries met to set up the road for the common currency， the Euro. At the moment, 27 countries are part of the European Union, with 17 also being part of the Eurozone. Our Chinese friends can use a vivid example to grasp the magnitude of this events: imagine that, in Asia, investments, people and services can freely move from one country to another. For example, Japanese could freely migrate to China and Chinese people could migrate to Vietnam, and so on. At the same time, Asian countries would be using the same common currency, with monetary policies and inflation targets being decided by an Asian Central Bank, let’s say, headquartered in the Philippines. Difficult thing to achieve, right? Europe did it!
Since the signing of the first treaties, Europe has enjoyed peace and economic prosperity for 70 years, an event never seen before – at least, not that I remember. During these years, European countries and European people have forgiven each other and underwent a process of re-conciliation: the hatred of the war period have given way to friendship and cooperation. In the history of mankind, it is rare to find such examples of success. No matter what damage the Eurozone debt crisis can bring in the future, we cannot deny the past successes of the European Union.
With this premise in mind, let’s turn our attention to what this current Euro crisis is about. First of all, we need to recognise that we are faced with two separate issues: Sovereign debt crisis and Eurozone crisis. They are two different things, albeit strictly inter-related. The former is due to inadequate fiscal policies implemented by individual countries over the last few decades. The latter is due to fundamental structural faults in the way the Euro system was created. The reason why the Euro issue been brought to the forum is because of the gravity of the sovereign debt crisis. These are two separate problems and, solving one, does not imply solving the other. The reason why the sovereign debt crisis has become so serious and needs immediate attention is due to the fact that the international debt markets don’t have the patient – rightly so – to wait for 17 leaders to take united actions. Furthermore, inside each of these 17 countries, there are many different political views, so that the Eurozone not only does not speak with a single voice, not even with 17 voices, but with 34 or more. One can imagine how, in this circumstance, constructive progress quickly hits against a wall.
I believe that the Eurozone should be dissolved: while European economic integration has been a success, a common currency area must be build on solid economic foundations, not just on a wishful political desire. Since the year 2000, the European economy has been relatively stable, so the structural problems of the Eurozone were never questioned. Until now. Unfortunately, existing measures taken by various government to respond to the crisis only offer short-term solutions. These measures may be useful to restore confidence (to those who believe them), but they cannot solve the fundamental problems of a common currency area. A common currency area must meet certain conditions and, at the moment, Europe does not meet them, nor it is likely to meet them in the foreseeable future. Let’s see what these conditions are.
First of all, each European country must give up control of its monetary policy and hand it over to a central bank. This happens already. But.. We know that countries can use monetary policies to control inflation and stimulate economic growth. At the moment these two tasks should be the responsibility of people working in Frankfurt, who need to manage it on behalf of all 17 countries. Moreover, and most strangely, according to its official mission, the European Central Bank is only responsible to maintain price stability (that is inflation must not exceed a certain value). But managing inflation for 17 countries is not an easy task. More absurdly is that stimulating economic growth is not part of the ECB role. In fact, in Europe, there is no one entrusted with this task. Funny or depressing? To tilt things on the tragic-comic side, let’s remember that it is exactly when debt levels are high that monetary policies should stimulate an increase in inflation, so that the value of those liabilities decreases over time – in other words, the debt washes off by itself. But what is the mission of the ECB? Keep inflation low, instead of high. So, the ECB stands on one leg and the leg on which it stands is upside down. Congratulations to those who designed the ECB.
The second contradiction is that the Eurozone has no fiscal integration. At the moment each country is responsible for collecting tax revenues and decide how to spend the money. In the US and China, each state and each province also use a common currency; but this is possible because fiscal revenues and expenditure, are largely managed by a central government, in other words, transfers take place. Similarly, Europe would need a central institution in charge of collecting and administering all fiscal revenues and expenditures. You can imagine the following situation: every month, one German tax collector, representing such central government institution, goes to Greece or Italy and asks each citizen and local company to pay him tax. This is, of course, a dream that politicians in Europe would like to see take place, but the average citizen will not accept this.
The third condition for a common currency area is full people mobility. In theory, within the Eurozone area, people can freely move from one country to another. However, in practice, because of language, culture, social and political difference, people mobility is not so easy – it is much easier for a Chinese person to move from Beijing to Shanghai and for an Italian to move from Rome to Munich. In the US, if, for example, the whole of North Dakota would be depleted of people, it could still be politically acceptable (this example is from Joseph Stiglitz). But in Europe, is Belgium were to become an empty field and all moved to Germany, it would not be easily digested.
With no fiscal integration, full people mobility and with a central bank with limited and confusing powers, the sustainability of the Eurozone is, at best, unclear.
In addition, European democracies have suffered some setback and doubts have arisen. Not long ago, months of riots and protests by the Greek people let the government to respond. So, they decided to hold a referendum and let the Greek people decide whether they wish to stay in or leave the Eurozone. Not long after this was announced, the Greek prime minister received criticism from the international financial markets and the international political community, chaos broke loose: it looked as if the world had gotten used to an oligarchic system and was adamant not to let citizen freely take decisions. As one of the oldest civilisations in the worlds, it is ironic that this happened in Greece. The situation was amusing: referendum – the ultimate form of democracy – is perhaps not best suited during period of economic recession when austerity measures must be implemented. European countries must make it clear to the rest of the world if democracy is also suited to this difficult times or it only works when things work well.
I believe that the Eurozone should break up, or at least be reduced in scope: a painful decision in the short term, but something that could bring long term benefits. In order for the European Union to survive and for economic development to continue, we should sacrifice the Euro, sacrifice the arguments of the politicians. At a recent EU meeting, the UK negative response to a certain proposal, clearly showed that tensions between countries are beginning to emerge even at EU level. In the future, when and if, the conditions are met, a new Euro can be re-establish. Perhaps, then, policy makers could also re-think the EU charter and explicitly include “Common Christian origin”, thus stressing the importance of member states common cultural background.
After the break-up of the Euro, each country would re-gain freedom to implement its own fiscal policies and focus on their own competitive strengths. They can also use competitive de-valuation as a mean to boost exports, they can set their own inflation target and decide how to best stimulate their economies. At the same time, I would like to point out, that China should not come to the rescue and buy European countries bonds; this would also be a short term solution, not the cure to the problem. The European economic crisis is a structural crisis: it appears as a financial crisis, but in reality is a crisis of an economic development model.
(The author is Head of Global Policy Institute China and Adjunct Professor of Finance at Zhejiang University). This article was first published in Chinese in Caixin magazine.