Is it the end for the euro?

After the bail-outs of Greece and Ireland, the euro's demise is being mooted, even in Germany. Are those who suggest Europeans would be better off going back to their national currencies right?

by Matthew Lynn
Last Updated: 09 Oct 2013

Few people have made their careers as close to the centre of the German political establishment as Hans-Olaf Henkel. After running the European operations of IBM, he headed the BDI, the country's equivalent of the CBI. For a decade, he was the voice of German industry, leading a board that included such business heavyweights as the bosses of Volkswagen, Daimler, Siemens and Deutsche Telekom.

Which was why, in Germany at least, people took notice when last December he published a book called Rettet Unser Geld!. Translated, it means 'Save Our Money' and, over the course of a couple of hundred pages, Henkel argues for the abandonment of the euro as it currently exists and its replacement by two currencies, one for the north of Europe, the other for the south. In the heartland of German industry, the most pro-euro group of arguably the most pro-European country, the survival of the single currency was now a subject of legitimate, mainstream debate. For a man like Henkel to argue for its break-up is rather like the CBI coming out for an 80% income tax rate and the nationalisation of the commanding heights of the economy.

'There is much more group-think in Europe than there is in the UK,' says Douglas McWilliams, chief executive of the Centre for Economics and Business Research. 'If you question the conventional wisdom, you tend to get frozen out of the discussion. But in Germany there is a real sense of the mood shifting. The euro is now being openly questioned.'

Very true. The euro was launched in 1999 as a business and financial currency, and in 2001 in the form of the notes and coins we are now so familiar with: but today it looks in perilous condition. Greece has already gone bankrupt. So too, in November last year, did Ireland, forced into a humiliating bail-out by the European Union and the International Monetary Fund. By the close of the year, Portugal looked a certainty to join those two, and the main subject of discussion in the bond markets was if Belgium or Spain, or indeed Italy, would be the next to join them. The grandest of economic experiments - and the most ambitious of the grands projets that the European political and industrial elite regularly embarks on - is increasingly looking like one of the shortest lived as well.

How did the euro get into this shape? Can it survive, and if so in what form? Those are the questions that are now being asked, questions to which there are no easy answers.

The idea of a single European currency is an old one. Victor Hugo argued in favour of merging the continent's monies in the 1850s and the idea has never really gone away. It acquired real momentum in the 1980s and early 1990s, however, and was finally agreed in the Maastricht Treaty of 1992. The point to remember, though, is that it was an experiment. There was plenty of economic theory about how a single currency could be made to work for 16 very different economies. But it was always precisely that - a theory, about which there could be no certainty on either side of the debate. Nothing on this scale had ever been attempted before.

At launch, the euro worked better than most people expected. Indeed, as it celebrated its first decade, the single currency looked like a huge success. The European Central Bank was a respected guardian of monetary stability. The currency was accepted everywhere. Parts of the economy were booming. It was even starting to challenge the mighty dollar as a global reserve currency.

Beneath the surface, however, three fault lines were emerging that were to build into the fiscal earthquake of 2010. First, Greece had blagged its way into the currency union. After being turned down in 1999, it had outrageously fiddled all its budget deficit figures in order to join the euro. Second, massive property bubbles were building up in some of the peripheral countries of the eurozone, particularly Ireland and Spain. And, third, equally massive trade imbalances were building up across the continent. Germany kept on getting more and more competitive, the rest of the eurozone less so.

The result was that tens of billions of debt had to be recycled around the continent, mainly through the banking system. Money was flowing around in an increasingly mad and unsustainable way. In Greece, it was through lavish government spending. In Ireland and Spain, it was through crazy property schemes. But it always came out somewhere. The root cause was always the same. The monetary system was creating a vast build-up of debts, either public or private, right across the continent.

In the end, it proved unsustainable. The markets turned on Greece first, refusing to finance government deficits that, when the real numbers were released, turned out to be more than 15% of GDP. Then they attacked Ireland, where the government finances had been ruined by the cost of bailing out the banks that had financed the property boom. Both have been rescued via a $1trn emergency fund created last year. But neither country shows any sign of recovery. Nor is there much sign that a default on the debts can be avoided. 'The adjustments facing Greece, Ireland or Portugal were always a tall order,' argued Simon Tilford, chief economist of the Centre for European Reform, in an analysis of the euro's woes. 'Now that borrowing costs have ballooned, those adjustments are impossible. Under no plausible economic growth forecasts will these economies be able to pay back their debts.'

In reality, many influential individuals and institutions are starting to believe there is now little prospect of the euro being rescued, despite the fact that Estonia - population 1.3 million - has just become the eurozone's 17th member. McWilliams puts it like this. Five things need to happen for the euro to come out of this crisis intact. One, Germany would need to grow at 3%-plus for four years to provide enough extra demand to keep the eurozone afloat. Two, a bail-out fund big enough to cope with a collapse of the Spanish and Italian debt markets needs to be constructed - that's more like $2trn than $1trn. Three, a new treaty needs to be written that allows the EU some control over economic policy in the weaker economies. Four, that treaty needs to be passed into law. And, five, there need to be massive cuts in public and consumer spending in all the peripheral nations. 'It's possible that one or two or even three of these things might be achieved,' says McWilliams. 'But all five is a very tall order. So, on balance, it's probably going to fail.'

True, breaking up the euro would be a colossal task. It took years of planning to bring it into being, and ending it isn't going to be any easier. But if you can make something, you can unmake it. If the euro were going to be split apart, how might it be done?

One possibility is that there would be two euros - this is emerging as the favoured view of Europe's corporate elite. Henkel is arguing for that solution in Germany. In the UK, it has been pushed by Martin Taylor, the former Barclays chief executive. There are even names for the two new currencies: the 'neuro' for the northern, German-led bloc and the 'sudo' for the southern bloc.

There would be some advantages. The big European corporates always liked the euro. It always looked a lot easier to have a single currency rather than fiddling around with 16 different ones. And two currencies for Europe would still be a lot more efficient than a dozen or more. The peripheral nations in the 'sudo bloc' could devalue sharply, making them more competitive against the German-led 'neuro bloc'. Problem sorted.

Well, not quite. In truth, there are lots of problems with splitting the euro. For starters, who'd want to join the sudo? It would be a loser's currency. It would be led by Italy, its largest economy, and, without being ungenerous, even the Italians probably wouldn't want to join a currency union of which they were the dominant member. The sudo members would also be responsible for the vast debts of bankrupt countries such as Ireland and Greece. A currency union led by Zimbabwe and Somalia would probably be more attractive.

Next up, even the stronger, German-led neuro bloc might prove unstable. It's not just the likes of Portugal and Greece that have found it hard to keep up with Germany. France has been steadily losing competitiveness as well. So has Belgium. Newer members such as Slovenia would also struggle. The new neuro might be only slightly more solid than the old euro.

Finally, if the euro were to collapse, the last thing anyone would want to do is embark on any more high-risk monetary experiments. The prospect of another failure would simply be too daunting and the subject would be taboo for a generation at least.

In reality, neither the neuro nor the sudo is going to work. The choice is either the euro, as we know it today, or the 'finito': the end of the single currency and a return to the old national currencies.

There will be a struggle to save the euro, of course. A trillion dollars will be thrown at the debt crisis, then another trillion. The treaties will be changed if necessary. Austerity will be imposed across the continent. But, in the end, reality will impose itself. In an analysis of how the crisis will play out, Ben May, European economist at Capital Economics, argued: 'There is a strong chance that policy-makers will not do enough to get through the current crisis and that some form of eurozone break-up eventually takes place.'

However, no one can predict how the end will come, or how long it will take. It could be one year, three, five or even 10. When it does happen it will be accompanied by dire warnings of catastrophe. Politicians will have spent so long trying to sell austerity by predicting the economic Armageddon that would ensue if the euro were to collapse that people understandably will be nervous. 'Complete break-up would have effects that dwarf the post-Lehman Brothers collapse,' argued a report by the Dutch bank ING in 2010. 'Governments would find themselves having to bail out banks again, worsening already fragile government finances. The risk of at least a temporary breakdown in payment systems would be enormous.'

Well, perhaps. There would certainly be difficulties. And if the collapse is chaotic - amid a run on Spanish banks, say, or an implosion of the Italian debt market - the risks would indeed be great. And yet, once the dust settled, the euro area might bounce back surprisingly quickly. Countries such as Greece, Portugal, Spain and Ireland would be liberated from grinding austerity programmes. With currencies that had devalued sharply, their economies could start to motor again. Italy, which was growing strongly during the 1980s and 1990s (overtaking the UK in GDP per capita at one point) could recover its verve. France could start to make inroads on an unemployment rate that has been stuck at almost 10% for the best part of a generation.

Germany would, of course, see the recreated Deutschmark appreciating sharply, which would hit its mighty export machine. But German companies lived with a strong currency through much of the post-war period. It didn't stop the Wirtschaftswunder, the economic miracle, of the 1950s and 1960s. Corporate Germany is in plenty good enough shape to live with a stronger currency. And, of course, ordinary Germans would be able to import more and take more holidays, rather than having to use a large chunk of national income to bail out their weaker neighbours.

Even the EU needn't suffer. Quite the reverse. The euro threatens to become a dark, oppressive force throughout much of the continent. In nations such as Ireland, Greece, Portugal and Spain, people are already starting to balk at the powers of sober-suited foreign bankers from the IMF and ECB.

Meanwhile in Germany, popular papers like Bild have been whipping up fury against subsidies paid to the struggling euro countries. Freed of trying to keep a dysfunctional monetary system together, the EU could get back to smaller, practical projects that actually improve people's lives.

The euro was a brave experiment, but it increasingly looks like a failed one. The sooner it is put to rest, the sooner the European economy can get back to normal and start growing again. And that surely would be good for everyone.

WORSE THAN WWII? - THE COST OF STAYING IN

If some bright spark at the European Central Bank were to come up with a slogan for the long, hard slog back to stability for the euro, he could do worse than 'Keep Calm and Carry On'. The citizens of the peripheral countries will need the kind of fortitude shown by the British during the Blitz.

During the course of WWII, British consumer spending dropped by 14%. The CEBR estimates consumer spending will need to be cut by 15% in Ireland, Greece, Portugal, Spain and Italy to restore their competitiveness against their eurozone neighbours.

Wartime austerity measures are emerging across the eurozone. In Greece, those earning more than EUR1,800 a month at a state-owned company face a 10% cut in their wages. There will be a ceiling of EUR4,000 on monthly salaries.

In Ireland, the minimum wage has been cut from EUR8.65 an hour to EUR7.65. Retired civil servants with pensions of more than EUR60,000 a year are seeing an income cut of 12%.

In Italy, an entire generation faces the prospect of zero economic growth, after already been in virtually permanent recession since joining the euro.

A study by Capital Economics concluded that it would require zero wage growth for a decade for Italy to be able to stay in the euro. That's 20 years without a pay rise. Whether people can stay calm in the face of austerity on that scale remains to be seen - after all, even WWII lasted only five years.

Matthew Lynn's new book, Bust - Greece, the Euro and the Sovereign Debt Crisis, is published by John Wiley. Management Today readers can buy it for £15.19 (a saving of 20%*) plus p+p by visiting wiley.com (or calling +44 (0)1243 843294) and quoting VB167.

*on orders received before 28 February 2011

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