It's a big mistake to delay work that's needed to restore the currency, says Henrik Enderlein.
The recent measures proposed by the ECB won’t change the situation at all: in its current configuration, the euro is not able to survive long term. The hasty rescue measures taken in the last few years, Mario Draghi’s defiant claim that everything is being done to safeguard the currency, a solid (yet half-finished) banking union – all this is not enough to protect the euro from the next real crisis. When the next storm hits, not only will the ECB be defenceless, but also the entire European policymaking framework of the fragmented euro zone – an area which may share the same currency, but is very far from having a united understanding of how it should be run.
Irrespective of how one sees the euro, there’s now way around a complete overhaul of the monetary union. After all the contentious attempts at bridge building, neither those for the bridge nor those against it are ultimately interested in an unstable structure. Those who wish to do away with it need to lead a controlled demolition campaign. Those in favour of preserving the bridge need to ensure its stability. The worst solution of all is for the bridge simply to collapse. It’s exactly the same in the case of the euro. Yet here, the bridge is becoming more and more fragile while no one is doing anything about it.
This state of the debate around the future of the euro is not only unsatisfactory. It is dangerous. It is high time to talk straight on the euro. Especially those in favour of a strong Europe shouldn’t make the mistake of continuously glossing over the weaknesses of the monetary union. The project of creating a monetary union has not yielded the successes it promised. And it is inherently unstable. On this note, here are four very directly-phrased assessments:
The diagnosis: The euro, in its original form, has failed
Firstly, the euro has not resulted in convergence in the euro zone, rather in divergence. Maastricht’s promise that economic cycles would adjust and align by means of a shared currency and that an optimum currency area was not necessary as a starting point for monetary integration, but that this would be an automatic by-product over time, has not proven true. In a project undertaken by the Jacques Delors Institut – Berlin in cooperation with the Bertelsmann Stiftung, it was found that the convergence between the last 11 founding member states stagnated right until the introduction of the Single Market. It rose between the mid 1980s and 1999 (coinciding with the convergence process prior to the monetary union) but has been declining noticeably since then. Today we again find ourselves in this ‘euro-11-zone’ in a similar environment to that of 1990. This is a scathing verdict on the economic policy in Europe. The euro must be led toward a zone of greater convergence by means of increased integration in the domestic market.
Secondly, the Maastricht Treaty has failed. Whoever believed that a contractual agreement would indeed result in compliance with regulations has certainly had to learn a hard lesson. The union, which was to be built on the foundation of responsible individual states, has not been successful, since member states did not orientate themselves to the currency union in their budgetary and economic policies, but rather to national political calculations. This diagnosis is sobering and holds very little hope. How more rules are to solve the problem of the failure to comply with regulations in the first place, is a mystery to me. A more politicized monetary union could be the answer.
Thirdly: the poor economic environment has made the euro vulnerable. The European debts are too high, the growth is too slow. Structural reforms have been absent all too often. The same can be said for investments. The most important economic values in Europe have fallen far behind the comparative figures for many other regions in the world. The Gross Domestic Profit of the euro zone remains below what it was worth in 2008. And nothing is pointing toward a quick recovery of these economic trends. This also means that the debt levels in many countries are no longer sustainable. How is a country like Italy to pay off its current debt amounting to 135 per cent of its GDP through growth alone? By doing nothing, the problem is only getting worse. Europe must find a way to implement structural reform, to invest again and also to enable the orderly restructuring of sovereign debt, without this resulting in withdrawal from the euro zone.
Fourthly, the ECB will not be able to rescue the euro for a second time – and it shouldn’t do it. Mario Draghi’s rescue mission in the summer of 2012 followed a very simple logic. The ECB stated that the then fiscally unreachable joint liability in the euro zone would be brought about by monetary policy. The measures did not need to be implemented, since the announcement alone was sufficient for stabilisation. However, the ECB’s bluff cannot be repeated. The criteria for the activation of the selective lending and purchasing programme “outright monetary transactions” (OMT) which were submitted to the Federal Constitutional Court are extremely restrictive. The fact that the ECB presented these criteria publically, and in so doing, virtually removed the possibility of activating the OMT, shows that central bankers would like to see the return of the “primacy of politics”. Essentially, they have signalled that it is not up to monetary policy to stabilize the euro, but up to a democratically legitimated union of member states. And they are right.
These four diagnoses lead to a difficult interim conclusion: not only has the original form of the euro failed, the euro itself is inherently unstable. The idea that individual states would comply with the agreed-upon rules has proven to be false. It was a mistake to attempt a monetary union with such a heterogeneous constellation of nations. And it was naïve to believe that this heterogeneity would just go away with the euro. Millions of people have been hit hard with the euro crisis – and we are still waiting on a viable solution to this crisis. The ECB filled the gap at the right time. But in reality it has only achieved the illusion of salvation. The fragile, temporary scaffolding which was build around the bridge has been imbued with a fallacious sense of stability. As a result, the bridge is no less dilapidated.
The options: Why dismantling for reconstructing the euro is not the solution
What then, can we do? Critics of the euro are likely to demand the immediate termination of this defective project. I consider this irresponsible. The demolition of the bridge would be bound with major costs – there were good reasons for building it in the first place. The euro ensures healthy competition in the European domestic market – a fact that is especially important for Germany – since devaluation is eliminated. The euro strengthens the position of our continent in the global market as it has become one of the world’s reserve currencies. The euro is also the political proof that we are serious about our project of building a truly integrated European Union.
Similarly, the exclusion or expulsion of individual states is dangerous. Not only because it is unclear how to go about this, politically and legally speaking, but also because a monetary union that contains an out-clause is nothing more than a system of fixed exchange rates. Imagine how the 2010-2012 crisis would have played out if an exit option were on the table. The consequences would have been devastating. Would financial markets and private investors have left their money in the crisis countries if jumping ship was an option? Would Ireland and Portugal have implemented their politically difficult, but economically necessary structural reforms if they had had the option to exit? The fact that there was not an option to exit safeguarded the euro in the crisis. Dismantling or reconstructing will both be immensely costly. The general overhaul is thus the wiser approach. Europe needs a selective deepening of the monetary union. As I see it, four steps are necessary.
The general overhaul: The case for a selective deepening of the Monetary Union
Firstly: Complete the Single Market. The Eurozone has been living under the illusion that it is an integrated market. This is not the case. Especially in the service sector, which constitutes 70% of our economies, there is a lack of transnational trade. As long as services are walled-in nationally by obscure rules that inhibit cross-border mobility and trade, the divergence between countries will remain intact. The euro zone must become a real single market with shared regulation of capital flows and the digital sector, as well as a distinct increase in mobility of labour. The fact that little has happened in these areas indicates that the main roots of the divergences in the euro zone are still misjudged.
Secondly: Complete the Banking Union. Although uniform supervision and transactions are two significant pillars, they do not guarantee stability. The next crisis in the monetary union could be caused by an outflow of deposits. If the question of whether the euro can survive is simply raised in Italy, it is just a question of time until savers move their deposits to German accounts. This deposit drain is the greatest threat the euro zone faces. The capital controls in Cyprus and Greece show that the euro does not have the same value in all countries. In this context separated deposit guarantee schemes are dangerous. The general scepticism in Germany about a European deposit guarantee scheme is understandable, given the remaining risks in many countries. But the scepticism is short-sighted. Those who block a shared system which can also be achieved through reinsurance, fall into the trap of temporal incongruity: the long-term costs of a monetary union collapse or a rushed overnight rescue, could substantially exceed the current risks.
Thirdly: Rework and politicise the crisis instruments. The ESM is far removed from a real European monetary fund, with true risk-sharing among countries as a goal that also requires a gradual transfer of sovereign rights. The fact that the ESM currently contains only pro-Rata accountability is consistent with the almost unlimited protection of national sovereignty in the crisis countries. However, the balance between sovereignty- and risk-sharing does not add up. In a monetary union, sovereignty ends when solvency ends. This clause is still implemented via the chaotic ad hoc transfer of sovereignty by Memorandum of Understanding to a faceless troika, operating largely outside of democratic checks and balances. However, this sovereignty transfer is neither transparent nor democratically anchored. In the next crisis the troika approach could contribute to political instability far sooner than anyone would like. A democratically-controlled European monetary fund, with a European Finance Minister at the helm, that guards the European rules, has room for political manoeuvre in crises and gives the troika a face, is urgently needed. Such a Finance Minister should also have a veto over national economies in case of emergency.
Fourthly: Improve the democratic control. Everywhere in the monetary union the euro is at odds with legitimacy deficit with the widest range of origins. In the crisis countries the monetary union represents occupation and austerity. In Germany it stands for a loss of power in the ECB and expensive bail-out packages. Both perspectives show that the national glasses do not even take the overall euro zone into consideration. These legitimacy deficits need to be tackled – ideally by a joint chamber of national parliaments and the European parliament to control the European monetary fund. In its structures of legitimacy Europe should also fulfil the requirements of a true multilevel governance system.
These four measures constitute what I would describe as a basic package that would ensure the euro’s long-term viability. Reduced integration is not the answer, but that doesn’t mean that increased integration is. However, even this basic package is currently on the back burner and with it three key questions remaining unanswered. Responding to these questions is of essential importance in a general overhaul of the euro.
The first question: How does the Eurozone deal with countries that refuse to take further integration steps and allow the urgently-needed sovereignty transfer? As mentioned above, an exit clause would be very dangerous. It would fundamentally alter the character of the euro zone. At the same time, the irreversibility of euro membership creates a susceptibility to blackmail that – if we are being totally honest – became a real problem in the negotiations with Greece. To avoid this, the euro zone must find ways to expel a country from the monetary union’s solidarity system in emergencies. The dictum would be: “Leave alone instead of leave out.” This, however, means that services such as the ECB’s liquidity support cannot become lifelines that countries are unable to survive without. That this kind of aid is currently being provided by national central banks and not the ECB is an anachronism.
The second question: Must a country that can no longer pay its own debts leave the monetary union? It is not mandatory. An ordered state insolvency without exit is possible, when the framework is clearly defined. But thus far only a few have had the courage to propose a mechanism for ordered insolvency in the euro zone. Probably also because it would render the widespread risk-free treatment of sovereign bonds in bank balances passé and banks would have to back state bonds with their own capital. Nothing would be more logical than to combine the move towards a European Sovereign Debt Restructuring Mechanism with a change in the risk weighting of government bonds. But where are the concrete proposal for this?
The third question: Do we need a multi-speed Europe? How should we deal with countries like Great Britain, who have no plans to join the euro zone and who could even decide to leave the European Union? This contentious topic calls for a pragmatic rather than an emotional response. The ‘Brexit’ referendum will define Europe’s future governance structure, not the essential characteristics of the European project itself. If Britain votes “Yes” for the EU, Europe will have to draw up two anchor points within the European agreement. If Britain votes “No”, these two anchor points will have to be restructured as separate contracts: an inner circle – the “Euro Union” – would be located within the current treaty, with an outer circle belonging to the “Single Market Union” remaining outside the agreement. It is certainly important for Europe that Great Britain remains within the European Union. Ultimately, however, the outcome of the Brexit referendum could prove decisive for future relationships between the EU and Turkey, Norway, Switzerland, and potentially even with Hungary and – one day perhaps – with the Ukraine. Britain’s new status may well reflect the future status of these countries.
Is the overhaul possible?
Can a general overhaul of the monetary union in the near future be successful? To be honest, probably not. Neither a European superstate nor a transfer union is necessary to do this. As outlined here, a combination of greater levels of shared sovereignty and shared risk, as well as a more democratic approach, is needed. For some countries, especially for France, shared sovereignty is the main concern. From Germany’s perspective, a higher level of shared risk is important – particularly after the many measures taken in the last few years. It is clear that both these issues need to be addressed. It would be beneficial for Germany and France to collaborate related proposals.
Unfortunately, not much is being done. The Five Presidents’ Report under leadership of Jean-Claude Juncker has only made a very small impact. This certainly has a lot to do with the overarching refugee crisis and the concerns about the Schengen. Furthermore, the political calendar could not be more difficult: first the Brexit referendum, which will take place in summer 2016, then the elections in France in early 2017, followed by elections in Germany in autumn 2017 – which go hand in hand with coalition negotiations. Not to mention the elections in Italy already marked for early 2018. None of this, however, is an excuse.
All those in favour of waiting until the summer of 2018 before rethinking and restoring the monetary union are taking too great a risk. The next storm in Europe could destroy the euro, and that’s in nobody’s interest. A collapse of the bridge would be fatal. Similarly, a project of controlled dismantling – especially in today’s climate – would be foolish from an economic and political point of view. A general overhaul is the correct approach. And the work needs to begin now.
This piece was first published in the Frankfurter Allgemeine Zeitung on 11 March and FAZ.net on 18 March. Translation from German by Anita Goldswain.