The Problems with the Euro Zone

The Problems with the Euro Zone

by Future Planet Europe

[1]TvzetinaBorizova, Small Farming in Sout East Europe at a Crossroads, article on November 19, 2013 on www.balcanicaucaso.org [1]EirikGrasaas-Stavenes, WTO Conducts War on Resources (WTO førerressurskrig), article in Klassekampen, November 13, 2013

While the four freedoms created the foundation for a free market and removed many tools of national governments to control the economic development of their countries, there still remained one obstacle to a fully open market.

That was the exchange rates used to protect local industry and promote economic growth. If a country started to become less productive than its neighbours, the balance of trade would become negative, and its exchange rate fall. This would help producers in the country to encourage exports and discourage imports.

But from the perspective of international business, the national currencies increase transaction costs, make import and export burdensome, and introduce uncertainties in financial calculations.

Flexible exchange rates also went against the interests of the most productive countries, such as Germany, who prior to the Euro saw its currency appreciate, which in turn partially offset the advantage it had from increased productivity. When the currency appreciated, it became more expensive for other nations to buy German goods, and so it lowered exports.

In order to remove this one final obstacle to an open market, the EU introduced the Euro as its common currency on 1st of January 1999. At that time it was only an accounting currency. Bank notes were issued three years later in 2002. The Euro is currently used by 334 million Europeans.

Initially, this move was welcomed by several scholars, such as the British Historian Niall Ferguson. The main problem, he thought, would be a monetary union without a common fiscal policy, that is, without a central government that controls expenses. 

Right after the Euro finally came into existence in 1999, Ferguson warned in an article published in Foreign Affairs in 2000 that “a monetary union without a fiscal union would fall apart after about ten years because of the divergence between the member states.[1] In 2010, Ferguson said, he was running around Europe trying to remind politicians that it was a similar banking crisis as Europe was then experiencing that caused the Great Depression in the summer of 1931. 

Historically, monetary unions have not been successful. In his recent book, The End of the Euro, Belgian business editor, Johan van Overtveldt writes that a monetary union between different countries has been attempted but failed in Europe before.

The two main monetary union failures were the Latin Monetary Union (LMU), formed in 1866 between France, Belgium, Italy, and Switzerland and the Scandinavian Monetary Union (SMU) formed in 1872 between Sweden, Denmark and Norway (joined in 1875).  The LMU never established a common monetary standard and this eventually led to its downfall by 1927, but it had essentially already failed during World War 1.  Despite the fact that the Scandinavian countries were largely integrated politically, culturally, and monetarily, their independent political systems created monetary policies proving to be incompatible with the union. By 1924, each member country no longer accepted coins from each country as legal tender in the partner countries and by 1930, the SMU officially disintegrated when all three countries left the gold standard.

While a lot of good attributes can be associated with a common currency, such as ease of monetary exchange and reduction of transaction costs, historically no monetary union has ever succeeded without a common fiscal policy.

That is, a common central authority controlling the purse string. So far only a national government has been able to provide the functional structure needed for a common currency. This fundamental fact was ignored when the Euro was introduced.

Short of forcing the countries of Europe into a much closer fiscal union, which would be tantamount to creating a federal republic of Europe, there is little hope that the Euro can survive with time. Therefore, the future of the Euro is uncertain.

In the meantime, the clear winner is Germany, who has benefitted immensely from the Euro. The great losers are Greece, Spain, Portugal and other countries with smaller economies and a weak industrial base. Those who opted out from the Euro, such as the UK and Sweden, have probably benefitted, as imports and exports to the rest of Europe have been simplified, while they are still being able to control their own monetary policy.

The Problems with the Euro Zone

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