Future and Adoptions - The Trouble with the Euro

Global Centre Stage

Lithuania may well be the eurozone’s nineteenth member, but its arrival, in many ways, could not have come at a worse time, believes Dr Binoy Kampmark

"If nothing changes in the next five years, the European project will be rejected."

Pierre Moscovici,
EU Commissioner for Economic and Financial Affairs,
Journal Gazette, Jan 20, 2015

There was something touching in the symbolic funeral in Vilnius held for the Lithuanian currency, the litas, which received its resting notice as the country formally adopted the euro on January 1. The litas had been in use between 1993 and 2014, having been embraced as a patriotic affirmation of independence after leaving a dissolving USSR. Lithuania, in the meantime, became the 19th addition to the euro zone.

Replacing currencies with supposedly better, collective options has become something of a post-Cold War fascination, notably in an area of the world where it was waged with great ferocity. In Europe, regional security and economic pacts sized each other up, be it the Organisation for Economic Cooperation of the West; or the Communist alliance in the East in the form of Comecon. The Maastricht Treaty of 1992 laid out the official framework, defining the pathway which members of the European Union would move into, first, the European Economic and Monetary Union (EMU) and then the euro. The euro’s creation in 1999 was affirmed a post-Cold War arrangement.

The single European project has put much stake in economic stability. Germany gave up the treasured and stable Deutschmark as part of the gamble – a more united, centralised Europe came before sovereign assertions to specific currencies. That said, the fortunes of the euro were always connected with the health of the German economy. Given that Germany remains the strongest economy within the zone, its fortunes, as The Economist noted as far back as 1999, tend to be closely bound. “That the euro twitches in sync with Germany, whose economy accounts for a third of the euro zone’s, is striking (The Economist, Dec 9, 1999).

Germany was always crucial in the single currency experiment – at least in terms of fulfilling the parameters of economic stability. For one, it dictated the budgetary sentiment of the zone. Despite the assumption that the use of the euro in a union came with criteria, divergences from the EMU criteria took place. Debt was a fundamental feature of the problem. The key restriction of having a maximum of 60 percent of government debt as a ratio to gross domestic product (GDP) was evaded, with the so called PIIGS (Portugal, Italy, Ireland, Greece and Spain) having debt-to-GDP ratio exceeding 100 percent.

Much of this was overlooked initially. In 2006, German economist Otmar Issing claimed that the euro, after a period of seven years, was ‘firmly established as the currency of over 300 million people.’ It was unprecedented for one vital reason: the creation and use of a currency without a state. Joshua Aizenman provided a sober corrective to this: the euro may well be a currency without a state, but it was ‘under the dominance of Germany’.1

Far More Than a Currency

That Lithuania has joined when others have seen probable cause for exiting the euro zone is an indication of the currency’s troubled fortunes. Opponents towards the adoption of the euro are found across the European divide. Their concerns tend to be from the same recipe book: a concern about loss of sovereignty, the surrender of various monetary functions to a broader body, and the fear that economic benefits simply will not stack up.

Moving over to the euro was always a thorny issue in the Lithuanian case. Local resistance has been aggressive – a November poll in Lithuania suggested that 39 percent of the population was against it. Their grounds of suspicion were well founded. While supporters of the euro’s adoption believe – and in this, it is very much a belief – that the adoption of the currency will lead to easier foreign loans and investments, the converse may actually be true.

The Lithuanian Prime Minister Algirdas Butkevicius sees the euro in broad financial and security terms. It is, in other words, far more than a currency. It is a broader promise, a deliverance of miraculous import. “The euro will be a guarantee of our economic and political stability. It will allow us to more rapidly develop the economy, create jobs, and increase incomes. I firmly believe that we will strengthen the European family.”

The Lithuanian Minister of Finance, Rimantas Šadžius, argues that the currency’s adoption follows a process ‘which will enable us to contribute to joint decision making. This creates a strong geopolitical and economic basis for creating a prosperous welfare state, generously embracing all the people of our country’ (Lietuvos Respublikos Centrinis Bankas, Jan 1).

The sovereignty issue is not being seen in purely financial terms. The future of the euro, and indeed, the euro zone, cannot be divorced from the overall security environment in which countries find themselves. For Lithuania, the Russian question looms, and rushing into the bosom of the common currency is also deemed to be a cover, however poor it may be in quality, for broader security concerns. The sentiment from the Baltic countries has tended to be rather clear: either you court Brussels with affection and appropriate respect, or end up being grabbed by Russian President Vladimir Putin (AP, Dec 31, 2014).

For all of this, there is a sense that adopting the euro is a panacea, a plug, to take one example that will ease emigration levels that are starting to produce chronic labour shortages. ‘Retaining talent,’ notes a Vilnius University spokesperson Nijole Bulotaite, ‘is one of our most pressing problems along with demographic changes’ (University World News, Feb 7, 2014).

The euro is not merely an economic matter, but one that ties in countries to a system of collaborative engagement that tends to force, rather than initiate, cooperation. Monetary policies are centralised, including the setting of interest rates by the European Central Bank. In theory, at least, the more the merrier, though such crowds can prove to be a disempowered lot. Lithuanians woke up on January 1 to realise that their institutions will not be able to determine interest rates and the budget deficit – that aspect of sovereignty, at least, has been surrendered.

Government borrowing rates are predicted to drop by one percent, while a single currency bloc does have advantages in terms of minimising investment risks. That is all to the good, till one realises that the countries in the euro zone are in a vicious cycle: to be credible as members, fiscal propriety is necessary; to have such fiscal soundness, an abandonment of sovereignty is required. All in all, evenness is sought – in terms of financial and economic performance. But Brussels cannot have it both ways: the wisdom of independent monetary policies that seek tight spending while also granting sufficient powers to the central bank.

European Problems

In that sense, the Greek problem is a European problem, which also translates into the euro problem. With elections scheduled for January 25, a leading candidate, Alexis Tsipras of the Left-wing Syriza grouping, is playing the euro game with all its contradictions. Tsipras claims that he wishes to keep Greece in the euro, but he wishes to ease the shackles, scrapping asset sales, repudiating debt, and abandoning austerity measures (The Economist, Jan 3).

Tsipras’ behaviour on the Greek political scene is broadly illustrative. It remains a classic error to link the embrace of a widely used currency with the assumption of economic performance, either current or future. Even Mario Draghi of the European Central Bank would have to concede in the Italian daily Il Sole 24 at the end of December last year that ‘our monetary union is still incomplete.’ Structural reforms needed to be embraced to ‘ensure that each country is better off permanently belonging to the euro era.’ His preference is a ‘capital markets union’. All to the good, as long as the capital is there.

Few should forget that the economic powerhouse of Germany bore witness to ‘no shop’ days in June 2002 in protest against retailer’s efforts to push up prices against their pre-euro equivalent. Economic unions come with stretches of growing pain.

It should go without saying that various countries in the euro zone, irrespective of their use of the currency, are ailing and stuttering. Institutional integrity was avoided in favour of idealistic hurriedness. Dealing in euros does not make loans any less troublesome if other parts of the economy are dragging. A collective in a currency union is only as good as its members. According to Paul De Grauwe of the London School of Economics, the very fact that a shared budget mechanism is missing from the euro system is fundamental. Such a ‘missing component… explains why the euro zone is so fragile’ (Journal Gazette, Jan 20).

Other Baltic countries have had reason to be critical of the euro’s adoption. Latvia’s Igor Pimenov, a parliamentary member, views the euro adoption an unnecessary mania. Those who retain their national currencies, he argues, have a better chance to right the economic ship. Then, there are the usual imbalances in various economies, with Lithuania being the euro bloc’s poorest member.

Last year, Pimenov made his views against the common currency clear in his campaign against its adoption. ‘We are not against European integration. But we voted against the euro because we are sure that it’s not the right time for Latvia to join the euro zone’ (Eurobserver, May 5, 2014).

US commentators also fear that hiccups in the euro market may well precipitate disturbances in the US markets, causing ‘a worse impact’ in the words of Terry Connelly, dean emeritus of the Ageno School of Business at Golden Gate University at San Francisco, ‘than the Great Recession because it would produce an even greater one worldwide.’ A run on banks is a very likely outcome to arise from a collapse of the euro. But that, even in the worst case scenario, is unlikely.

Price Higher than Returns

Lithuania’s admission to the euro club also comes at a time when the currency itself has been battered. The big league players are still incapable of resolving their differences, with Germany continuing on its unbending austerity platform, and France and Italy deflecting on promised structural reforms. France, despite its size in the union, feels left out. The Economist noted in October 2014 that the entire zone was feeling the deflationary phenomenon. ‘A region that makes up almost a fifth of the world’s output is marching towards stagnation and deflation’ (The Economist, Oct 25, 2014). Cuts to budget expenditures encouraged by Germany will only serve to deepen that deflationary trend.

The price of admission to the euro zone may well be higher than its returns. This very point is being debated in Greece with elections scheduled for January 25. Greek Prime Minister Antonis Samaras has issued a warning that the country may well exit the euro zone altogether (Bloomberg, Jan 5). The German Chancellor, Angela Merkel, is putting on a brave face, suggesting that the zone will cope.

Lithuania may well be the zone’s 19th member, but its arrival, in many ways, could not have come at a worse time. Europe’s dissident parties are taking stock on a currency they see as institutional madness and dysfunction. Podemos, Left-wing political party in Spain, has cheered the exploits of Syriza in Greece, hoping for a continental rally against the bind of the euro. To put stock in a currency’s powers of salvation for broader economic deficiencies is never sound policy. The possibility of Grexit is not something to derive comfort from, though weaker economies are finally growing.

The fractious big players are at wit’s end about how to deal with the problem, while the small members either remain submissively silent or are seeking a noisy withdrawal. The euro itself, however, is a currency that continues to have legs. It will have to continue to do so, if a broader crisis in the interbank service is to be avoided. Otherwise, the very idea of a fiscal compact, currently envisaged, will be abandoned.

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Dr Binoy Kampmark

Dr Binoy Kampmark was a Commonwealth Scholar at Selwyn College, Cambridge. He lectures at RMIT University, Melbourne, and may be contacted at bkampmark@gmail.com.

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    1 J. Aizenman, "The Eurocrisis: Muddling Through, or On the Way to a More Perfect Euro Union?", NBER Working Paper, 20242.

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