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12th June 2005
Article for The Japan Times
By David Howell
What Future Now for the Euro Currency?
LONDON- Now that the proposed Euro-Constitution has been well and truly sunk
(although parts may be salvaged), could the same fate happen to the
Euro-currency?
Before this is dismissed as unthinkable it has to be remembered that the Euro
was originally introduced not as a monetary scheme but as a political one. It
was depicted as a giant step towards political union in Europe and towards the
emergence of one integrated European bloc which would be a rival both for the
almighty American dollar and for American hegemony generally.
The ambitious scheme for a single European currency – the Euro - was intended
from the start to rest on three pillars – first, monetary cohesion provide by
the European Central Bank; second, budgetary and fiscal solidarity, provide
initially by the so-called Stability and Growth Pact; third eventual political
cohesion and integration of the EU member states.
The first pillar remains squarely in place. But the second pillar has crumbled.
Budgetary discipline has been abandoned in Italy and could well be discarded in
Germany. Several states find it intolerable that their public spending, and the
borrowing necessary to finance it, should be limited by rules which seem
unnecessary and onerous. New and much laxer rules for budgetary limits within
Euro-zone states have been devised which hardly provide any discipline at all.
Yet it was this Stability and Growth Pact which was supposed to be the rock on
which the Euro rested, pending the arrival of full political union in Europe.
That was the third pillar, which has also been badly shaken by the French and
Dutch rejections of the whole new Constitution scheme.
The outcome is that the Euro, which until recently looked so strong, suddenly
seems to be a riskier proposition. Meanwhile, the strains of trying to impose a
single interest rate on twenty five highly diverse nations, many of them with
widely varying economic growth rates and social conditions have combined with
new doubts about the EU’s future to make the financial community increasingly
uneasy.
The Italians in particular are finding the Euro particularly irksome and a
senior Italian Minister has spoken out demanding the return of the former
currency , the Lira. But the Dutch have also complained loudly, arguing that the
Netherlands should have followed the British policy, which has been to stay well
clear of the Euro-zone. There have even been rumours from Frankfurt, the
heartland of financial prudence and the home of the ECB, that all was not well
with the Euro.
Investors have grown particularly wary of bonds issued by the Italian
Government, even though these are denominated in Euros and the Italian
Government is being forced to offer higher rates than elsewhere to persuade
investors to take up its paper.
The irony in all this is that the main alternative to the Euro, namely the
U.S.dollar, has been looking far from healthy until very recently. The Central
Banks of China, Japan, South Korea and other Asian nations, who over two or
three years had been patiently accumulating enormous dollar holdings to prop the
dollar up were just beginning to switch some of their holdings into Euros, with
the result that the dollar had been sagging and the Euro had been riding high.
Now all that has suddenly changed. The Euro’s longer term future no longer looks
so good, so that the Asian Central Bankers are likely to be having second
thoughts. Certainly the outward and visible sign of this has already been a
sharp depreciation in the Euro against the dollar in recent days.
So where now for a currency which was born with high hopes but now lacks not
just a single Government behind it , but even the hopes that such a Government
will ever now come into being? One certainty is that the British will be
reinforced in their determination to stay well outside the Eurozone and thus
also stay clear of the sharp swings between the Euro and the dollar which have
added to international financial instability.
Another strong likelihood is that the recent new entrants into the EU from
Central Europe will be much more cautious before they, too, commit themselves to
the Euro and give up their own denominations. Instead they will probably favour
a kind of semi-fixed relationship with the Euro itself, not unlike the old
Deutschemark Zone system, whereby a number of European countries kept their
currencies roughly in line with the all-powerful DM.
For those countries already in the Eurozone the exits are not nearly so easy.
Disengaging from the Euro system could prove immensely complex and expensive. If
Italy attempted it the immediate effect would be to make all its borrowing very
much more expensive still. Furthermore, a very large number of people in Western
Europe have invested heavy political capital, as well as personal commitment, in
making the single currency work.
All this suggests that while the Euro may lose some of its shine it will survive
in a more modest form – possibly within a currency union covering France,
Germany, Belgium, Spain and maybe Italy. This would be an area of relatively
slow growth and weak competition, resisting reform and possibly protecting
itself increasingly with barriers against rising Asian challenges and other cold
and unwelcome trade winds.
Eventually, of course, that would lead to falling living standards and
impoverishment. But the process might take many years and in the meantime all
these countries would remain delightful places to visit and in which to holiday
and use the Euro currency in an atmosphere of tranquillity.
And if that is the way these once great European nations wish to manage their
decline who is to say that they are wrong?
ENDS
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