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19mar10


Moment of Truth for Europe's Common Currency


Greece's financial difficulties have exposed numerous weaknesses which threaten Europe's common currency. Now, policy makers and economic experts are trying to find ways to stabilize the euro. SPIEGEL ONLINE takes a look at the proposals.

French Economics Minister Christine Lagarde seems to be itching for a fight. At the beginning of the week, she triggered indignation in Berlin when she blasted Germany's trade surplus in an interview with the Financial Times. The fact that Germany exports more than it consumes domestically hurts the country's European neighbors, Lagarde griped.

On Wednesday, she added more fuel to the fire. Speaking to the French radio station RTL, she said that when an economic union such as the euro zone faces difficulties, "everyone" should contribute to the solution. Countries with a deficit, she said, ought to reduce it, while those with a trade surplus cannot "stand on only one leg." "For instance, perhaps Germany could reduce its taxes a little to stimulate domestic spending," the minister suggested.

Germany's Christian Democratic Chancellor Angela Merkel reacted coolly. "We will not give up our strengths in those areas where we are b," she said in German parliament on Wednesday. The chancellor may have shown recent interest in the long-shunned concept of a "common economic government" for Europe. But she would like it to be pegged to Europe's economic success stories, not those countries which are lagging behind.

But it is precisely the less competitive countries that pose the biggest problem for the euro zone. The disastrous budget situation in Greece has highlighted the common currency's weaknesses in recent weeks and similar situations in Spain, Ireland, Italy or Portugal could aggravate the situation even further.

Competitive Discrepancies

Critics warn that the euro zone is about to face a crucial test. Since the introduction of the common currency, they argue, the countries within the zone have grown further and further apart instead of growing together into a single economic zone, partly because there are no longer any currency fluctuations to offset competitive discrepancies.

The community now consists of countries like Germany and Finland on the one side, with large current account surpluses, and countries like Greece and Portugal on the other, with massive deficits. The latter, unable to keep up with the continent's powerhouse economies, lived on credit for years, partly as a result of low interest rates.

The logical conclusion would be a common economic policy for the entire EU. But this is an idea that meets with fierce resistance, since hardly any country is willing to relinquish control over its own budgetary and industrial policies.

So what can the community do to avert crises like the one that happened in Greece in the future? What should happen in the event of the worst-case scenarios become reality? SPIEGEL ONLINE clears up the most important questions surrounding the future of the Euro.

Is Europe Laying the Foundation for a Common EU Economic Government?

The name sounds suitably ambitious. European Commission President José Manuel Barroso has come up with a package of economic policy goals to be attained in the next 10 years. It bears the title "Europe 2020." Those goals are:

  • That 75 percent of people below the age of 64 are employed;
  • That 3 percent of the gross domestic product is invested in research and development;
  • That the EU's climate targets are implemented;
  • That 40 percent of young people have a university education;
  • That the number of people threatened by poverty is reduced by 20 million.

The aims of "Europe 2020" are to be broken down into "country-specific recommendations" for each EU country. To that end, the member states would have to submit their initial "national reform programs," included a timeline for implementation, by the fall of 2010. Barroso wants to see the plan approved in June.

However, it's unlikely that Barroso's plan will simply be rubber-stamped. And even if it is, the community would still be miles away from a common European economic government. On the one hand, the plan includes no sanction mechanisms whatsoever for countries that do not reach their goals. It only calls for the issuance of warnings.

On the other hand, the concept does not affect truly sensitive political areas like budgets and wage policy, even though they are precisely where the community's problems lie. Different wage costs lead to competitive disadvantages, and a member states that lives beyond its means for years can harm the entire euro zone.

In other words, if the community hopes to avoid budget crises like the current one in Greece, it will have to come up with Plan B.

How Can the EU Stability Pact Be Made More Robust?

Has the Stability and Growth Pact, which was designed to provide for a b European common currency, failed? It's hard to say. What is clear, however, is that its implementation has been a disaster. The Maastricht Treaty established clear criteria for budgetary policy in those countries belonging to the common currency zone, one of which was that new, year-on-year borrowing could not exceed 3 percent of GDP, and that a country's total debt could not exceed 60 percent of its economic output.

That, at least, was the theory. In practice many countries, including Germany, have violated one or more Maastricht criteria since the introduction of the euro. Penalties, however, have been virtually non-existent. The reason: for financial penalties to be imposed, they must be approved by a two-thirds majority in the EU's Economic and Financial Affairs Council (ECOFIN). Given that it is made up of economics and finance ministers from the 27 EU member states, many of which have violated or are in violation of Maastricht criteria, a two-thirds majority is difficult to come by.

So what could be done better? The obvious answer is: Accelerate the process of evaluation and make penalties automatic. This is exactly what many economists are now calling for.

But this solution also contains a basic dilemma. "Financial sanctions or the curtailment of subsidies for financial weak countries are not very credible approaches," says Kai Konrad, a professor at the Max Planck Institute in Munich. Financial penalties, he points out, would be payable precisely when -- and because -- the offending country has no money.

What Should the EU Financial Constitution Look Like?

Economic expert Konrad has a different approach to the problem. Instead of asking how to protect a country from bankruptcy, he asks why bankruptcy is such a bad thing. "If all the world's investors tried to maintain a balanced portfolio, that is, put their eggs in various baskets, a Greek bankruptcy would not be overly dramatic," he says.

The country itself wouldn't suffer terribly, because, by imposing a moratorium on payments, it could cancel its interest and debt payments, saving a lot of money as a result.

The problem, says Konrad, is that "we have investors who make one-sided bets. On the one hand, because everyone else does it, and, on the other hand, because it makes it more likely that other countries will jump in to help out in an emergency."

This "Samaritan problem," says Konrad, explains why a small country like Greece has such an impact on the stability of the euro, and why a country with a population of 11 million, whose economic output is smaller than that of the German state of Baden-Württemberg, is "systemically relevant."

"If we can manage to put an end to casino capitalism in the financial markets, the European Stability Pact will function," says Konrad. The only question is how to make it work. Konrad proposes "establishing impulses," such as "massively" raising the equity ratios for banks. He reasons that when an investor, a bank, in this case, loses a bet it also loses a percentage of its equity capital, and the higher the ratio, the more a bank stands to lose by making risky investments.

However, this approach would not yet solve the problem of all euro countries being negatively affected by the economic deficiencies of one. Dennis Snower, the head of Kiel Institute for the World Economy (IfW), has a different idea: To establish debt commissions in individual countries. The commissions would have the independence of central banks and would also have the power to issue mandatory rules. "The commission must observe the economic cycle and set individual deficit limits accordingly," says Snower. The goal is to achieve an anti-cyclical debt policy. When the economy is doing well, new lending is restricted. When there is a threat of recession, the government is permitted to pump more money into the markets.

Eurogroup chief Jean-Claude Juncker is warming to another idea: the imposition of debt ceilings, based on the German model, in all countries in the monetary union. In Germany, this instrument, which is enshrined in the country's Basic Law, goes into effect in 2011. Beginning in 2016, the federal government, under normal circumstances, will only be permitted to borrow new funds up to an annual limit of 0.35 percent of GDP, and by 2020 the German states will not be allowed to borrow from banks at all anymore. "We will have to think about an instrument like this in the euro zone," Juncker told the German newspaper Rheinischer Merkur. This goal doesn't seem completely unrealistic. The instrument is already being discussed in Austria.

Could a European Monetary Fund Help in an Emergency?

A European Monetary Fund (EMF) would kick in when a euro country is already in trouble, that is, when it is deeply in debt and on the verge of bankruptcy. Then the fund could come to the country's aid and impose restrictions on fiscal policy in return. That much seems clear.

German Finance Minister Wolfgang Schäuble, a member of the center-right Christian Democratic Union (CDU), was short on details when he injected the idea of an EMF into the political discussion. In an article in the national Sunday newspaper Welt am Sonntag, Schäuble wrote that he wants an "institution that has the experience of the International Monetary Fund (IMF) and has similar powers of intervention. The euro zone wants to be able to solve its problems under its own steam." Chancellor Merkel added that an EMF would also have to "regulate the orderly insolvency of a country." So far, so vague.

Many questions remain unanswered. Should an EMF be given its own bureaucracy, that is, analysis and supervisory units? Or is the real goal to create an instrument for emergencies, that is, clear mechanisms for crises like the Greek debt crisis? And where would the money that an EMF would distribute come from?

One proposal for an EMF stems from the chief economist of Deutsche Bank, Thomas Mayer, and Daniel Gros, the director of the Center for European Policy Studies (CEPS), a Brussels think thank. They are calling for the payment of contributions by countries that do not abide by the Maastricht debt rules. The countries would be required to pay 1 percent of the difference between their actual and allowed debt level. According to the economists' calculations, this would have enabled an EMF to collect 120 billion ($164 billion) in funds since the beginning of the monetary union.

The weakness of this proposal is obvious: Financial penalties would be imposed on governments that are already low on funds. The alternative would be for financial b euro countries to fund the EMF. That, too, would create problems, with the use of the funds likely becoming subject to b political pressure.

Another problem is the question of how the EMF can penalize countries that do not abide by its reform rules. Of course, it can impose fines, and of course it can slash credit lines or possible loan guarantees. But that brings us back to the dilemma of financial penalties being imposed on cash-strapped offenders.

How Likely Is an EMF?

There is considerable skepticism about the idea of an EMF. "I don't believe that we will get very far with this form of technocratic regulation," says Kai Konrad of the Max Planck Institute. Klaus Zimmermann, head of the German Institute for Economic Research (DIW), also believes that it doesn't make much sense to "create yet another naval gazing organization."

Jörg Krämer, chief economist at Commerzbank, is worried that an EMF could undermine the Stability Pact even further, because, on the one hand, rules would be established to encourage solid government finances and, on the other hand, the EMF would create mechanisms to address the possibility of those rules being violated. "This makes the system less credible from the start."

There is yet another problem: It will take years to develop an EMF. And if Europeans truly intended to create a counterpart to the IMF, they would even have to reopen the Treaty of Lisbon. However, any amendment to the contract that serves as the basis of the EU requires a unanimous vote, and the corresponding parliamentary resolutions in all member states -- and, in Ireland, a referendum.

Were the euro countries to overcome the hurdle by creating a treaty on the model of the Schengen, border-free travel agreement, it would result in a watered-down version of the EMF. Should the idea get that far, Germany could still pose a problem, because its Federal Constitutional Court has already made it clear that the transfer of further competencies to the EU is likely to cause problems.

Despite the many obstacles, Europe's Economic & Currency Affairs Commissioner Olli Rehn intends to develop a concept for an EMF by June. However, the commissioner has already made it clear that this would be only one of many possible instruments. Politicians in other euro countries are also being noncommittal. "I see no need for the member states to hand over economic policy competencies to a European institution," Irish Vice President and Economics Minister Mary Coughlan told Handelsblatt. And French Finance Minister Lagarde said that the proposal was not a priority for the euro countries.

[Source: By Anne Seith, Spiegel, Deu, 19Mar10]

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