The Future of Euro and EU

With the continuous outpouring of bleak economic data from the EU, the ironies of Brexit and recent Yellow Vests and other much more right wing anti-EU movements, many are justified in expressing deep pessimism bordering on despair about the prospects for the sustainability of the monetary union. Some are skeptical now even about the EU project even as they reject the proto-fascist and neofascist alternatives. I should hasten to add that I am not in the latter group of skeptics. But I will argue here that breaking up the monetary union--- however disruptive it may be in the short run--- will actually be beneficial, particularly for the distressed countries. It will also be better to do it before Germany decides unilaterally to exit the euro instead of shouldering the unwelcome responsibilities such as bailing out the Southern Tier Eurozone countries like Italy. At the same time, I want to argue that Europe can and most move forward to at least a democratic quasi-federalist EU.

During the second decade of the 21st century, at least in some areas at least, some progress was in evidence before Brexit and other regressive movements took center stage. For example, even before the Greek crisis and the broader crisis of the PIIGS, at least some structural causes of the EU crisis were identified. Contrary to the not-always-well-informed American press which seems congenitally pessimistic regarding the future of EU, actions were being taken by the EU to address some of these deep problems. For example,, on September 12, 2012,to be exact, a little known German constitutional court---little known to the outside world and particularly in the US, that is--- took a momentous decision and prepared the way for the country’s participation in a new European bailout fund. Furthermore, even earlier the European Central bank (ECB) had reversed an earlier policy stance and decided that it would serve as a lender of last resort for government bonds after all. I will come back at the end to argue for more steps in the right direction for creating a truly federal EU. But right now I will raise an ominous question: will euro survive given the level of debt in Southern Europe and the German reluctance to bail out these debtors?

There are arguments for maintaining the status quo mainly because of the costs of changing the monetary system. Therefore, the answer to this question is not obvious. We are also witnessing the Brexit case that underlines that even without the extra burden of changing from euro to national currencies, exiting the EU is messy and difficult. But what if the strongest member of the EU, namely Germany decides that it does not wish to maintain the euro any longer? Although Germany has benefited handsomely by running continuous trade surpluses to the tune of several trillion euros since 2000, it never envisioned the prospects of bailing out the southern tier of the eurozone, much less cherish it. Therefore, it is almost axiomatic that once Germany decides to quit the euro and starts issuing Deutschemark once again, the euro will die also. While such a scenario is not inevitable, the fiscal trends in the southern tier countries make it a possibility. It may have been inconceivable a few years ago in practical terms. But my personal experience with the methodical and disciplined descendants of Hjalmar Schacht convinced me even in 2007-2008 that ECB and the German Finance Ministry had many contingency plans including one for exiting the Eurozone. Indeed times have changed, and German resolve to maintain the euro regime is much less in evidence. Many private actors in Europe seem to be also expecting such a contingency at some point in the future. In fact, even many non-German European private citizens and firms are putting their euro accounts with German banks already. However unlikely now, if and when Germany quits the eurozone, the value of the new German currency will appreciate immediately which is not good news for the German exporters but for all holders of the new currency including those from abroad with euro holdings along with the German citizens. Surely this is a much better bet than holding the nearly worthless euros elsewhere.

Anyone who knows anything about realpolitik knows that if the political class in Berlin makes the decision to drop the euro on grounds of sound finance, the temporary decline in German trade surplus will be acceptable to this elite class. Given the German edge in robotics and automation in general and superior social democratic labor-management relations and generally fair social contract between the citizens and the government, it is a good bet that Germany can withstand such a transition without as much chaos as the other countries run a healthy current account surplus . Even France will not have an easy time in this type of transition. Apart from Germany, the Netherlands and Finland in the Eurozone will also be able to manage such transition relatively quickly and easily. The other Scandinavian countries are not part of the eurozone. They can pat themselves on the back once again if the scenario of German exit from the euro materializes.

I may have started sounding like Cassandra; but my purpose is more positive than predicting disaster. The important point I wish to make is that ending the euro may not spell the end of the EU. Rather a more democratic EU with better representative regional institutions which will be much more cautious about getting entangled with the US imperial projects will be a better(more perfect?) union. Among other things such a genuinely democratic EUwill promote genuine human rights in Europe and elsewhere peacefully. All this can become possible without the albatross of euro. Perhaps the European leaders should read Coleridge’s great poem along with tomes of economic treatises and reams of statistics.

No thoughtful democrat can doubt any longer that a genuinely democratic federalist project away from the dangerous and disastrous neoliberal path followed by EU so far is much to be preferred to the current situation. It should be recognized before it is too late that the neoliberal path is leading rapidly towards neofascism in Europe. Europeans who value democracy and human well-being need to act quickly with an understanding of the deeper causes of the European malaise.

The deep underlying causes of the by now semi-permanent eurozone crisis are indeed the flaws in the design of the transnational monetary union. The Economic and Monetary Union (EMU) launched in 1999 consisted of the euro and the European Central Bank (ECB) for a common monetary policy. While the countries surrendered their ability to formulate and implement independent monetary policies, the fiscal and other economic disparities were not addressed. Nor was there a fiscal union, or even strong fiscal federalism and other institutional mechanisms required for coordinating structural policies to address the uneven economic development in Europe. Both the Werner Report of the 1970s and the Delors’ Report of the 1980s, which served as the blueprint, had developed a three-stage roadmap comprising closer economic coordination among members, binding constraints on member states’ national budget, and a single currency. The Maastricht treaty reflected these. But Krugman’s inept joke at the time about the unpronounceable---by the provincial American tongue at least--- name of the city indicating future trouble, did contain the germs of an apt economic argument and judgement. But that argument, not fleshed out by Krugman then, was far from the complacent conventional wisdom in Euro-American academe.

In hindsight it seems clear that in their eagerness to put through a full and irrevocable European unity, the treaty makers had hastily concluded that the two convergence criteria written into the Maastricht Treaty – a three per cent limit on annual fiscal deficit and 60 per cent limit on gross public debt to GDP ratio - would be adequate for maintaining the irrevocable European unity. In truth, this was the result of using a flawed theory---monetarist in its origin and naïve in terms of political economy and politics during possible crisis. In fact, no possibility of a crisis was countenanced.

On the positive side, the institutional flaws have now been identified honestly at least by some and can be fixed. A key shortcoming in the design of the EMU was the absence of the lender of last resort in government bond markets. It is axiomatic that when a country issues sovereign bonds in its own currency there is an implicit guarantee from the central bank that cash will always be available to pay out the bondholders. One can call it an “implicit contract”, following the insights of contract theory, a branch of theoretical economics developed vigorously in the last twenty five years in North America and Europe. The absence of such an implicit contract in a monetary union – where bonds are issued in a currency over which individual countries have little or no control - makes the sovereign bond markets prone to liquidity crisis and contagion, very much like banking systems in the absence of a lender of last resort. Just as in the previous paragraph, the outcome was both the inability to use good theories that were in fact available and to use good long term statesmanlike political judgment.

The situation was compounded by the lack of flexibility of ECB earlier. For a long time, the ECB interpreted the no-bailout clause in the EU treaty quite rigidly. The “Central Bank” was reluctant to pursue the role of lender of last resort. Here, the Scandinavian Central Banks, or even the Bank of England have turned out to be better mangers of a capitalist monetary-financial economy than the inept ECB which even now is reluctant to move quickly. Blaming the Germans ---even if largely accurate---will not get the EU out of this monetary mess.

Most crucially, there are those crucial economic and political well being issues connected to the policies of fiscal austerity. Related to all this is the crucial question: which class will bear the burden of adjustment? Internal class struggles could derail the whole effort that is underway now of fixing EU’s problems without changing the fiscal rules. It remains to be seen ultimately how technically astute and politically wise the ruling elites in the most powerful EU countries are. The fiscal compact and banking union are both steps in the right direction. But such partial measures can not solve the serious longterm issues of 21st century capitalist economies and polities. Ultimately, only a more deeply democratic union based on fair class compromises can save the EU.

Therefore, a simple euro vs. no euro formulation of the debate without considering the larger democratic project for Europe obscures the key issues of (quasi-) fiscal federalism. With or without euro, EU will need a social democratic fiscal federalism that is based on negotiations between big capital and labor in particular. But it will also have to be based on a broad-based consensus among all constituencies including the immigrants and non-white citizens in EU. Responsibilities for avoiding a looming replay of the 1930s and a neofascist future demand no less from both the elites and ordinary citizens in the various countries that are parts of the EU.

Notes: The writer is a Professor of Economics, University of Denver. Josef Korbel School of International Studies and former Senior Economic Adviser to UNCTAD.