The fall of the Berlin Wall in 1989 showed that the time for much closer, stronger European bonds had grown near. Hopes for a peaceful and prosperous future were higher than ever, among both leaders and citizens. This led to the signing of the Maastricht treaty, which formally established the European Union in 1993 and created much of its economic structure and institutions – including setting in motion the process of adopting a common currency, the euro.
The eurozone structure
The basic idea behind the structure of the Euro was that self-regulating markets would ensure prosperity across the Eurozone as long as:
- Inflation was kept in check by the European Central Bank
- Member States had fiscal discipline, keeping their public deficits and public debt low
For these purposes, the European Central Bank was given a sole mandate to hit a 2% inflation target – regardless of patterns of unemployment and economic activity across the Eurozone. Unlike other Central Banks such as the US Federal Reserve, its mandate does not include ensuring price stability and guaranteeing full employment. Only the former is within the realm of its mandate.
Similarly, the Stability and Growth Pact required member states to ensure that their public deficit was kept below 3% of their national income (GDP) and their public debt did not exceed 60% of GDP.
Since the 2008 crisis, the Organization for Economic Cooperation and Development (OECD), the European Commission, the National Institute of Statistics and Economic Studies, along with other statistics institutions within the European Trade Union Confederation, have all agreed on this fact: In recent decades, social inequalities have increased significantly across Europe. And not only in Greece or Spain: the situation is the same in Sweden and Germany. In the past twenty-five years Swedish society has experienced a considerable growth in inequality; according to the OECD, between 1985 and 2008 the country recorded the highest growth of income poverty among industrialized countries.
After its implementation, the euro fairly quickly became the second most important currency in the world, but as of 2015, it has failed to supplant the U.S. dollar at the top of the world’s monetary heap.
From its introduction in 1999 up until the 2008 financial crisis, the euro followed a steady upward trajectory in value against the U.S. dollar, with the EUR/USD exchange rate rising all the way up to just under $1.60. But the 2008 financial crisis wrecked the euro’s rise versus the dollar in almost an instant. The euro has been in steady decline versus the dollar since then, losing approximately a third of its exchange value, which by 2015, had fallen all the way back down to just above $1.10. The majority of currency market analysts are projecting the euro’s further decline to par value with the U.S. dollar, and some analysts are even predicting both the euro and the EU will eventually collapse and be dissolved.
But it is not a true monetary union even after the grudging repairs implemented since the crisis years from 2010 onwards. The United States is a full-blown monetary union, with a significant federal budget, a federally-issued safe asset, centralised bank supervision and a federal system of deposit insurance. If the banks go bust in Texas, the government of Texas does not have to pick up the pieces: the feds do the job. Nobody worries that the Texas dollar (deposits in bank branches in Texas) might come to be worth less than real dollars in New York or Massachusetts. Nor can the governor of Texas be threatened with expulsion from the dollar zone unless unsecured creditors of bust Texas banks are rescued by Texas taxpayers.
None of these federal mechanisms exist in Europe. The critics of the common currency warned that when a crisis hit, neither national governments nor EU institutions would manage to do much to avert deep recessions and unemployment.
The eurozone debt crisis was the world’s greatest threat in 2011. That’s according to the Organization for Economic Cooperation and Development. Things only got worse in 2012. The crisis started in 2009 when the world first realized Greece could default on its debt. In three years, it escalated into the potential for sovereign debt defaults from Portugal, Italy, Ireland, and Spain. The European Union, led by Germany and France, struggled to support these members. They initiated bailouts from the European Central Bank and the International Monetary Fund.
In 2009, Greece revealed that its previous government had grossly underreported its budget deficit, signifying a violation of EU policy and spurring fears of a euro collapse via political and financial contagion.
In 2010, with increasing fear of excessive sovereign debt, lenders demanded higher interest rates from eurozone states with high debt and deficit levels making it harder for these countries to finance their budget deficits when faced with overall low economic growth. According to the EU institutions and the IMF, this programme of fiscal contraction and structural reform would lead to improved economic performance. However, the result was to push countries deeper into recession and undermine the productive capacities of the economy.
In Greece, which has been subject to the most severe austerity measures, real GDP per capita has declined by more than 25%. Living standards have collapsed, and many Greeks have been left with little choice but to migrate. Across the periphery unemployment has ballooned, reaching over 25% in Spain and Greece. Youth unemployment peaked at 50%. During this crisis, several of these countries including Greece, Portugal, and Ireland had their sovereign debt downgraded to junk status by international credit rating agencies, worsening investor fears.
When the full scale of the banking failures began to emerge, the initial European response was to identify the crisis as made-in-America, while acting with markedly less alacrity and less competence than did the US authorities. There had been gross mismanagement of European banks and gross failures of bank supervision, including in Germany. The first bailout of Greece (or rather of its creditors) in the early months of 2010 was undertaken against the best available advice and must rank as the original sin of the crisis response in Europe. Greece duly defaulted two years later. The imposition on Ireland by Jean-Claude Trichet’s European Central Bank of full pay-outs to foolish unguaranteed bondholders in bust banks was another egregious error, resisted unsuccessfully by Mody and his then colleagues on the IMF staff.
The euro has failed to achieve either of its two principal goals of prosperity and political integration: these goals are now more distant than they were before the creation of the eurozone. Instead of peace and harmony, European countries now view each other with distrust and anger. Old stereotypes are being revived as northern Europe decries the south as lazy and unreliable, and memories of Germany’s behaviour in the world wars are invoked.
The ECB held a lot of sovereign debt. Default would have jeopardized its future. It threatened the survival of the EU itself. Uncontrolled sovereign debt defaults could create a recession or even a global depression.
It could have been worse than the 1998 sovereign debt crisis. When Russia defaulted, other emerging market countries did too. The IMF stepped in. It was backed by the power of European countries and the United States. This time, it’s not the emerging markets but the developed markets that are in danger of default. Germany, France, and the United States, the major backers of the IMF, are themselves highly indebted. There would be little political appetite to add to that debt to fund the massive bailouts needed.
The euro is often described as a bad marriage. A bad marriage involves two people who never should have been joined together making vows that are supposedly indissoluble. The euro is more complicated: it is a union of 19 markedly different countries tying themselves together. The costs of dissolution – both financial and emotional – may be very high. But the costs of staying together may be even higher. Nonetheless, There are political leaders throughout Europe who have become politicians because they still believe that democratic politics can bring about changes that will deliver shared prosperity to ordinary citizens.
If the policy remains the same ,the Eurozone economies will continue to stagnate in the near future, as austerity measures sustain high unemployment and falling living standards in the periphery countries, while fiscal restraint in Germany and other core countries promotes conditions of weak demand across the Eurozone. The doubling down of existing imbalances would see the core and the periphery economies diverge even further, rendering the initial vision of Eurozone convergence a distant pipe dream.
- The Euro and Its Threat to the Future of Europe by Joseph Stiglitz
- Investopedia, The Guardian, OECD.org, the Balance.