Euro in Limbo

Norbert Walter

Norbert Walter was the former Chief Economist of Deutsche Bank.

Germany is (one) key to the future of the Euro. Germany is a country endowed with a Chancellor who is capable and willing to lead. It is, however, also a country with its own mind – and a very peculiar one at that. The governing coalition consists of two parties in which bourgeois majorities have quite a narrow national focus. These majorities accurately reflect popular sentiment in the country, which goes something like this: we Germans have gone to great lengths and worked in a disciplined way to keep down private and public debt – despite enormous challenges (unification, bank rescue) – to levels well south of those in Japan, the US or the southern European periphery. We should not now tarnish our success by bailing out the offenders, which would save them the effort of helping themselves.

But the opposition to cooperative action does not end there. A large majority of macroeconomists are telling students and the public – and much of what they say is echoed by the media – that the bleeding of the countries with sound finances must stop, and that the right conditions must be set in the countries that have not abided by the rules of the currency union (i.e. wage and cost discipline, fiscal discipline). These countries – they suggest – should leave the Euro, reintroduce their national currencies, declare default, inflict a haircut on all the creditors, and start anew.

This economic advice from the German professors is echoed by the investment bankers on Wall Street and in the City. It is also widely seen as the most probable sequence of events by investors around the globe, particularly in rich emerging markets.

Such a sequence of events has a probability of less than 10 percent. But more importantly, it is not at all desirable. The suggested solution would – if tried – prove to be a recipe for disaster. The new currency would take two years to be introduced, with chaos ensuing during the changeover. The citizens of southern Europe, who had become accustomed to a strong currency, would not accept a weak and depreciating national currency. In the same way that we saw a dollarization in an inflation-prone Latin America in the 1980s, we would see the Greeks turn their backs on the New Drachma and their Greek banks to hold accounts in safer places and in safer currencies. Since the existing debt is in Euros, the introduction of a depreciating drachma could not make debt servicing any easier. Would such an environment stabilize southern countries and reestablish growth momentum? Certainly not. It would make disinvestment by foreign investors more likely than new investments. Greek politicians would be forced to defend their policies on their own, as they would not be able to blame any outside institution for having put pressure on them.

How would Germany fare? It would be confronted with an internal European Market in disintegration mode − partners in disarray, weak growth, and an increased exchange rate, which would probably weigh excessively on price competitiveness. This is a cocktail that would certainly breed recession.

Why is nobody studying Latin America in the 1980s? Why is nobody studying the currency-anchoring policy of Austria and the Netherlands in the 1970s and 1980s, or the policy that Estonia has been pursuing just over the last few years? It is obvious that in troubled waters, being anchored to a stable currency as a member of a tightly integrated internal market – in terms of trade and investment – is preferable to a floating exchange rate regime with excessive volatility that often gives rise to problems that would otherwise not come into existence. So much for normative reasoning.

But how will events unfold? Which role will Germany play?

Will the German president refuse to sign legislation that he believes is not in step with mainstream German thinking? Will the Constitutional Court rule against certain rescue packages? Will the parliament reject Merkel’s and Schäuble’s proposals? Or will there be a majority in the Bundestag for such proposals thanks to support from the Greens and the SPD, which will diminish the influence of the CDU and FDP opponents to the rescue packages? Or will the harsh fiscal restrictions in southern Europe drive more citizens onto the streets and prompt them to call for another republic?

These questions are anything but rhetorical! Still, I do believe – if and when we approach the endgame – that Europe and the Euro will not be sacrificed. Strong political will and eventual economic insight shall emerge, and business elites will understand that narrow commercial or national interests are outdated concepts in an interconnected, globalized world.

Europe will be much better off if it preserves the institutional setting of an ever more integrated Europe, along with an aspiration for enlargement.

There is no doubt that this cannot be based on the continuation of “light touch” regulation of the financial markets. The current situation is much more conducive to winning the support of the UK Government for tougher, more effective, and more international regulation. If Europe speaks up, even the elephant − the US − will listen. We need Basel III, we need rating agencies that are not financed by the issuers of securities, we need fixed remuneration of supervisory bodies in the financial sector (no profit-related bonuses), and we need anti-cyclical regulation (downpayments have to increase when asset prices rise and vice-versa).

The Euro should not be put at risk. For the next decade the Euro is the only serious competitor to the Dollar. In the same way that the world is better off with Airbus competing with Boeing, the financial markets are also better off with the Euro challenging the Dollar.

Dr. Norbert Walter is a Consultant at Walter & Töchter Consult and a AGI Non-Resident Fellow.

The views expressed are those of the author(s) alone. They do not necessarily reflect the views of the American-German Institute.