The decline and fall of the euro empire

By Owen Bennett

The events of recent months have not been kind to the euro. Long the apple in the eye of many a Brussels bureaucrat, its fundamental flaws have been exposed by the economic turmoil of recent times. Although it would be overly harsh to credit all woes of the eurozone countries to their membership of the euro, it is apparent that the currency contributed to their afflictions in no small measure. Greece presents a prime example of how membership of the single currency can be a factor in fiscal crisis.

As a pre-condition to monetary union, member states are required to surrender control of domestic monetary policy, including policy tools such as interest rates and availability of credit. It is the remit of the European Central Bank (ECB) in Frankfurt to adjust monetary policy in order to control the eurozone economy. However, there is a glaring quandary with this situation. The 16 economies of the eurozone have vastly different economic fundamentals, with each having varying policy requirements at any one time. It is this conundrum that exacerbated the property bubble and consequent slump in Ireland: at a time when contractionary monetary policy was required to prevent the economy from overheating, the ECB was pursuing a policy of expansion.

Moreover, up until recently, many investors and bondholders believed that euro sovereign debt was practically risk-free. One benefactor (or victim) of this mentality was Greece. For years, Greece spent too much, earned too little and plugged the gap by borrowing, in order to facilitate its economic decadence. It flouted EU rules and used imaginative accounting to mask the country’s course toward financial meltdown. However, the party has ended and Greece, like the other PIIGS countries (Portugal, Ireland, Italy, Greece and Spain), has awoken with a bad hangover.

During a slump, currency devaluation is often seen as the most attractive means to kick-start the economy. Although a number of intrinsic problems are associated with the devaluation of a currency, the dual benefit of cheaper exports and more expensive imports can be the vehicle to drive economic recovery. Unfortunately, eurozone members do not have the ability to manipulate the euro’s external value at will. Devaluation of the euro is a policy decision that rests with the ECB and so far, much to the dismay of the PIIGS countries, policymakers have resisted calls to devalue.

It is difficult to see how the many diverse monetary requirements of the eurozone can be reconciled to ensure sound economic management in each of the 16 member states. It is very conceivable that in five years time, the makeup of the eurozone will be altered from its present state, with the possibility of a number of weak economies being forced to leave the single currency.

As the Daily Telegraph commentator Jeff Randell lamented, “The euro was a boom-time construct. In the biggest bust for 80 years, it is falling apart”.