It has been a rocky 2011 for the Euro, with opponents grabbing the opportunity to claim the currency was fundamentally flawed since its introduction across the continent on New Year’s Day in 2002. However, despite the Greek economic crisis, a couple of bailouts, and fears for similar collapses in nations such as Ireland, Portugal and Spain, the Euro is still with us and, for the more reasonable commentator, rumours of its demise have been a little premature.
But for a moment let us imagine the worst. What if, the Euro did cease to exist? If, with national elections around the corner, the German chancellor Angela Merkel decided it would be politically advantageous to dump the currency it has propped up in the past few months? Currently, the Chancellor does not have enough coalition votes to secure backing for the reworked package for the European Financial Stability Facility (EFSF), and the pressure and focus will clearly be on Germany and its chancellor to see what their next move will be. With German companies also revising their outlook down for 2011/12, the internal pressure and political stakes have never been higher.
But would this be enough pressure to push Germany, and others such as France, to leave the Eurozone? Any positives would soon be replaced by shamed faces within the two nations that pushed the single currency upon most of the European Union. But, what if, the Euro’s largest champions finally had enough of the bailouts? Or, rather, their citizens took to the streets to demand their withdrawal, not unlikely in one of the protest-capitals of the world, Paris. Leaders would have to make a clear choice; European or national interests.
A full collapse of the Euro will seem shocking to many and highly improbable but the practical consequences are not so hard to predict. Those 17 countries within the eurozone would, in all likelihood, revert to the currency they held before the Euro. The European Central Bank, would be forced to disband and return its stock of gold to the member states, proportioned according to how much each nation brought in when they joined the single currency. When it comes to central bank reserves, each nation would revert to the old system of holding US Dollars.
The Wider Implications
There, sounds simple. The trouble is, when it comes to global financial markets nothing is that simple. There would be the question of proportioning European debt back to the member states; a complex and controversial matter that could take decades to resolve. Whilst the processes involved may appear straightforward and manageable to some, the reaction to those processes being activated would be potentially catastrophic. The global foreign exchange markets could well go into meltdown, and any recovery would see low confidence and high volatility in the renewed currencies. The once great Deutsch Mark would be a shadow of its former self, while the respectable French Franc would join the Italian Lira in comedy numbers when simply buying say a carton of milk.
With the interrelationships among world economies plain to see in recent years, economies all over the world would feel the destructive effects of a Euro collapse. There would almost certainly be a rush to gold and other precious metals, and despite having its own near-economic bombshell recently, the US would feel an initial benefit as, without any current viable alternative, the Dollar resumes its almost total dominance as the safe haven of world currencies.
Shrink the Eurozone?
However, let’s come back down to Earth. Most observers agree that a full collapse of the Euro remains highly unlikely. Instead, a distinct possibility is a shrinking of the Eurozone; itself a damaging blow to the single currency, but not the economic death knell a full collapse would usher. With Some sectors of the financial elite estimating that the EFSF will need over 2 trillion Euros to see the eurozone though the crisis, staying true to the principles of a single currency for all member states will be truly testing. The thought of allowing new entrants into the eurozone, such as Turkey and former eastern bloc states, is certain to remain on hold, and as public opinion swings violently against any further bailouts, poorer countries in the eurozone could well be cast out.
Fortune Favours the Brave
But past examples indicate such a situation may not be all bad. In early 2002, following its three-year economic crisis, Argentina went it alone when it unpegged the Peso from the US Dollar. The economy suffered, but Argentina survived and indeed, its economy, like many in South America, is now enjoying something of a boom just nine years down the line. It is the region’s third largest economy and now considered an Emerging Market by the FTSE Global Equity Index, while also taking its place among the G20. In short, Argentina is proof that nations can survive such a currency upheaval. There are many differences between Argentina and the current European situation, but it does demonstrate that clear, strong leadership can lead to a path through, and long-term prosperity after, a crisis.
One Potential Future
For a country leaving the eurozone, exchange controls would be imposed in order to limit the damage to their revived currency and prevent a capital implosion. Exchange rates would inevitably drop, but Argentina has shown even Greece could turn the situation around if it manages to impose some strict financial controls on its economy in the future. Years, if not decades, of rebuilding would be required, but this partial collapse of the eurozone would, at least, save the currency and, initially at least, give it a boost. Following the departure of the weaker nations, the Euro would rocket in value, bringing confidence back to the currency, but at the same time hitting exports hard. This is likely to be short lived, and the upside of a boost in value is that eurozone debt, particularly with the US, would fall and its overall future would look a great deal more secure than it does today.
Europe without Germany?
There is, however, one more possible, if unlikely prospect. This is Germany’s unilateral withdrawal from the Euro as the nation’s politicians sense that their fiscal sovereignty is being undermined and there is no further benefit to the currency or their political careers if they remain a part of it. For most, such a move would herald our first scenario, a total collapse of the Euro. Certainly, the currency would find it incredibly tough to survive without its most powerful member, if at all. But, for Germany, a move could herald a return to the days when the Deutsch Mark was the king of European currencies. And for the remaining eurozone countries, a fairer dynamic would remain. So, despite this being an unlikely outcome of today’s Euro turmoil, it is easy to understand why the more right wing members of Germany’s political elite are pushing for it. In truth, no one really knows the full consequences of any of the scenarios above, but examples such as Argentina can give us pointers. What we do know is that the effects of any of these outcomes would be dramatic, painful and long-lived.
A Fourth Option
There is also a fourth option. No one pulls out, Germany continues to support the bailouts, Greece restructures its economy, along with a few other nations, and the Euro survives to fight another day. Next year heralds the 10th Anniversary of the eurozone and, despite its rollercoaster ride, it would take a very brave person to suggest more than candles will be blown out next January.
American History could Provide the Answer
What is clear is that, if Europe is to compete with the US and keep pace with China, the eurozone must have much greater cooperation and cohesion between member states on the overall objectives of the zone. If countries continue to self serve their national interest above that of Europe and political and monetary policy cannot be aligned, we are in for a long period of uncertainty.
Europe could do worse than look back in US history and consider how Alexander Hamilton constructed an economic model that consolidated the debts of the states into a US national debt. In 1790 the US had a debt of $54 million with the states owing another $25 million. No foreign credit was available to the Government and all other paper money was worthless. Hamilton allowed the state debts to be converted into federal debt and market forces determined the exchange rate of each state’s debt against federal debt. This offers more than one lesson for Europe. Firstly, without the free market being allowed to operate without intervention, problems will arise. Secondly, without political compromise, sometimes against the pressures of a country’s domestic politics, confidence will continue to be absent. In other words “The needs of the many outweigh the needs of the few’* September 2011
* Star Trek II: The Wrath of Khan (1982)_ Mr. Spock