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Economic policy

Economist debate: The euro and Europe

This house believes that the euro, as a single currency, is dividing Europe and should be abolished.

The voting pattern for this motion has been remarkably consistent, no matter the sharpness of the arguments: a clear majority is against breaking up the euro. The motion has been defeated; it is clear that this house does not believe “the euro, as a single currency, is dividing Europe and should be abolished.”

If the audience is in any way representative of European citizens, then it seems there will be solid support for all the things that need to be done to salvage the euro: more money to help weaker states, more co-ordination of economic policy and the joint issuing of Eurobonds. But as the convictions expressed on the floor can attest, it will not be easy. A strong and articulate minority opposes any more moves towards fiscal or political union. Read more below and on the Economist website.

Opening statements.

Hans-Olaf  Henkel

Defending the motion.

Hans-Olaf Henkel
Professor, University of Mannheim and former head of Germany’s business federation
Having been an early supporter of the euro, I now consider my engagement to be the biggest professional mistake I ever made.

Guy Verhofstadt

Against the motion.

Guy Verhofstadt
Leader, Alliance of Liberals and Democrats for Europe and former prime minister of Belgium
Is the euro facing problems? Of course! Should the solution be to abolish the euro and put it outside with the rest of the garbage? No.


Anton La Guardia

The moderator’s opening remarks

Anton La Guardia

When The Economist held a debate on the euro last year, a majority in the audience voted against the motion: “This House believes the euro will fragment over the next ten years.” That was soon after the first Greek bail-out, and the decision by the euro area to arm itself with its big bazooka, known as the European Financial Stability Facility (EFSF).

Much has happened since then. It is not unreasonable to assume that, were the same vote taken today, the result would be reversed. The bazooka did not scare anyone for long. Ireland, and then Portugal, succumbed to the assault on the markets, and Greece has had to seek a second bail-out. Market contagion started to spread to Spain and Italy.

The “indignados” have taken to the streets of Spain and, sometimes more violently, of central Athens. Voters in northern creditor states are also indignant about having to prop up “peripheral” economies that they see as profligate, unreformed or incompetent—or a combination of all these sins.

Relations among leaders of the euro zone have become more embittered as they have struggled to contain the crisis and argued over who should take the losses: the crippled debtor states such as Greece, through greater austerity; the creditor states like Germany, through fiscal transfers of one form or another; or the financiers, through debt rescheduling, or even outright haircuts on bondholders.

The Greek prime minister has complained that confusion and cacophony are worsening his country’s plight. And according to a French satirical weekly, Le Canard enchaînê, President Nicolas Sarkozy of France has privately expressed frustration with both Angela Merkel, the German chancellor, who has insisted that private creditors take a hit on Greece, and Jean-Claude Trichet, the president of the European Central Bank, who argued that this would worsen the crisis. In Mr Sarkozy’s view, the Germans were displaying “criminal” egotism, while Mr Trichet was playing “Belgian roulette”: unlike Russian roulette, which has one bullet in the cylinder, “in Belgian roulette the whole cylinder is loaded with bullets,” said Mr Sarkozy.

An emergency summit of the euro zone on July 21st finally agreed a second Greek rescue plan roughly as big as the first one, now with a lower interest rate and longer maturities. This would be backed by a modest contribution from private creditors. The EFSF, moreover, would be made more versatile: it would be allowed to extend short-term credit lines and, subject to unanimous approval, buy the bonds of vulnerable states in the secondary market.

Bond spreads for Greece and other vulnerable states narrowed at first, but then started rising as markets took stock of the hazy details and the remaining weaknesses. Nobody thinks the crisis is over; the question is whether the euro zone can limp on through August.

So is the whole experiment of a monetary union without a fiscal and political union a terrible mistake? Instead of wondering, as we did last year, whether the euro will survive, we ask our debaters to consider whether it would not be better to kill it off.

Both of our debaters agree that the euro has not promoted economic convergence, as many had hoped. On the contrary, one of the causes of the crisis is the economic divergence that has taken place, barely noticed, during the good years. They differ, however, over how to respond.

Hans-Olaf Henkel regrets ever having supported the creation of the euro. Though painful, he says, it would be better to arrange an orderly divorce. Rather than evict weaker states from the shared home, he thinks credit-worthy northerners should leave of their own accord. Guy Verhofstadt, by contrast, says communal living has helped protect the economies of its members from even greater turbulence. He thinks it is time to turn the cohabitation into a real marriage.

There will be many valuable, interesting and pithy contributions from the floor. For now, I hope the debaters will expand on their arguments. To Mr Henkel: most currency areas encompass diverse economic zones, not least Germany itself, with its federal structure and its enduring east-west divide. Why can the euro zone not be made to work with greater integration?

Mr Verhofstadt draws a comparison between the euro area and another federal state, America, arguing for more Europe. But how far does the EU need to travel down the road to a “United States of Europe” to save the euro, and is this a price voters are willing to pay?

Indeed, to both our contributors, is anybody asking Europe’s citizens what they want?

Hans-Olaf  Henkel

The proposer’s opening remarks

Hans-Olaf Henkel

Having been an early supporter of the euro, I now consider my engagement to be the biggest professional mistake I ever made. Here are the reasons:

First, politicians broke all promises made in the Maastricht agreement. Not only was Greece let into the European Union for purely political reasons, but the fundamental rule, “no member to exceed its yearly budget deficit by the equivalent of 3% of GNP”, was broken over a hundred times. Mandatory punitive charges, provided for such cases, were never applied. To top it all, the no-bail-out clause was wiped out in the wake of the first Greek rescue package.

Second, the “one-size-fits-all” euro turned out to be a “one-size-fits-none” currency. The euro itself caused some of the problems politicians are now trying to solve. With access to interest rates at much lower German levels, Greek politicians were able to pile up huge debts. The Bank of Spain helplessly watched the build-up of a real-estate bubble without being able to raise interest rates. Deprived of the ability to devalue their currency, countries in the south lost their competitiveness.

Third, instead of uniting Europe, the euro increases friction. Students in Athens, the unemployed in Lisbon and protesters in Madrid not only complain about national austerity measures, they also protest against Angela Merkel. Moreover, the euro widens the rift between countries with the euro and those without. Bulgaria and Romania would surely love to join and enjoy German guarantees, but does anybody believe Britain or Sweden will ever find it attractive to join a transfer union?

Instead of addressing the true causes of its illness, politicians prescribe painkillers for the euro patient every time another Greece, Portugal and Ireland pops up. It suffers from three discrete diseases:

1. As a result of the financial crisis, many banks are still unstable.

2. The negative effects an overvalued euro has on the competitiveness of the southern states, including Belgium and France.

3. The huge level of debt of some euro-zone countries.

Treating a patient who suffers from three diseases simultaneously is indeed difficult, and it would be misleading to proclaim that there is an easy way out. But it is irresponsible to maintain there is no alternative. There is.

Plan A: “Defend the euro at all costs”, as pronounced by José Manuel Barroso, president of the European Commission. He could have added “to the Germans, the Dutch, the Finns”. The end result will, however, be detrimental to all. Various rescue packages have led the euro zone on the slippery path towards the organised irresponsibility of a transfer union. If everybody is responsible for everybody’s debts, no one is. Competition between politicians in the euro zone will focus on who gets most at the expense of the others. Harmonisation will replace diversity. The result is clear: more debts, higher inflation, lower standards of living, but—and that will please a lot of politicians—whatever is left of will be more evenly distributed. The competitiveness of the euro zone is bound to fall behind that of other regions of the world and, by the way, will over time also fall behind those European countries which refuse to be part of it.

George Soros’s Plan B: a Greek default or its departure from the euro zone. This implies risks too high to take. First in Athens, then in Lisbon, Madrid and perhaps Rome, people will storm the banks as soon as word gets out. A “haircut” would not improve the country’s competitiveness either. Soon, the Greeks will have to go the barber again.

Plan C: Austria, Finland, Germany and the Netherlands get out of the euro zone and create a new currency leaving the euro where it is. If planned and executed carefully, this could do the trick: a lower-valued euro would improve the competitiveness of the remaining countries and encourage their growth. In contrast, exports from the northern states would be affected but they would enjoy less inflation and be spared having to look after the southern states forever. Some non-euro countries would be likely to join this second monetary union. Depending on actual performance, a flexible membership between the two should be possible

The implementation of Plan C requires that each of the three underlying problems be addressed separately:

1. We must rescue banks, not countries. Stabilisation of banks on a national level should replace current European umbrellas. In many cases, this requires temporary nationalisation of banks.

2. Germany and its partners in a new currency must forgo a significant portion of their guarantees to help refinance Greece, Portugal and others. As much is already lost anyway, this is an acceptable price for an “exit ticket”.

3. The creation of a new central bank based on the Bundesbank, preferably not led by a German. The name of the new currency should not be D-mark.

4. The mechanics would be similar to those used in joining the euro. If it was possible to form one currency out of 17, it should also be possible to form two out of one.

This will not be an easy task, politically and mechanically. It requires conviction, persuasion, and first and foremost the courage of Chancellor Merkel. Paradoxically, help could come from the south, where voters are getting tired of being lectured by her on what to do. For both north and south, an end with difficulties seems much better than difficulties without an end.

Guy Verhofstadt

The opposition’s opening remarks

Guy Verhofstadt

Is the euro facing problems? Of course! Should the solution be to abolish the euro and put it outside with the rest of the garbage? No. On the contrary, abolishing the single currency now would be a crucial mistake. It would once again introduce monetary limits combined with variations in exchange rates and risks. It would seriously hamper trade and economic activity within the European Union and could potentially give it a fatal blow. In short, it would mean the end of the successful internal market that we currently have in Europe.
The euro has certainly increased intra-EU trade. Thanks to the euro, consumers have a wider choice allowing them to buy goods and services at lower prices. The success of the ECB in keeping inflation low has been a source of stability and has made it possible to keeping borrowing costs low for both the private and the public sectors, thereby contributing to more economic growth and employment. The euro is also attractive to foreign governments as a reserve currency. This is of benefit to the whole euro-zone economy because widespread holdings and a high demand for euros encourages third countries to price their exports in the single currency—thus reducing costs to euro-zone members as there are no exchange-rate costs.

Even after the start of the financial crisis in 2008 the euro brought stability and security. I seriously doubt that Europe, without the common currency, would have been able to weather the economic storm that followed the collapse of Lehman Brothers. A European Union without a single currency would have had to deal with an avalanche of currency devaluations and even depreciations. This would have led to a situation in which internal trade within Europe would have come to a standstill. A European Union without the euro could have fallen back to a situation in which protectionism gained the upper hand, as happened after the first world war. This would have plunged Europe into a long period of economic stagnation.
Does this mean that the euro is not in a problematic situation? Not at all! But it is crucial to recognise these problems and design structural solutions to solve them. Instead of throwing out the baby with the bath water by abolishing the single currency, we should do exactly the opposite. We should strengthen the foundations of the euro zone that are currently lacking.
The real reason for the euro crisis is the fact that the euro zone is a monetary union that is not supported by an economic and political union. This is a unique situation. Nowhere in the world will you find a common currency system that is based on 17 independent governments, 17 different economic policies and 17 bond markets. The result is that, despite the existence of a stability pact (which is too weak in its current form), the divergence between the euro countries (their competitiveness and their effectiveness) increases, rather than decreases. This has led to a decrease in the cohesion of the euro zone and hence to the current euro crisis (mainly in the form of increasing “spreads”). For almost a decade, decision-makers have claimed that “peer pressure” and “best practices” (the so-called Lisbon Strategy) would strengthen the cohesion of the euro. They claimed that member states would not have to give away any of their decision-making power or sovereignty. They were wrong and the crisis has revealed that this idea is an illusion. In reality the contrary has happened: the cohesion within the euro zone, for example the distance between the German and the Greek economies, has diminished not increased. We are now dealing with the consequences of this development.
The difference with America and the dollar is telling. California is almost bankrupt. It is not even capable of paying its civil servants. But despite the fact that California is one of America’s major economies, its difficult situation is not causing significant unrest in the country or significantly affecting the dollar. By contrast, Greece represents barely 2.5% of European Union GDP, but despite its insignificant size it is shaking the foundations of the euro zone. What is the difference? Behind America and the dollar stand a government, a substantial budget, a central bank and a common bond, which are all supporting the system. These institutions do not find themselves in a healthy condition—far from it. But for the financial markets it is the consistency of the system that counts. The solidarity between the different parts of the system is deeply rooted. It has a common bond market and a federal government that is far from being a “lame duck”. All these conditions are lacking in the European Union and in the euro zone mutatis mutandis.
The question is not whether our single currency should be abolished or not. The question is whether our leaders dare to take bold measures or not. If they continue to come up with half-hearted measures as they have done over the past 18 months, it will lead to the end of the euro. That is obvious. However, if they show courage and transfer additional powers to Europe, like Helmut Kohl and François Mitterrand did in their time, a viable European economy and a euro that can take over the dominant role of the dollar are within reach.

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