As euro nears 10, cracks emerge in fiscal union

[leobold1]

As euro nears 10, cracks emerge in fiscal union - International Herald Tribune

By Mark Landler
Published: May 1, 2008

FRANKFURT: The euro turns 10 next January, a milestone that will be marked with celebratory speeches, inch-thick scholarly papers and a commemorative two-euro coin, designed by a Greek sculptor. It was chosen from five candidates in an online poll of European residents.

For Greece, winning the coin contest may be the high point of the festivities. Seven years after forsaking its drachma for the euro, the Greek economy is faltering, inflation is spiking and exports have been hobbled by the surge of the euro against the dollar.

Greece, said Thomas Mayer, the chief European economist at Deutsche Bank, is an "accident waiting to happen."

By most yardsticks, Europe's common currency has been a success, emerging as an alternative to the fading dollar for bond dealers, central bankers, Chinese exporters, even Jay-Z, the American rapper, who put a pop-cultural imprimatur on the currency by flashing a wad of 500-euro notes in a music video.

Yet fissures are forming in the European monetary union that threaten to widen in coming months.

Greece, Portugal, Italy and Spain — the sun-drenched fraternity sometimes called Club Med — are struggling with eroding competitiveness, rising prices and bloated debts. Meanwhile, Germany, the sick man of Europe for most of the euro era, is suddenly vigorous again. Economically fit after years of reforms and fortified by brisk global demand for its machinery and other goods, it has fended off China to retain its status as the world's export champion.

Germany's northern neighbors are generally doing well, too, which has rekindled talk of a north-south divide: a north that is growing decently but is concerned about inflation, and so prefers higher interest rates and is willing to live with a strong currency; a south that is worried about stagnating, and prefers lower rates and a weaker currency.

When leaders and laggards use the same money but have opposite problems, tensions are bound to surface.

Take Italy, perhaps Europe's shakiest economy. Facing high labor costs, slumping exports and a gaping public debt, its old remedy for hard times would have been to devalue the lira. Now, chained to the mighty euro, it cannot do that. Instead, it will probably have to endure a recession and rising unemployment, something no politician — but especially not one just elected, like Silvio Berlusconi — wants to face.

Berlusconi has already said he wants the European Central Bank to weigh more than inflation when setting monetary policy. In other words, the bank should lower interest rates, which would probably deflate the euro somewhat and make it easier for Italy to sell its wine and shoes overseas.

Berlusconi has found an ally in Nicolas Sarkozy, the French president, who has tangled repeatedly with the central bank on the same issue. Sarkozy will assume the rotating presidency of the European Union in July, giving him a ready-made platform for his views.

The founders of the euro anticipated such tensions; some feared they would strangle the currency in its crib. But in the late-1990's, when the monetary union was being created, Europe's leaders set aside national concerns for the goal of a common currency.

"There was a major political will to get to the union," said Alexandre Lamfalussy, who was president of the European Monetary Institute, the forerunner of the central bank. "There was also political will in the countries to put their own houses in order. I remember being very surprised at the time."

Today, though, "the old temptation of the governments to find a culprit for their problems has returned," he said. "It is a wider problem than one or two political leaders."

In some sense, the political honeymoon for the euro ended in May 2005, when voters in France and the Netherlands rejected the proposed constitution for the European Union. While that document had little direct bearing on the currency, it symbolized Europe's steady march from economic to political integration, a process that, for now at least, has stalled.

Like so much in European history, the debate over the euro is at heart a debate over the role of Germany. When the monetary union was being fashioned, weaker states like Italy justifiably feared having their fortunes lashed to a Teutonic locomotive.

Unexpectedly, though, Germany fell into a deep slump soon after the euro began circulating in 2002, three years after its adoption as Europe's currency. Because it accounts for a third of the monetary union's economic output, Germany, with it troubles, bequeathed Europe an easy-money policy — the reverse of what Italy and its neighbors feared.

"Rather than struggling to keep up with Germany, they got tremendously low interest rates," Mayer of Deutsche Bank said. "Instead of wearing a hair shirt, they were partying like crazy."

In Germany during that time, companies underwent a painful process of cutting costs and streamlining operations. Gerhard Schröder, the former chancellor, pushed for an overhaul of the labor market, which probably cost him his job but helped make Germany competitive again.

Now the party has moved to Berlin, and the hair shirts are being handed out in Rome, Madrid and Athens. In Spain and Ireland, the European Central Bank's low interest rates fueled American-style housing bubbles, which have burst with predictable consequences.

Given the deepening distress in these countries, experts said they were surprised that there had not already been more complaints. In 2005, when the divide was less striking than it is today, an Italian labor minister, Roberto Maroni, called for Italy to abandon the euro and return to the lira. He was hooted down, even by members of the previous Berlusconi government.

Part of the reason for the quiescence may be that Europe has remained steady despite the recent financial upheavals in the United States. Few countries, it seems, can contemplate trading the discomfort of a robust euro for the vagaries of their old currencies. Putting up with Germany's interest rates, economists said, is a fair price to pay to avoid messy Italian-style currency devaluations.

"There will be lots of talk about Spain and Italy leaving the euro, but the weak cannot afford to leave," said Daniel Gros, a German who is director of the Center for European Policy Studies in Brussels.

Still, the rigors of life under the euro may keep this club from growing. Poland, Hungary, the Czech Republic and other Eastern European countries once hoped to adopt the currency fairly soon after joining the European Union. Now, with a deeper awareness of its cost, most will wait until after 2012.

Europe's monetary union may be lasting, but it is not widely loved.

[Caldric]

Some claimed the devalue of the dollar was intentional to lower trade problems. Some claim Greenspan planned that. Did he? I don't know but I do know Euroe products are having a harder time in the US.