Why the Euro Will Not Disintegrate
Market analysts forecasting the demise of the euro and the break-up of the European Union are doing so on fundamentally flawed assumptions about the process of European integration, economists and policy experts told CNBC.com.
Ewald Nowotny, one of the European Central Bank's governors, told CNBC on Tuesday that the future of the single currency is not in doubt.
That he had to do so at all marks how far the hyperbole surrounding the European debt crisis has come, with commentators now routinely saying that the euro zone is at an inflexion point, where the monetary union and the entire political "experiment" of integration are now threatened by the troubled economies in the periphery.
The sovereign debt crisis and Greece's impending insolvency have highlighted a number of divisions in the European Monetary Union (EMU), not least the near-impossibility of setting a monetary policy that suits both a resurgent Germany and a weak Southern European bloc.
It has shown the complexity of matching multilateral politics with practical economic policymaking, and it has shown how a mismatch between monetary union and fiscal integration can cause political fractures. But this does not mean that it has shown the impossibility of making the EMU work, experts said.
"I've been a harsh critic from the very beginning of the crisis about the way that Europe has handled it, or rather mishandled it. There are times I have virtually torn my hair out of my head at some of the things that were going on," Alessandro Leipold, the chief economist at the Lisbon Council think-tank and a former acting director of the International Monetary Fund's (IMF) Europe division, told CNBC.com.
"At the same time, one has to realize that this is the way that Europe works and as frustrating and as harmful and as costly as that has been, I think that all of these factors detracted attention from what has indeed been done," Leipold added.
Mechanisms in Place
The mechanisms and structures that have been built include the European Financial Stability Facility (EFSF) and the European Financial Stabilization Mechanism (EFSM) - AAA-rated bond issuers which can raise capital from the markets to assist struggling member states – and the European Stability Mechanism (ESM), a permanent structure to succeed the EFSM from 2013.
"If you go back and think what the situation was when the Greek crisis first broke out, since then you've had credit mechanisms created – the EFSF and the EFSM – and a broad agreement on a permanent crisis-management mechanism in the form of the ESM," Leipold said.
"The IMF has been brought in and procedures have been agreed with them. The ECB has shown flexibility – some might say too much, but it has – funds have been disbursed and programs are in place and are being carried out. EU surveillance has been broadened and strengthened," he added.
Echoing the sentiments of a number of experts contacted by CNBC.com, Leipold said that despite his reservations about the "parochialism" of European policymaking, the institutions in the union have shown considerable flexibility in throwing out their own preconceptions about the deployment of public funds.
Integration is a series of steps, and each step is incomplete, leading to another corrective step, Leipold said.
Mujtaba Rahman, European analyst at political forecasting firm Eurasia Group, concurs.
"The default position is more integration, which is why commentary, especially that coming out of the US, is very focused on euro break-up is biased towards thinking about the downside scenario, and is not really thinking about the upside scenario," he told CNBC.com. "The upside scenario I think is one that's more consistent with the history of European projects."
"If you look at how European integration has worked, these countries integrate economically, that produces some form of negative externality that then needs correcting by further integration," Rahman added.
No Exit From the Euro
No Euro Exits
The single currency – now approaching the tenth anniversary of its adoption – has exposed the fact that previously, the individual currencies within the EU masked the weaknesses in Southern Europe and allowed those governments to artificially become competitive with the stronger core by devaluing the drachma, lira or peseta.
While the single currency has made finding that competitive edge harder, Rahman said, it has also brought into focus the real reforms that had been put off in the past.
"I think there's an acceptance now that the reform needs to be structural, it needs to be substantive and it's going to take time. They're doing it under a fiscal and a monetary and an exchange rate constraint. That makes it more difficult, but it means that when you do get the adjustment it won't just be the nominal depreciation play that we've seen for the last decade, it's going to be real and meaningful," he said.
Rahman was among analysts keen to pour water on the possibility and attractiveness of a euro exit for the Greeks, despite the short-term flexibility.
Greece, or any other country wishing to exit the monetary union would be stuck with euro-denominated debt and a rapidly depreciating currency, and would be far more exposed to speculative attack.
"Not being a member of the euro but being a member of the free trade area and internal market may sound great theoretically in the current context, but once this crisis is over you're still in this situation where you face exchange rate volatility vis-à-vis all the other trading partners," Rahman said. "Even the pure economics may not make sense in the medium term."
This, of course, assumes that it is the peripheral countries themselves that would push for an exit from the euro, and that the decision lies with their political leaders.
"When people ask us 'is Greece going to leave the euro?' our immediate pushback is that Greece doesn't have the agency. It's not really Greece's choice – it's Germany's choice and it's France's choice," Rahman said.
"On the competitiveness side, Germany's in great shape, and for that reason it has a very strong interest in making sure the euro survives, because historically its competitiveness was always undercut by companies like Italy, Spain and the rest devaluing their way to competitiveness. That would always have an immediate impact on the competitiveness of German exports," he added.
Runaway theories about the disintegration of the union were given credibility by the lack of momentum behind the integration agenda, after the exhausting process of referenda and negotiation that accompanied the passage of the Lisbon Treaty - a wide-ranging document that was supposed to cement the centrality of European institutions on issues including foreign policy – according to Jan Techau, the director of Carnegie Europe.
"This is one of the problems - there was no vision that could be used to counter the slippery slope of euro-pessimism, everybody thinks that the entire project is going down the drain and nobody has an answer to it," Techau told CNBC.com.
Techau, like many others, has been critical of the way that policymakers have handled the crisis, particularly what he sees as their apparent ignorance of the interplay between politics and market reaction. However, he too said that stepping forwards towards integration, not backwards, is the far more likely scenario.
Helmut Kohl, the former German chancellor and one of the architects of the single currency, believed that monetary union would drive political union.
"Of course, it didn't happen in an orderly way, and now possibly it's coming in a disorderly way, because now everyone's realizing that you can't have a currency and a single market and communalized trade policy without also having more political cohesion and more fiscal union," Techau said.
"Maybe, in the end, ironically, Helmut Kohl will be vindicated because the answer to the crisis is either disruption, or another bold step towards integration," he added.
Fiscal union, of course, is nigh on impossible, critics have said. Except, a "soft" fiscal integration is already being discussed, in the form of bonds issued through the EFSF.
Combined Euro Area Bond
Writing in Foreign Affairs this week, Lorenzo Bini Smaghi, another member of the executive board of the ECB, laid out a proposal for an embryonic form of this, combining EFSF aid with debt brakes on individual countries.
Analysts are already saying that the mooted plan to have the EFSF buy up member country's sovereign debt shows that the union is on the trajectory towards a combined euro area bond.
In Foreign Affairs, Bini Smaghi wrote what others in the European "experiment" have known from the start – that political union is a prerequisite for a functional monetary union.
"This latest challenge should have come as no surprise; it would have been a miracle had the currency been immune to such problems," Bini Smaghi wrote. "If anything, the past few years have shown that although the euro is a remarkable construct, it is incomplete: the euro zone is financially unified but not yet politically unified enough."
The resolution to the crisis, he wrote, is a step forward, not a step back.
Europe might be at an important moment in its history, where it can integrate better or fall apart.
The most noise seems to be coming from commentators who believe in disintegration, but those who really understand the inner workings of the EU say the opposite: economically it does not make sense, technically it is exceptionally difficult and politically it is nearly unthinkable.