The Guest Blog

Euro’s Stay of Execution Will Be Short-Lived

Moorad Choudhry|Treasurer, Corporate Banking Division, Royal Bank of Scotland

The commentary first thing Monday morning was how Asian markets had risen on the back of the Greek election results. Hong Kong, Tokyo, Mumbai, were all trading up on relief that the euro as it currently stands had been given a stay of execution, because the party with the most votes back in Athens was “pro-austerity.”

That fact reflects globalization and inter-connections in financial markets as much as anything, as well as the importance of the euro to world economic stability. The Greek economy represents less than 2 percent of the EU economy, hardly a significant share of world output, and yet developments there are influencing events around the world. The heirs to the creators of modern civil society should be proud.

The positive sentiment lasted barely a few hours though. The same problems that we’ve been tracking since January 2010 haven’t gone away, and are sending markets down the sell path again. Spain appears to be heading for a sovereign bailout, its 10-year bond yield has remained above the dreaded 7 percent level, and it’s only a matter of (short) time until the European Central Bank (ECB) starts buying Spanish sovereign debt, or lends more to Spanish banks to do this instead, or we have some more formal bailout mechanism. Then Italy moves back into view, and as we all know the pot isn’t big enough to underwrite Italian sovereign debt, unless we have a serious change of heart from the German government.

Professor Milton Friedman

Given the track record to date, it is probably too much to expect EU leaders to announce a plan for genuine fiscal integration at their summit next week, but that is the only thing that will make the euro viable over the long term in its current form. Banking union, eurobonds, a common regulator, these are ultimately just toppings; the main ingredient needed for monetary union to work is fiscal union. That’s not to say that the aforementioned items are not necessarily desirable, just that they don’t address the main issue, noted by Professor Milton Friedman at a lecture at the Bank of Canada in 2000 and worth repeating today:

I think the euro is in its honeymoon phase. I hope it succeeds, but I have very low expectations for it. I think that differences are going to accumulate among the various countries and that non-synchronous shocks are going to affect them. Right now, Ireland is a very different state; it needs a very different monetary policy from that of Spain or Italy…

You know, the various countries in the euro are not a natural currency trading group. They are not a currency area. There is very little mobility of people among the countries. They have extensive controls and regulations and rules, and so they need some kind of an adjustment mechanism to adjust to asynchronous shocks – and the ?oating exchange rate gave them one. They have no mechanism now…

It’s only a year old. Give it time to develop its troubles.


The author is Professor Moorad Choudhry, Treasurer, Corporate Banking Division, Royal Bank of Scotland.

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