Europe's Economic Pain Re-opens Debate on Currency

“We told you so.”

When the treaty establishing Europe’s common currency was approved in the early 1990s, Europe’s political and business elite had high hopes that it would bind the Continent’s disparate economies and often bickering nations as never before.


And as the euro made its debut in the early 2000s, there was an outpouring of support from many citizens pleased that they would no longer have to change Spanish pesetas to French francs or Dutch guilders to German marks as they crossed borders from one country to another.

But not everybody was caught up in the celebration. A noisy band of dissenters, many of them economists from outside the Continent, issued a warning: the euro was doomed to struggle, they proclaimed, maybe not immediately but certainly before long. Different countries would pursue such different economic policies, they argued, that it would ultimately place an unbearable strain on the currency and some of its members.

Today, many of those predictions — handily dismissed at the time — are coming true.

For most of 2010, Europe struggled to contain a debt crisis that has prompted investors to drive up the yield on government bonds. And despite two bailouts — for Greece and for Ireland — the anxiety has not dissipated, and attention has turned to other faltering economies like Portugal and Spain.

Last Friday, the cost of insuring Greek debt pushed higher on speculation that Athens might restructure its debt in 2013. That followed a warning on Thursday by Fitch, a major credit rating agency, that a downgrade of Greek debt was imminent. Fitch had already downgraded Portugal’s debt on concerns about its growth prospects and its ability to cut its deficit.

“I knew from the very beginning that putting all these heterogeneous countries together would not work,” said Wilhelm Nolling, a member of Germany’s Bundesbank governing council before the establishment of the European Central Bank who is now a professor of economics at the University of Hamburg.

"We were told that the euro would achieve peace in Europe forever, but I am sad to say that the opposite is true." -Germany's Bundesbank governing council member, Wilhelm Nolling

If history is any guide, these critics say, even more troubles could be on the way. They point to a handful of little-known and less ambitious common currency efforts that failed in the past.

To be sure, Europe’s decision to embrace the euro was widely debated at the time, and even supporters worried that a monetary union without more political and social cohesion to back it up might founder.

But the criticisms were glossed over in the euphoria at the end of the cold war and the hope that firm rules for countries joining the common currency would secure a unified economy and forge an unbreakable European identity.

The most forceful opposition was centered in Britain, which, along with Denmark, agreed to sign the Maastricht treaty in 1991 setting out the path to a European single currency only after insisting on the right to opt out of any final step.

And it was not just the perennial euro skeptics of Britain’s Conservative Party who warned of troubles ahead. Ed Balls, then an obscure editorial writer for The Financial Times, wrote a report in 1992 identifying what he termed a crucial flaw in the plans for the euro: Europe lacked the type of federal taxes and transfer payments used in the United States to ease economic divergences among its many states.

'Political Will Is Not Enough'

Published by the Fabian Society, a left-of-center research group in London, the Balls paper caught the eye of Gordon Brown, then shadow chancellor for the out-of-power Labour Party.

Mr. Brown hired Mr. Balls and then seized on his core argument when the Labour Party gained power in 1997 to insist that Britain stick with the pound — despite general support for the euro from Prime Minister Tony Blair and a majority of the Labour Party hierarchy.

"The real problem is that the only way countries like Greece and Spain and Portugal can regain their competitiveness with Germany is to impose a decade of restrained living standards on their populations. That is the time bomb ticking inside the euro." -Former UK Chancellor of Exchequer, Norman Lamont

“Having the political will is not enough,” Mr. Balls, who remains an important figure in the Labour Party, said in an interview. “You need a level of integration and commitment that goes well beyond that.”

That it was a Labour and not a Tory government that kept Britain from joining the euro no doubt grates on the nerves of Britain’s traditional euro skeptics.

For example, Norman Lamont, the former Conservative chancellor of the exchequer and the recognized leader of this pack, says he has “never heard of Balls’s paper.”

Mr. Lamont, who as chancellor from 1990 to 1993 led the British side in the Maastricht negotiations and pushed for the provision to opt out of the currency, points instead to a speech he gave in November 1990 as the earliest and most specific public critique of plans to create the euro.

“The fact is that Europe is not ready for a single currency,” Mr. Lamont said in that speech, which came a month after Britain joined the exchange rate system in Europe that preceded the euro.

The address was intended to bolster the flagging fortunes of Prime Minister Margaret Thatcher, who was on the verge of being ousted as leader by a growing pro-Europe faction within the Conservative Party.

Mr. Lamont highlighted the disparity in inflation, budget deficits and employment levels that separated poorer southern nations from core European economies. “So long as such divergence exists,” he said, “a move to a single currency would represent a massive leap in the dark.”

Mr. Lamont served as chancellor under Ms. Thatcher’s successor, John Major, presiding over the collapse of the pound and Britain’s humiliating expulsion from the exchange rate mechanism in 1992.

As for his doubts about the euro, they have become even more pronounced.

“I have always said that the euro will break up,” Mr. Lamont said in a recent interview. “Not after the first crisis today, but after the second crisis, which could be 10 years away. This is, after all a political project, not an economic project.”

Mr. Lamont points out that previous currency projects in Europe, like the Latin monetary union formed by France, Belgium, Italy and Switzerland in 1865 and a similar one in Scandinavia, by Sweden, Denmark and Norway in 1875, lasted more than 30 years before they collapsed.

“The real problem is that the only way countries like Greece and Spain and Portugal can regain their competitiveness with Germany is to impose a decade of restrained living standards on their populations,” he said. “That is the time bomb ticking inside the euro.”

But for the euro’s defenders, this crisis pales in comparison to the 20th century wars that tore Europe apart and represents little more than a speed bump on the road to an even more united Continent.

That view was put forward this month at the opening of the European Commission’s new representative office in London. Called Europe House, the building is the former Tory headquarters where Mrs. Thatcher, Britain’s most senior euro skeptic, celebrated three election wins — a footnote that European officials highlighted smugly during the evening’s festivities.

“We remember what happened in the last big crisis — it was something horrible, and such a threat is always waiting for us,” said Jerzy Buzek, the former prime minister of Poland and current president of the European Parliament.

A glass of white wine in his hand, Mr. Buzek paid little mind to the notion that the current financial unrest in Europe would lead to the euro’s collapse.

“Let us answer by having more solidarity,” he said. “We are a beautiful, fantastic Europe, and overcoming history is an imperative for us.”

Indeed, even in Ireland, which along with Greece has paid the steepest price for being tethered to the euro, economists are mostly uniform in their support of a single currency. They cite in particular the benefit of monetary stability and the fact that the euro zone has been saved from the harmful dynamic of competitive devaluations and capital controls that has flared up in emerging market economies.

“In an integrated world, having a common economic approach to policy has a lot of strength,” said Philip R. Lane, an economist at Trinity College in Dublin who oversees the influential Irish Economy blog.

But Mr. Nolling, the German economist, insists that whatever the euro’s supposed advantages, in practice European policy makers have gone too far in their effort to preserve the single currency.

The financial rescues of Greece and Ireland, he contends, are “unconstitutional” because they violate the euro zone’s no-bailout clause.

Germany’s constitutional court is expected to rule on a case brought by Mr. Nolling and a group of like-minded economists and lawyers early next year. While few expect a decision that would reverse the Irish and Greek interventions, the challenge is a blunt reminder that Germany, the European nation with the deepest pockets, remains deeply divided over the merits of the single currency and that further financial rescues could face many obstacles, both political and legal.

“We were told that the euro would achieve peace in Europe forever,” Mr. Nolling said, “but I am sad to say that the opposite is true.”