Sunday, June 05, 2005
In our discussions of the EU crisis today on our radio show, SCSU Scholars' King Banaian made the point that without a viable EU, the euro has become superfluous.I don't think I went so far as to say superfluous, but it removes what I think is the primary mover in the push for the euro. Roger Cohen noted yesterday that much of what has moved the European project forward has been a stubborn momentum, a sort of inevitability that this was going to happen. That has been the primary mover, and it appears to have run out of steam. For example, Matthew Lynn of Bloomberg notes,
[T]he economics of integration that have dominated Europe for the last 30 years have come to an end. Forget convergence. The big trend in the next few years will be Europe's economies going their own way, not with each other. In time, even the euro's survival might be called into question.
Since the constitution has been so decisively rejected by the voters, it puts a stop to any plans for further integration. Electorates won't tolerate it.
An elected EU president? Forget it.
A harmonized tax system? Don't make us laugh.
A single European army? Only in the dreams of a few ``eurocrats'' in Brussels.
The path that the large European countries followed toward a single government now seems to have reached a dead-end.
That has three main consequences for Europe's economies.
First, the euro club may well now be closed and the three EU countries that opted to remain out -- Britain, Sweden and Denmark -- aren't likely to change their minds. Questions will be asked among the accession countries whether they should live up to their treaty obligations to join the euro. In the Czech Republic, that debate has already started. Governments will find it tough to sell the single currency to skeptical electorates.
Next, political leaders who have been triumphant in anti-constitution campaigns will be emboldened to take the next step. If you can defeat the constitution, you could pull out of the euro, as well. In politics, once a bandwagon gets rolling, people want to jump on board. Anyone investing in euro-area assets will have to ask themselves: ``Am I happy to be holding this asset if, at some point, it reverts to an old national currency?'' Many investors will answer ``no'' to that question.
Third, the creation of a single European economy is now unrealistic. Trade barriers have been broken down, and capital markets have been freed up, boosting all economies involved. Indeed, the gains from integration may well have allowed countries to ignore the declining competitiveness that results from unreformed labor markets and overgenerous welfare systems. Yet if no further steps toward integration are taken, those gains will be lost. Countries will have to reshape their own national economies if they are to grow again.
H/T: Edward Hugh who also notes that any disappearance of the euro would take a good deal of time. I agree with that, but any further opening of a spread in interest rates between Eurozone countries undercuts one of the three main benefits of the common currency (the others being lower inflation and a lack of costs involved in trading in multiple currencies.) Captain Ed also notes an article in Stern that suggests the currencies will be separated as they are. I doubt that, as it creates confusion and because it's unlikely they have the proportions of the various flavors of Euro notes in proportion to the size of the economies.
The importance of that loss of momentum should be emphasized because the economic argument isn't as strong as it might need to be to persuade Europeans of the euro's viability, particularly in light of weakening support for the EU constitution. I recommend my mentor Tom Willett's paper from last year in which he explored the viability of Britain joining the EU or Canada joining a monetary union with the U.S. Tom has been a long-time skeptic and critic of people overselling monetary unions, and much of the former paper is vindicated by the events over the last week.
Someone asked me today why we didn't emphasize more what was the impact of the EU failure is for the US. I see three. First, without an EU constitution each of the countries that support the GWOT will be freer to continue to do so. There is unlikely to be any more lecturing from Chirac to Poland. Second, the instability of relations between Eurozone countries may help induce more trade with the U.S. and close some of the trade deficit. But the euro will fall versus the dollar, which eventually increases imports from Europe; as well, higher interest rates there will induce capital to stay in Europe and probably push up U.S. interest rates. Last, the discussion of what China will do with all its dollar reserves takes a new turn when there's not an alternative currency available. Perhaps the fraction of their reserve accumulation that goes to dollars stays high, and that could counteract the rise in interest rates that a mention in point two. I won't guess which effect is larger.