Is the end of the euro in sight?


More than 20 years after the launch of the euro, it would be easy to assume that the currency’s survival is assured. When something lasts this long, it’s tempting to conclude that it works and therefore will be permanent.

Yet the story of monetary systems is that they regularly fail.

The European states set up a monetary union in 1865 which failed in 1927. The attempt to build a monetary system around a US dollar tied to gold, the Bretton Woods agreements, lasted from 1944 to 1971. At the time, both systems were considered a permanent structural feature, but both eventually died.

They died because economic realities have changed and therefore political realities have changed. Such changes have now taken place in Europe, requiring a decision to inflate the euro area’s excessive debt burden.

The single currency, as it is currently constituted, is unlikely to survive this change in economic and political realities.

The story of the single European currency is a story of often painful economic adjustments which ultimately created a new economic equilibrium between all members of the euro area. There is now only one interest rate to govern the 19 members. The creation of this apparent economic equilibrium has meant an adjustment of prices relative to productivity which now allows each of the 19 economies to produce economic results acceptable to all. This produced major economic upheavals, including high unemployment, especially youth unemployment, and massive bankruptcies, especially during the European sovereign debt crisis of 2001-2012.

At first glance, the difficult obstacles to aligning prices, especially labor prices, with national productivity levels have now been covered, albeit at a terribly high social and political cost of mass unemployment, bankruptcy and deregulation. ‘lost opportunities.

However, the belief that we must now move closer to a functional currency with adequately adjusted prices ignores a huge and growing imbalance that has worsened as, arguably, prices relative to productivity levels have risen. improved.

The dangerous new imbalance is a balance sheet imbalance. The gap between the debt-to-gross domestic product (GDP) ratios of the main euro area member states is at record levels. The economic reality is that some members of the eurozone have to inflate their debts and others not. Finding an interest rate in the single currency that can meet the different goals of different nation states is almost impossible. There cannot be one rate of interest now to rule them all.

When the euro was created in 1999, Germany’s ratio of non-financial debt to GDP was 198% and that of France 195%. These two key countries in the single currency experience set out to create a single currency with similar debt levels.

The latest available data shows that Germany’s ratio of non-financial debt to GDP has barely changed since the launch of the euro and is now only 209% of GDP. While in France, the non-financial debt / GDP ratio reached 371% of GDP! It is not the highest debt-to-GDP ratio in the world, but it is one of the highest and a level that the famous Japanese economy only exceeded for the first time in 2018.

Germany may be the biggest economy in the eurozone, but France is by far the biggest debtor, with the euro value of its debts 23% higher than that of Germany.

How to create an appropriate monetary policy for one of the most indebted economies in the developed world while simultaneously creating an appropriate monetary policy for one of the least indebted is the economic and political challenge which now threatens the survival of the single currency.

The problem with too high a debt-to-GDP ratio is that it creates a crisis-prone financial system when cash flows decline or when interest rates rise.

On two occasions since 2008, we have seen the consequences for heavily indebted economies when a recession leads to lower cash flow and defaults – a recession could turn into a depression.

Having now negotiated another recession, through extreme measures to transfer wealth from government to the private sector, we face a different challenge for an over-indebted system.

How much can interest rates rise to tackle high inflation rates before they cause a debt crisis?

A single currency system involving only one interest rate, how to guarantee the right level of interest rates for both France and Germany? If there cannot be a single interest rate policy for the 19 states whose needs must come first? Will monetary policy in the euro zone focus on inflating France’s debts to the detriment of the reduction in the purchasing power of German savings?

Given the current level of interest rates in the euro zone, it seems fairly clear that France’s priorities will take precedence.

Too high an interest rate in the euro zone risks creating a recession or even a depression in France. Too low an interest rate in Germany only risks the slow decline in the purchasing power of savers’ wealth as interest rates fail to compensate for high inflation rates.

Interest rates that are too high are a clear and present danger to stability in Europe, while rates that are too low create a different deferred problem. In the long run, negative real interest rates have perverse effects and undermine the efficient allocation of capital. Ultimately, this misallocation of capital undermines economic growth and job creation, but it is atrophy that progresses at a much slower pace than the political cycle.

However, one day German savers will react negatively to the transfer of wealth on their part to the large debtors in the euro area, most of whom are not German, and the entire euro area will pay the price for the misallocation of capital that results from real interest rates.

When that time comes, the only option will be to place barriers to capital flows within the eurozone to ensure that different interest rates can be applied across nation states.

This movement, when it comes, will signal that there is no longer a single currency. The return to independent monetary systems will ultimately lead to a fragmentation of the euro. Thus, the urgency to inflate debts in the euro zone, particularly in France, is slowly leading to a dissolution of the single currency.

Economic and political realities have changed and a new monetary system must be created to accommodate these changes. This monetary system will end pretty much as TS Eliot predicted the world would end: “not with a bang but a whimper”.

Russel napier is chairman of Mid Wynd International Investment Trust and leads an investment course at the Edinburgh Business School. He is a freelance columnist for the Star. Contact him by e-mail: [email protected]

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