31 July 2005
Shadow on the Euro
By Gwynne Dyer
How fast the tide turns. Back in February, a report that the South
Korean central bank was planning to keep a bigger share of its foreign
currency holdings in euros and a smaller portion in US dollars set off
speculation that the euro would soon overtake the dollar as the world’s
preferred reserve currency. Five months later, the speculation is about how
long the euro will survive.
Last Thursday, Italian prime minister Silvio Berlusconi publicly
blamed the euro for all of the Italian economy’s ills: recession, high
prices, joblessness, the lot. “Italy is not a disaster” he said, “but
Prodi’s euro has ripped us all off.” (Romano Prodi, who defeated
Berlusconi in 1996 and brought Italy into the euro, will be the
opposition’s candidate for prime minister again in next year’s elections.)
Italy’s current economic miseries date approximately from the time
when the euro replaced the lira. Since that was also about the time when
Berlusconi took over the management of the economy, it makes good political
sense for him to blame all those problems on “Prodi’s euro.” last month,
another senior minister in his coalition government, Roberto Maroni of the
Northern League, even called for a referendum on pulling Italy out of the
euro and bringing back the lira. But it’s not just Italians who dislike
The French and Dutch “no” votes on the new European constitution in
May and June have cast a shadow over the whole European project. Although
the referendums were not about the euro, French and especially Dutch voters
listed the new currency as one of their major grievances against Brussels.
A recent poll showed that 56 percent of German voters want the mark back.
Could the euro really just fall apart?
International currency arrangements have a habit of falling apart
whenever the going gets rough. The last time it happened was 1972, when
the Bretton Woods system of fixed exchange rates, in which each major
Western currency had a predictable value in every other currency, collapsed
under the inflationary pressures caused by the Vietnam war and the first
oil-price shock. That collapse, after much turmoil, led to the floating
exchange rate regime that has lasted until today.
The euro, which replaces the old francs, marks, guilders, pesetas,
escudos, drachmas, and liras of the European Union, is not yet five years
old. It depends, as all currencies do, on people believing that it will
hold its value over the long run. That credibility is now in danger.
What makes the euro so vulnerable is the fact that there is no
government behind it. There are twelve governments behind it, to be sure,
but they have not submitted themselves irrevocably to a single
decision-making authority. If a major political or financial crisis hits,
there is always the chance that one or more of those governments will
decide the joint currency is no longer in its interest.
The euro is a one-size-fits-all straitjacket that does not serve
all the countries that have adopted it equally well even in non-crisis
times. For example, it imposes the same interest rate on Germany (which
needs a lower rate to help it escape from a long economic downturn) and on
Spain (which should be raising the interest rate to cool the inflation
caused by its booming economic growth). Only a large range of benefits from
this single currency would compensate for its obvious costs, and most
eurozone citizens don’t see those benefits.
All large areas that use a single currency suffer from the same
problem to some extent. Maine and California, for example, would generally
do better economically with different interest rates, whereas the US dollar
imposes a single interest rate nationwide. Being shackled to the same
interest rate is part of the price they pay for being parts of the same big
country (and they pay it willingly because they also benefit from belonging
to a larger whole). But at least, in a crisis, there is a single US
government that sets policy for all fifty states.
No single government sets policy for all twelve countries that use
the euro. The European Central Bank has day-to-day responsibility for
running the currency, but the separate national governments of the EU
retain their sovereignty and in a crisis could override the ECB. That
means the euro could fall apart in theory. Is it likely to do so in
Not this time around. Italian politicians may play with the idea
of bringing the lira back to distract an angry electorate, but it would be
“economic suicide,” as ECB chief economist Otmar Issing put it, for Italy
alone to abandon the euro. The real danger for the euro will come much
later, perhaps in the next recession but one, around 2015-18.
By then 22 countries with wildly diverse economies will be using
the euro, for all the recent entrants to the EU also plan to adopt the
currency. More importantly, by then other big EU countries besides Italy
may also have concluded that the euro does not serve their purposes.
European governments rushed into the euro in the 1990s, knowing
full well that the political foundations for a single currency did not yet
exist, as an emergency response to the collapse of the Soviet empire and
the reunification of Germany. They intended closer political integration
to follow, but that project has now stalled. If it is not re-started, then
sooner or later (but probably later) the euro is doomed.
To shorten to 725 words, omit paragraphs 5 and 9.
(“International…today”; and “All…states”)
Gwynne Dyer is a London-based independent journalist whose articles
are published in 45 countries.