Whatever the results of the vote tomorrow on our membership of the European Union, few Brits would hanker to be part of the beleaguered eurozone. But what actually went wrong with the euro?
Well, Germany’s notion of monetary union resembled the rather austere Scottish school Gordonstoun, which the Duke of Edinburgh thought would toughen up his son, Charles. The German economic values of sound money, self-improvement and budgetary rigour are the equivalent of Gordonstoun’s cross-country runs and cold showers.
But the eurozone came to better resemble another private school—the chaotic Summerhill in Suffolk, where lessons were voluntary and the children ran rings around their teachers. And indeed, perhaps school is the best analogy for understanding what happened to the euro.
Entrance exam
Getting into the euro was meant to be tough. Germany insisted that the Maastricht Treaty set out five tests relating to inflation rates and deficits, designed to weed out the duffers.But Spain, Portugal and Greece were not keen on being placed in a remedial class while the favoured few forged ahead. And no country, not even Germany, found it easy to meet the five criteria. Ultimately, continental Europe’s three biggest economies, Germany, France and Italy, all resorted to some creative accounting to pass the fiscal tests.
The tests were tough—and would have been tougher had they not been fiddled—but they were the wrong tests, for the wrong countries, at the wrong time. Worse still, they did not set in process the convergence among the disparate economies of the EU that was needed for successful monetary union.
Curriculum
Like traditionalists calling for a return to the three Rs, Germany, with the backing of the European Commission, wanted monetary union to follow teaching by classic German methods, forcing through the structural changes that it considered had been ducked by too many countries for too long. To make sure that all the members of monetary union got the message, the European Central Bank’s mandate in 1999 was to keep inflation below 2 per cent a year.The ECB had to target the money supply in the way that the Bundesbank always had, setting interest rates in the same way and using the same techniques. Germany’s only real concession to its new pupils was to join the single currency at an uncomfortably high exchange rate that disadvantaged its exporters, but after that it was meant to be a case of hard graft for everybody.
Term starts
The euro’s arrival in 1999 coincided with a period of rapid economic growth, in part stimulated by the collapse of oil prices and in part explained by the American-led technology boom. But when the euro started to fall in value, true to its mandate and to its Bundesbank lineage, the ECB responded to a weaker currency by raising interest rates. But it went too far, tightening policy too aggressively at a time when the global economy was weakening anyway.The slowdown was particularly hard on Germany, which responded by taking steps to make itself leaner and fitter. If the rest of Europe was like the fictional schoolboy Billy Bunter, forever waiting for a postal order to arrive, Germany was the school swot, burning the midnight oil to stay at the top of the class. The sacrifices made by German workers were considerable. which may explain their lack of sympathy for workers in Greece, Spain and Portugal after 2008.
Streaming
The German approach was not copied across the eurozone. Elsewhere, joining a single currency with a one-size-fits-all interest rate led to the availability of much cheaper credit. Interest rates were too high for some countries and too low for others. The ECB insisted that a common monetary policy coupled with structural reforms would lead to convergence and the financial markets assumed that because the central bank had spoken that it must be so. It wasn’t.Monetary union led to divergence, not convergence. Impressive growth rates in Spain, Greece and Ireland belied an underlying weakness. Germany had a rising trade surplus while deficits grew bigger in Spain, France, Italy and Greece. This was not quite what had been envisaged. It had been assumed that capital flows would be used to build up the productive capacity of the weaker eurozone countries, not to build second homes for BMW workers from Munich. Billy Bunter got his postal order—and spent it in the tuck shop.
Cheating
The Germans were not in much of a position to seek to remedy this. They had set up the ECB to be a clone of the Bundesbank. In place was a Stability and Growth Pact (SGP) designed to prevent member countries from running up excessive budget deficits. Except that in 2002 and 2003, Germany and France ran deficits in excess of the SGP’s 3 per cent limit.Romano Prodi, president of the Commission, had powers to punish the offenders—by demanding an interest-free deposit to the Commission, which would be surrendered if they failed to reduce their deficits below the permitted limit. But Germany and France refused to pay. Prodi backed down, giving the signal that other countries could also break the rules with impunity.
Inspection
Any parent would have been proud to receive a school report like the IMF’s report on the eurozone in July 2007. "The outlook is the best in years," it noted. But in 2013, the IMF compared the PIGS (Portugal, Italy, Greece and Spain) with four former Soviet bloc countries (Poland, Hungary, the Czech Republic and Slovakia). The latter had attracted foreign direct investment that built factories and created lasting benefits, rather than speculative cash that pumped up housing bubbles.Exams
The big test for the eurozone came in August 2007, when what had been considered a local and containable problem in the US housing market turned into the most acute financial crisis since the 1930s. The single currency failed the test. The crisis did, however, determine what sort of establishment the eurozone was going to be. It was Germany that provided the funds to keep the school going when the crisis broke, and so the school would be run along German lines."Europe Isn’t Working" by Dan Atkinson and Larry Elliott is published by Yale, price £14.99 hardback
