Toward the Dissolution of the Eurozone
A currency driven by political idealism more than economic reality, the Euro has severe, structural issues that threaten Europe's economy and politics. The time is now to abandon this ineffective monetary union.
The Eurozone, a monetary union between 19 member states within the European Union, represents the largest shared economic region on the globe. Member states share a common currency and central banking authority, and they must meet the criteria of several macroeconomic indicators. Though this union seems sound, structural flaws within the Eurozone make continual, cyclical economic crises inevitable—only a move away from this system can prevent an imminent currency crisis that would permanently damage European multilateralism and political cooperation.
The creation of the Eurozone can be best described as a political project, an attempt of European leaders to remedy disunity by increasing integration. After two catastrophic world wars, internal turmoil characterized the political landscape of mid-20th century Europe. The signing of the Rome Treaty in 1957 established the European Economic Community (EEC), a customs union agreement with ambitious goals beyond economics. Its founders hoped it would usher in the creation of a new inter-European identity in the hopes of preventing a world war and restoring trust. Belgium, France, Italy, Luxembourg, West Germany, and the Netherlands were original member states, but other states joined in the following decades. This system involved newly eased restrictions on work and travel between EEC countries. The fall of the Berlin Wall in 1989 marked a turning point for European unity—the Maastricht Treaty established the European Union (EU) in 1993, and with it came a new set of economic institutions that would lay the groundwork for the adoption of a common currency. The most significant among them was the European Central Bank (ECB), which effectively established a monetary union. The Euro was then introduced as a common currency for EU member states in 1999.
Proponents of the current system argue that a common currency promotes cross-border trade and economic stability. While seemingly sound, the reality is more complicated. EU Member states like Sweden, which do not use the Euro, have actually seen higher rates of growth and trade than those who do. Non-EU Eastern European nations have seen faster growth rates than those with similar economies in the Eurozone. Deeper economic analysis points to a much more grave conclusion for the fiscal and geopolitical future of the EU.
The Eurozone creates inflexible monetary policy across countries, which makes individualized interest rates impossible. This means individual countries can’t resolve the Phillips curve—the inverse relationship between rates of unemployment and inflation. In the Eurozone system, rates that deal with overemployment in one country aggravate underemployment in another and vice versa because of barriers to labor migration and structural differences between countries. That results in the ECB playing a game of whack-a-mole that only worsens with time. Member states are also forced to share the same fixed interest rate. This one-size-fits-all approach enables excessive debt and frightening inflation for countries experiencing rapid growth, who would be better served by greater rates. It robs states of the ability to react individually to issues unique to their economies in a timely manner—a delay which can compound, as was the case with the Greek Debt Crisis.
The current system also breeds irredeemable tax inefficiency. The combination of balkanized, regionally determined fiscal policy with the Eurozone’s framework of a uniform, centralized monetary policy creates a race to the bottom with tax rates. Rather than leading to healthy competition, inefficient allocation of capital resulting from free mobility in the absence of tax harmonization leads to a race to the bottom, forcing states to undercut one another by lowering tax rates on imports. Capital will naturally flow into areas that tax it least rather than where marginal productivity is highest. Countries are incentivized to marginally undercut other countries to attract greater labor and capital, which causes tax rates to continually drop until they reach equilibrium at zero. This downwards spiral leads to unstable austerity policies, poor responses to supply shocks, and insoluble debt bubbles that pop in the long run.
The structure of the Eurozone uniquely enables bank forum shopping, a harmful form of cross-border arbitrage. Cross-border arbitrage, the buying and selling of treasury bonds and government securities across Europe, allows shareholders to exploit different prices of the same security in different countries. Potentially the most harmful implication of this process is that it allows a state to benefit from a favorable bankruptcy of another, posing risk to economic stability. Arbitrage thus both inherently relies on and exploits market inefficiencies. Easy mobility across banking decreases the ability of domestic crisis mitigation because of offshore risk to safe assets in other countries. By creating a system that thrives on economic imbalances, cross-border arbitrage increases the volatility of recessions and permanently stalls economic recovery.
The disparity in economic recoveries between the EU and US in response to the COVID-19 crisis elucidates the inefficiency of the Eurozone. International Monetary Fund (IMF) predictions indicate that the U.S. is likely poised to not only return to but exceed pre-pandemic levels of growth, while the Eurozone is projected to lag behind. The four largest economies in the Eurozone saw their growth projections slashed by the IMF, which has major implications for the smaller economies that rely on them. In the year after the onset of the pandemic, US GDP expanded by 6.4%, while that of the Eurozone lagged behind, at 4.4%.
Unfortunately, there is no quick fix. The shortcomings of the Eurozone are structural, meaning that reforms will be ineffective. Senior economist Silva Dall’Angelo described the slow growth caused by the Euro as part of an “institutional problem” within the framework of the economic structure, pointing towards the unfortunate reality that flaws within the monetary union are irreconcilable.
Grounded in lofty ideals rather than pragmatic fiscal realities, economic imbalances engendered by the Eurozone have only deepened political division. The process of debt mutualization has transformed the EU into a system of creditor and debtor states, exacerbating disparities and emboldening accusations that some member states take more than they give. Germany, which contributes almost 30% to the total GDP of the Eurozone, was the most staunch opponent of debt mutualization, while Greece and Portugal, which each account for under 5% each, aggressively sought bailouts. The exacerbation of political tensions between creditor and debtor states has been reflective of a wider pattern of political discord between Northern and Southern European states.
By engendering opposition, the moral hazard presented by these unequal economic burdens has stoked the flames of political division and emboldened populist, Eurosceptic rhetoric that has real political implications. A right-wing populist party in Finland known as the Finns has grown in popularity by opposing economic concessions to Greece. Their leader, Finland’s former foreign minister, Timo Soini, has been an outspoken critic of the current European economic system, referring to the Finnish government’s bailout of Greece as "a moral hazard and a pyramid scheme that will continue as long as the milkmaid has a cash cow to milk.” The rise of the Finns has had very real consequences—the Finns now hold 38 parliamentary seats and represent the second-strongest party behind that of the Prime Minister. Finland represented the single toughest holdout against a deal to renegotiate Greek austerity measures in 2015, leading to political tensions between the two nations that have yet to resolve.
The fallout from a currency crisis would likely lead to the disintegration of the EU itself. It is unlikely that the union would be available to survive the opening of long-standing wounds coupled with economic disaster. A Eurozone collapse would endanger the Schengen Agreement, which ensures the free movement of goods, services, and capital among member states. Almost 1.7 million people reside in one Schengen country while working in another and every day around 3.5 million people cross internal borders, underscoring its political and economic importance.
A monetary system that not only engenders but relies on inflexibility is unlikely to prove sustainable, especially in the face of unpredictable challenges—illustrated by the economic fallout resulting from the COVID-19 pandemic. An alternative is not unthinkable. The dissolution of the Eurozone would likely push states to create new regional monetary unions or return to national currencies. The concept of a monetary union between the Netherlands, Austria Denmark, Sweden, and Finland led by Germany has been introduced by European political thinkers, as has a Latin monetary union led by France that includes Spain, Italy, and Greece. Engaging in a process formerly known as redenomination, states would reintroduce their national currencies at the appropriate exchange rate, adjusting wages and prices. An organized transition would involve the re-establishment of national central banks and the dismantling of the ECB. The euro would not be taken out of circulation until each country has completed its redenomination process—in this interim, each currency can be pegged to the gold standard to ensure economic stability.
Given the imminence of a disaster, economic authorities fear that there will come a time when they will no longer have the luxury of a well-mediated and gradual process. François Heisbourg, chairman of the International Institute for Strategic Studies (IISS) wrote, “The dream has given way to a nightmare. We must face the reality that the EU itself is now threatened by the euro. The current efforts to save it are endangering the Union yet further.” The status quo represents the ideal time to transition. The current system of instability threatens a run on the banks that would cause them to go bankrupt. A preemptive, orderly reversion to national currencies may be the only way to avoid an impending catastrophe.
The collaboration required by this process would strengthen EU solidarity, renewing faltering commitment to multilateral cooperation. Perhaps the greatest barrier to economic reform remains an apprehension rooted in the familiarity of tradition. But given the current system’s unsustainability, it is clear that change is on the horizon. The time is now for leaders to capitalize on this opportunity and forge the way to a more unified Europe, one ready to take on the challenges of tomorrow.
Meera Sehgal is a first year Political Science and Communications double major at American University. She is a staff writer at the America Agora.
Image courtesy Images of Money, Creative Commons