ECONOMY AUGUST 9, 1999
It’s been just seven months since the European Union adopted a single currency managed by a single central bank. But the problems inherent in this arrangement have already begun to emerge. In the spring, Oskar Lafontaine, Germany's finance minister, resigned after clashing with the German chancellor and the chairman of the European Central Bank, Wim Duisenberg, over Duisenberg's management of Europe’s monetary policy. The trouble: Germany’s economy is weak. But the European central bankers appear to have been far more concerned with the weakness of the euro. So they have been unwilling to take the necessary measures—such as cutting interest rates—to help stimulate Germany’s economy, fearing that they will drive down the euro’s value still further. To the amazement of most observers, Duisenberg even hinted last week that interest rates might be raised.
It is foolish for the central bankers to equate the success of the euro with that of the European economies. After all, currencies fluctuate. And Americans do not regard a spate of dollar depreciation as a stain on their economic virility. But the Europeans, having set short-term currency strength as a test of success, have not only failed their own misguided test but also failed in their responsibility to help provide noninflationary growth in Europe.
This cloud will pass; some think the euro is already starting a phase of recovery. But the past few months have illustrated the fundamental contradictions implicit in a structure in which the central bank is independent not only of any single country's politicians but also of any single country's citizens.
Of course, in any country in which the central bank is independent, rows occur from time to time between the finance minister and the central bankers. But, within a single country, all parties can at least find comfort in the fact that each has a common frame of reference. The European Central Bank is unique in that it is not balanced by a group of politicians of stature who operate within the same boundaries. The bank’s territory is Europe. The territory of the politicians is each one’s own nation-state. And, while the president of the European Central Bank is answerable, ultimately, to the governments of the eleven countries whose currencies have been subsumed in the euro, these governments have no single interest but, rather, eleven different interests.
Their economies vary: for example, France, with its heavy agricultural emphasis, remains quite different from Germany, which emphasizes industry. The economic cycles of the 15 members of the EU are also different. While Germany now languishes, Ireland is in the midst of a boom. The boom started with a combination of a farsighted tax policy designed to encourage inward investment and, ironically, the munificence of the EU, which doled out vast subsidies to enable Ireland, one of the poorer countries in the union, to build roads and motorway bridges. For the past several years, the Irish economy has been booming, with close to eight percent growth in the past year. House prices have shot up. Consumer prices, already on the rise, are likely to go up a good deal further.
The Irish government is powerless to do anything about this because it must live with the interest rates set for the euro by the European Central Bank. Under the current circumstances, it seems likely these will remain low--and, given the weakness of the largest economy in Europe, they may indeed go lower. So, after a little more boom, a bust is inevitable: as domestic prices rise, the balance of trade will go badly into deficit, and finally unemployment will go up as demand for Irish goods, from domestic or international sources, hits the rocks. At that point the government will appeal for more money from the Cohesion Fund of the European Union, and the whole cycle can begin again.
PROPONENTS OF THE euro point to the United States as proof that divergences in economic performance between one region and another can be self-correcting. In the United States, if jobs are hard to find in a region that is experiencing a recession, people move to an area where prospects are brighter. But American workers have an advantage over their European counterparts: no matter where they move, the language will remain the same. Meanwhile, even within many EU countries, language remains an obstacle to mobility. In Belgium, the Flemish- and French speaking populations find it hard to understand each other. In France, words introduced from America or the U.K. are officially outlawed. A true euro enthusiast should, to be consistent, embrace the concept of a common language—the most logical choice being English. However, a camel would go through the eye of a needle a good deal more easily than the nations of Europe would agree to the demotion of their languages. Even the most zealous euro enthusiasts recoil from such a ghastly prospect.
The unwillingness of Europeans to contemplate a single European language demonstrates just how flawed and flimsy the sense of community and integration in the EU really is. It also makes it extremely unlikely that divergences among the economic patterns of different countries can be dealt with through large scale labor migration. That leaves large-scale bailouts by the EU, financed by collecting funds from its richer members, as the only real instrument for correcting the economic disparities that will occur when euro interest rates are at the right level for some countries and the wrong level for others. And institutions, particularly new ones, that rely on continuous sacrifice by some of their members do not tend to last long.
Richard Oldfield managed an investment advisory firm based in London. This article appeared in the August 9, 1999, issue of the magazine.