Euro: A flawed currency on weak foundation

The crisis has its roots in decisions made in the 1990s when European leaders were designing the euro.

The debate about how to distribute the cost of preserving the euro often revolves around a fundamental question that is unspoken but implicit: Who caused this infernal crisis anyway?

A hint: It wasn’t just the Greeks.

In Germany, however, the prevailing stereotype is that the dissolute Greeks squandered the privileges of eurozone membership. There is a palpable resentment among German taxpayers who feel they are being asked to pay for the sins of the Greeks as well as the Spaniards and Italians.

It is, of course, not that simple. While it is true that a series of Greek governments bears a large share of the guilt for the euro crisis, for mismanaging the country’s economy and finances, there are plenty of other culprits. They include the German and French banks that lent Greece money and fuelled the Spanish housing bubble and the European political leaders who, more than a decade ago, introduced the euro even though they knew it had basic flaws.

The circle of perpetrators could also include the fickle bond investors who underpriced the risk of Greek debt before 2010 and whose volatile reaction to even minor events has lately been wreaking havoc with borrowing costs for Spain and Italy and, by extension, those countries’ economies. It could include the bank regulators and national governments that created incentives for European banks to load up on European government bonds.

The popular debate, though, seems to revolve around cultural stereotypes. The southerners are dolce vita spendthrifts, while the Germans – and sometimes the Finns, Austrians and Dutch – are scrooges with no sense of European solidarity. Some of the stereotypes are more offensive: The German chancellor, Angela Merkel, has even been portrayed in the Greek and Italian media as a latter-day Hitler. “The blaming game that dominates the political debate in Europe is a clear indicator that cross-border policy cooperation in Europe has ground to a halt,” said Giancarlo Corsetti, a professor of macroeconomics at the University of Cambridge.

The question of blame was in the air last week as Merkel, along with the French president, Francois Hollande, and other eurozone leaders confronted the likelihood that Greece would need more help than it has already received in order to avoid a chaotic exit from the currency union. Last Saturday, Hollande gave the new Greek prime minister, Antonis Samaras, some reassurance, expressing his commitment to keeping Greece in the eurozone.

“For me, the question should no longer be asked,” Hollande said. “Greece is in the eurozone and should stay in the eurozone.” Like Merkel, Hollande said that the new Greek government “must demonstrate the credibility of its programme and the willingness of its leaders to go all out.”

But Hollande added a key phrase demonstrating his unhappiness with some of the austerity measures the Greeks had had to enact. The Greek government must press forward with economic reforms, he said, while making sure that it is tolerable for the population. Hollande made a point of “saluting the Greek people” for their “painful efforts of the last two and a half years.”

The euro could collapse unless Europeans stop pointing fingers and agree to share the cost of a solution, said a group of economists convened by the Institute for New Economic Thinking, which is financed by the investor George Soros.

Specific countries

“The extent to which markets are currently meting out punishment against specific countries may be a poor reflection of national responsibility,” the so-called INET Council said in a report last month. “Absent this collective constructive response, the euro will disintegrate,” the council said.

The debt crisis has its roots in decisions made in the 1990s when European leaders were designing the euro. Many economists had warned then that Europe still lacked key elements necessary for a common currency to work, like a joint European bank regulator and a system for dealing with troubled financial institutions.

Those shortcomings came into painful relief after Irish banks began to get into trouble in 2006. Ireland had to bear most of the cost of the bailout by itself, precipitating a national debt crisis from which it is still recovering. Spain now faces a similar problem with a banking crisis it cannot afford to fix on its own.

The eurozone also lacked an effective means to discipline members that violated debt and deficit spending limits set by treaty. Several countries soon exceeded them. In fact, Gerhard Schroder, the German chancellor until 2005, was one of those calling loudest for the rules to be watered down so he would not have to cut government spending.

These flaws were well-known. But European leaders, led by France and Germany, proceeded with the common currency anyway, on the theory that they could deal with its shortcomings later. Now they are trying to create a common bank regulator and a stricter fiscal system amid a crisis much larger than anything they ever imagined.

“When we started the euro we knew the construction was not good,” said Corsetti, the Cambridge economist. The idea that they could deal with flaws as needed “was a hubris that turned out to be very costly.”

It is true that, before and after joining the euro in 2001, Greece obscured the true extent of its debt, sometimes with the help of financial transactions engineered by Goldman Sachs. But it was not exactly a secret that Greece was fiddling with the numbers. Eurostat, the EU statistics agency, warned about it as early as 2004.

Yet European banks, especially French and German banks, continued to lend Greece money. At the end of June 2009, just before the debt crisis exploded, Greece owed French banks 76.5 billion euros, or $95.7 billion at the current exchange rate, and German banks 38.6 billion euros, or $48.3 billion, according to the Bank for International Settlements. The figures include both government and private-sector debt.

If Greece was the addict, those banks were the dealers. German and Frenchbanks also lent huge sums to Spain and Italy. “It was German government decisions and German banks – and Austrian banks and Dutch banks and Finnish banks – who lent the money to all these countries,” Adam S Posen, a US economist who is an external member of the monetary policy committee of the Bank of England, said on BBC television this past week.
Germany lent the money so it could be used to buy German exports, Posen said.

“Germany has been running a scheme in their own interests,” he said. Now Germany is struggling to hold the eurozone together. Merkel met in Berlin on Friday with the Greek prime minister, Samaras, and pledged to support Greece as it tries to mend its economy and stay in the currency union. Spain will also need money to rescue its banks. And Europe must decide how to contain borrowing costs for Spain and Italy so that they do not join Greece on the list of endangered euro members.