Long before the UK referendum, many argued
that monetary union was undermining the European Union. Many had expected
Greece to be forced out not once but
twice.
There is a cottage industry of books
forecasting the demise of EMU. Johan Van Overtveldt, the former Finance Minister of Belgium, penned “End of the Euro” in 2011 and its
captures the spirit of the genre. Jen Nordvig, a currency strategist,
authored “The Fall of the Euro: Reinventing the Eurozone and the Future of
Global Investing” in 2013, and
anticipates the demise of EMU. The same year Dimitris Chorafas’s, “Breaking
up of the Euro” was published.
Not to be outdone, a couple of months ago, Nobel Prize-winner and former chief economist at the World Bank Joseph Stiglitz brought us
“The Euro: How a Common Currency Threatens the Future of
Europe.” He anticipates that Greece and Italy will leave the monetary union. He has also advocated
that Germany leaves as well. He
calls for an amicable divorce and the
subsequent creation of a northern and southern currency bloc.
To the contrary, we were among the few that
did not expect Greece to leave the monetary union or be expelled. Paul Krugman, another Nobel Prize
winner, sought to explain why he was wrong about Greece leaving,
admitting that the political will was not sufficiently appreciated. We
have long argued that Europe, the EU, and
EMU are political constructs. The monetary
union itself was an economic solution to
a fundamentally political problem: Under what conditions can Germany be reunified after the Berlin Wall fell?
We make two points here. First, many
observers compare monetary union to some perfect model that they dream up rather
than ground it in the historical record and existing conditions. In this,
they are utopians Second, the EU that exists today is not the same
EU that existed before the crisis.
European Economic and Monetary Union is almost
17 years old. Consider where the US was 17 years after declaring
independence from the greatest empire at the time (and the first and true
Brexit!). It was not clear that the new republic would survive and indeed
another war with England was around the corner (1812). The colonies
fought the Redcoats under Articles of Confederation, which required unanimity
in decision-making and provided for a weak central government with no power for the federal
government to tax or raise an army.
There were two decisive events.
First, the Continental Congress was to reform the Articles of
Confederation. However, rather than reform the document, they pulled an
end run. It did not revise the Articles. It replaced them.
And rather than the Continental Congress accepting the changes, the
Constitution would be ratified by the rules within the Constitution
itself. Second, Hamilton devised a plan that in essence nationalized the
states’ debt. Some states, whose territory saw greater conflict, were more
in debt than others. This generated claims that the nationalization
was unfair. A large compromise was
eventually worked out, which included the location of the capital
itself.
The founders of the European project
understood that countries would be loath to sacrifice sovereignty unless it was
the more expedient path, which means a
crisis. They might not be disappointed by what has happened over the last several years. This has been a crisis of historic proportions
and out of it has come new institutions
and a new capacity of old institutions.
Consider as an example what happened earlier
this week. The EC has pushed back against eight countries’ draft 2017
budgets. No, Europe does not have a fiscal union. However, it has
developed a mechanism to enforce some broad agreements on deficits and debt
reduction. This did not exist before the crisis. Members submit draft
budgets to the EC prior to securing parliamentary approval.
When pressing Italy, for example, the EC says
it is not sufficient that it keeps its deficit below 3% of GDP as mandated by
the Stability and Growth Pact. That agreement also requires countries
to keep the debt level below 60%. Prime Minister Renzi argues that the
migration crisis and the earthquake meet the definition of exceptional
circumstances. The EC is not convinced
that Italy will spend the sums it suggests to address these developments, which
lifts the structural deficit to 1.6% from 1.2%. It gave Italy 48 hours to
defend itself.
Spain has been without an elected government
since the end of last year. It simply rolled the 2016 budget into
2017, which means no progress. Rajoy is likely to pass the vote of
confidence over the weekend as at least 11 Socialists will abstain. Rajoy
may have found breaking the political logjam was difficult, but his troubles
will likely intensify. The EC expects him to correct the budget, something on the magnitude of 5 bln euros in savings as soon as possible,
which means, in the language of EC euphemisms, by the end of the year.
The EC oversight is not the same as fiscal
transfers or a fiscal union. However, to ignore the reforms, new institutional capacity, and
practices is to miss the important evolution that has and continues to take
place. This is not unique to the
EU. When the US was as old as the EMU, only white men with property could
vote. Political parties, which are not
even mentioned in the Constitution, were just crystallizing.
The territorial integrity of the United States
was questionable as former Vice President Arron Burr demonstrated by trying to
form another country west of the Appalachian Mountains. And like EMU, the
US was not an optimal currency zone as it would have three distinct economies
(growing manufacturing and shipping in the Northeast, plantation slavery in the
South, and commercial farmers in the Midwest) into the middle of the 19th
century.
Europe, like the United States, is still a
work in progress. Our bullish dollar view has been predicated on the
divergence of monetary policy and financial conditions broadly
conceived. In addition to these economic considerations, the
saliency of political factors increase next year with elections in Netherlands,
France, Germany, and possibly Italy will rise. Although nearly
every European country has an anti-EU or anti-EMU party, none have wrested the
reins of power (In the UK’s case, it was a faction within the majority party
that campaigned for Brexit). France’s presidential election (Spring 2017) and Italy’s parliamentary
elections (scheduled for 2018) pose the biggest risks to this pattern.
Plenty of grist for more jeremiads on
Europe. Stack them next to the ones from the past two centuries claiming the
end is nigh for America.