By Nitin Mehta, CFA
A year is a long time in a stressed currency union. Last October, we conducted a poll of CFA Institute members based in Europe about the future of the eurozone. At that time, 70% of respondents agreed that a failure of the euro would be a failure for Europe. However, 63% believed that a breakup was unlikely. And even amongst those who thought otherwise, only 36% expected it to break up in less than a year. It turned out that the majority was right. So far.
Not surprisingly, a major theme of this year’s CFA Institute European Investment Conference in Prague was the prospect for the euro. Most speakers opined on the subject, sharing and supporting their various arguments.
Anatole Kaletsky, co-chair of GaveKal, laid out the necessary conditions for the long-term survival of the euro: political, fiscal, and monetary federalism. He stated that nothing less would safeguard the common currency, and deemed central control of tax and spending, joint responsibility for debt and banking, and central bank support for federal debt essential to underpinning the unit. He added that in the near term, the European Central Bank‘s (ECB’s) “safety net” would save the euro, and there may be a continuation of the crisis, but a breakup would be unlikely.
Wolfgang Münchau, the European economics columnist for the Financial Times, was less certain. He described the rolling European sovereign debt crisis and the banking crisis as two drunks supporting each other to keep from falling. He admitted that the ECB’s new bond-buying programme, termed Outright Monetary Transactions (OMT), addresses many crisis points, especially the sovereign and bank debt problems, while breaking the circuit of ever worse expectations. But, he stated, OMT may never be taken up, or worse, it may create political resentment in Germany and reduce scope for any political maneuver. In any case, he believes the program needs a banking union to be effective.
So where does that leave the outlook, especially for Spain and Greece? Münchau fears the worst for Spain, given its present policy trajectory. He stated that a severe recession, fiscal overshoot, and a future possibly worse than that of Japan was likely. For Greece, Münchau does not think it will be much better. As austerity becomes ever harder to implement, political change is likely and a default is all but certain. He contended that while OMT addresses many of the crisis nodes, it is far from a sufficient resolution. The program is likely to slow down the political process for adjustments, setting the stage for a period of relative calm to be followed by a new acute phase.
The theme continued in a debate at the conference between a French professor and a German professor who provided a contrast in opinions about the sustainability of the euro. Catherine Lubochinsky, professor of economics and finance at the University of Paris 2 (Panthéon-Assas), analyzed the genesis of the crisis and what the issues revealed about transfers, competitiveness, and sovereignty. Optimistically, she highlighted the potential for creative cooperation with rescue funds, stabilization tools, and unified regulatory institutions, as well as the need for a banking union. “Politics provide the best pointer to the future of the euro,” she said.
Responding to Lubochinsky, Markus Kerber, a German professor of public finance and political economy at the Technische Universität Berlin, declared emphatically that “the euro has no future.” The only question that remained, he stated, was how to bring the matter to a close. He proposed a radically different solution: The creation of a parallel currency zone amongst the countries with a current account surplus. The new currency would be heralded as the Guldenmark — a fitting response, he argued, to the economic inequality in the eurozone.
Kerber shared his belief that the single currency is a mistake that can be rectified by following an unusual path. The Guldenmark would function as a second currency alongside the euro. It would allow those countries that did not wish to “gamble with their fiscal solvency” to exit the eurozone as a group.
The idea of a parallel currency in Europe is not entirely new. At the time when the European Monetary System was in operation, the idea of a 13th parallel currency — the ecu — was often discussed. The concern then, as now, was about the risks of currency substitution and the loss of monetary control that may ensue. Kerber’s response to such criticisms was to ask how a transfer union can be avoided in the absence of a parallel currency, which would cater to the differing economic strengths of the member countries of the eurozone — an issue that remains at the very crux of the challenge for the euro.
Despite the conference speakers having differing views on this topic, they seemed to agree on one point: Ultimately, the resolution on the future of the euro must come from choices made about the political economy.
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