Some thougths about the future of the euro

By: Susanne Mundschenk and Wolfgang Münchau

The European news coverage on exchange rate pretends as though the real dispute over exchange rate policy is between the politicians on the one hand, and the European Central Bank on the other. According to this narrative, the politicians would like to prevent the euro from rising beyond an agreed threshold, while narrow-minded central bankers regard any form of exchange rate policy as essentially incompatible with their price stability mandate.

 

The last Ecofin meeting has shown that this not the case. When it comes to the exchange rate, the real conflict is not between central bankers and politicians, but between politicians. In one corner of the ring you have Sarkozy, cautiously supported by eurogroup president Jean-Claude Juncker and Joaquin Almunia from the European Commission. In the other corner, you have the fiscally conservative finance ministers of Germany, Austrian and the Netherlands.

 

If there was ever a fight between the central bankers and the politicians, the politicians would win it. We have no doubt about this. The reason we do not have an exchange rate policy is entirely the result of political disagreement. Under EU voting rules, nothing much ever happens if you have two large countries on opposite side of a debate, and this is why this issue remains largely unresolved.

 

The interesting and troubling aspect of this political confrontation is that the respective national positions are invariant to political change in member states. No matter who is in power, the left or the right, the positions are unchanged. It makes absolutely no difference whether the Dutch finance minister is an ultra-liberal like the never-ending Gerrit Zalm or his Socialist successor Wouter Bos. In Germany, there has been no real change in the position since the days of Theo Waigel, the 1990s finance minister, a Bavarian conservative, and his SPD successors. Sarkozy may be a little louder than his predecessors, but he makes exactly the same points as the string of French Socialists in the 1990s. This is not a fight between the left and the right, the liberals and the Socialists, the Keynesians versus the Monetarists, not even between the North and the South, the war mongers versus the peaceniks, or any other division you can think of - except one. This is a very oldfashioned European clash between nation states, and a clash between unwritten norms. This is not exactly what you want to have in a monetary union.

 

A year ago, everybody got excited about the prospects that Italy might one day have to leave the euro. Italy has since not solved any of its problems. On the contrary, the Prodi administration has wasted one opportunity after another to achieve real reforms, and has been riding out on the wage of the economic upswing.

 

But to us, the real threat to the cohesion of the monetary union is not Italy, or even a post-property-crash Spain. The real issue is the political gulf between France and Germany. The Franco-German dispute is a reminder, if any was needed, that these are two countries that have ideologically not moved an inch since the negotiations of the Maastricht Treaty. On the contrary, they have learnt to distrust each other more since the start of the euro. Whether it is the funding of the Galileo space satellite project, EADS, or the management of the euro. France and Germany are almost on opposite sides of most economic debates.

 

From a political economy perspective, they are about the least likely countries you would ever want to join in a monetary union. Heterogenous preferences between these two countries make compromises look like national sacrifices, even if there are strong ties between the two economies. The French establishment believes, rightly or wrongly, that exchange rates should be, and can be, managed; that monetary policy should serve the goal to stabilise economic growth and inflation simultaneously; that budget deficits are largely irrelevant, or to the extent that they are, this is a purely domestic issue.

 

Most importantly, France, unlike Germany, believes in the supremacy of politics over economics. In the French political system, there is no such thing as independence from the state, its institutions and elected representatives. The German system, by contrast, is full of independent quangos, not only the Bundesbank, but also the cartel office, the banking regulator, even the public broadcasting networks. The two countries have a totally different concept of the state. This is why the French idea of an “gouvernment economique”  had no chance to be discussed seriously by the Germans even if some forms of cooperation make sense economically also from a German perspective.  

 

 

The Germans accepted monetary union reluctantly, hoping, at least during the 1980s, that it would ultimately give rise to some form of political union. As we now all know, that turned out to have been an error of judgement. The Reform Treaty has clearly strengthened the EU's political dimension, and is so useful in many respects. But even its most ardent advocates do not claim that the EU has made big leap towards political integration. How Germany could ever have hoped to find a lasting compromise with the French politically is from today’s perspective a mystery.

 

But lack of political integration is not the worst bit. The worst bit is the lack of an integrated economic policy. This is something we had reason to expect back in 1999. We have made no progress on external representation. We still send troikas to China, whose economic leadership remains unimpressed. And we still have Germany, France and Italy representing their national interests within the G7. The stability and growth pact, mark I, collapsed in 2003. Its successor is currently in the process of collapsing as France and Italy have unilaterally exempted themselves from the agreed annual reductions in structural deficits. And of course, we are still debating the remit of Article 111, formerly Article 109, of the European Treaties, and what it means for exchange rate policy.

 

 

Herb Stein's recently much quoted quip about lack of sustainability applies just as much to the future of a monetary union, as it does to global imbalances or financial bubbles. If France and Germany continue this way, expect politicians to emerge in either country who will begin to question the merits of continued EMU membership. We are not talking about the respective governments, but about opposition parties. There is no shortage of economic populism in either country, so this is not a totally unrealistic scenario. In fact, the euro would probably make an almost ideal target for a ruthless populist.

 

 

So if you think that Sarkozy's repeated criticism of the ECB is harmless, irrelevant or plainly good fun, be careful. On a couple of occasions, Angela Merkel has already hit back with equal force. During the July eurogroup meeting, Steinbruck told Sarkozy into his face that his fiscal policy sucks. The tone is getting much more aggressive. The technical pros and cons of an exchange rate policy seems a side issue to us. As Herb Stein would have put it, either the French would have to stop, or the Germans, or else the EMU would stop. Something has to give here.

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