Waking from the Euro Dream by N
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FEATURE Waking from the Euro Dream By N. Graham Allen, FCMA, CGMA, and Mark Kavolius, CIMA® he forces originally behind the represent an early chapter to a longer the assumption that the status quo will formation of the euro are being story. Th at great minds foresaw the prevail. T supplanted and forgotten in the fundamental fl aws in the EMU long Th e EMU is not built upon a current European economic and politi- before it was formed suggests we should solid foundation of widely accepted cal climate. In this article, we examine carefully consider whether Greece economic principles, and several key the structural challenges facing Europe’s represents a waypoint rather than a tenets, or structural challenges, create a Economic and Monetary Union (EMU) fi nal result. valid argument against its sustainability, and how it never recovered from weak Concern that a longer story might including the following: fi scal enforcement. We also examine the be in the making stems from the man- • Th e EMU is challenged to maintain a remedies needed to ultimately create ner in which the European Union2 single monetary policy built upon 17 a successful single European currency, (EU) has addressed the symptoms of diff erent sovereign fi scal policies; it and we explore the need for urgent the malady that today besets the EMU also lacks a good disciplinary mecha- reform to the EMU. instead of the malady’s root cause. nism for reining in the profl igate In 1980, a charismatic union leader As a result of its March 2012 debt spending of one or more member named Lech Walesa started a labor restructuring, Greece now benefi ts countries. organization known as Solidarność in from a reduced sovereign debt load and • A lack of labor mobility creates Poland’s Gdansk shipyard. At that time, a promise of fi nancial support from the pockets of long-term unemployment no one had any way of knowing that EU, the International Monetary Fund within the EU. In the United States, the formation of Solidarność and the (IMF), and the European Central Bank a common language and culture still subsequent shipyard strike it organized (ECB), so long as it maintains austerity prevail, and labor fl ows relatively would rank among the pivotal moments programs designed to reduce govern- freely between states. In Europe, leading to the collapse of the Soviet ment spending. Nevertheless, Greece’s labor moves less freely, as a result of Union, the removal of the Berlin Wall, economy continues to face fundamental cultural, language, and other barri- and the reunifi cation of Germany. challenges, including sub-par gross ers, a situation that sometimes cre- Today, one may justifi ably ask whether domestic product (GDP) growth, high ates chronic regional unemployment. recent events in Greece are simply unemployment, and rich public pen- • Th e EU lacks an authoritative execu- a Greek tragedy, caused by decades sions. Moreover, sovereign fi scal weak- tive body capable of creating and of irresponsible economic behavior nesses continue to emanate from other executing decisive crisis manage- (falsifying economic data, lax tax col- EMU member countries, including ment policies. lection eff orts, etc.), or if these events Ireland, Italy, Portugal, and Spain. Many are symptomatic of the beginning of the EMU countries face diffi cult economic Unlike the case of the 2008 U.S. end of the EMU.1 prospects, and requests for further credit crisis, where a single treasury support could weigh on the patience of secretary (Hank Paulson) exercised A unifi ed Europe is the result of plans. core members such as Germany and authority to impose changes on the It is, in fact, a classic utopian project, a France. In addition, a changing political banking system, none of the European monument to the vanity of intellectuals, landscape could widen the ideological governing bodies, including the a program whose inevitable destiny is gap among EMU member countries. European Commission (EC), can act failure: only the scale of the fi nal dam- in such a unilateral manner..3 At pres- age done is in doubt. Challenges to an Effective and ent, major decisions can, for example, —Margaret Th atcher Sustainable EMU require the consensus of the EU, the British Prime Minister (1979–1990) While current events and economic IMF, and the ECB, as well as that of realities trigger concern, an understand- the individual member countries. Even Margaret Th atcher’s quote suggests ing of certain historical aspects sur- then, local politics often remain at odds that Greece’s debt restructuring could rounding the EMU’s founding weakens with those decisions, a situation exem- January/February 2013 41 © 2013 Investment Management Consultants Association. Reprint with permission only. FEATURE plifi ed by the confl icting relationship infl uence. As the situation played out Kohl were the two primary public faces between the ECB and the Deutsche and the Soviets settled into economic of the euro. Bundesbank.4 defeat, the failings of communism led to Between the demise of the Berlin Th roughout this article, we refer to the collapse of the Berlin Wall, a critical Wall in 1989 and the signing of the these tenets as the “EMU’s structural event that galvanized support for the Maastricht Treaty in 1992, civil servants challenges.” formation of the EMU. worked at a frantic pace to draw up the terms of the arrangement, buoyed by Foundations of the EMU– On the day the Wall came down … prom- reunifi cation enthusiasm in Germany. Peace through Economic ises lit up the night like paper doves in fl ight. Late in the negotiations, Germany Interdependence —Pink Floyd extracted a high price for retiring its How did the EMU reach the point “A Great Day for Freedom” beloved DM in favor of the euro. First, where its potential collapse even merits Germany insisted on an independent discussion? To answer this question, The Convergence Period, European central bank, whose mandate one has to examine the EMU’s origins 1992–1999 would be to guard against infl ation; this and understand how, why, and when Germany struggled unexpectedly dur- was in confl ict with France’s preference, it was formed. In addition, one must ing the pre-convergence period as it which focused more on monetary understand the history of politics worked to reunify the country follow- policy. Second, and at the last minute, within the EU. ing the fall of the Berlin Wall in 1989. Germany insisted that the central bank Th e German people had internalized a be prohibited from issuing Eurobonds Anyone around here who isn’t confused healthy aversion to infl ation, having that eff ectively could obligate one doesn’t understand what’s going on. seen their country’s economy twice country to pay for the debts of another. —anonymous Belfast citizen, 1970 decimated in the 20th century by In fact, the Maastricht Treaty, in Article hyperinfl ation. Indeed, in the post- 103, Section 1, specifi cally prohibits the Briefl y, the EU’s roots trace back war years, the deutschmark (DM) had EC from becoming liable for the debts to the European Coal and Steel become a symbol of West German of a member country. Perhaps, at the Community (ECSC), established by economic recovery, independence, and time, the Bundesbank already was look- the Treaty of Paris in 1951. Th e ECSC nationalism. Th erefore, in 1990, West ing ahead to the possibility that it might formed a six-nation common market Germans considered it a bitter pill to become Europe’s fi nancial backstop for coal and steel, partially to ensure swallow when, as a condition to the and didn’t like what it saw. Today, the peace among the constituent nations reunifi cation, they agreed to a one-for- clause eff ectively prevents issuance of (France, West Germany, Italy, Belgium, one exchange between the DM and East a Eurobond guaranteed by all member the Netherlands, and Luxembourg). German mark. countries, and some maintain it also Later, the Treaty of Rome, executed Ultimately, the process of European should prohibit the ECB from directly in 1957, built upon the success of the monetary unifi cation was accelerated, purchasing sovereign bonds in the open ECSC and led to the founding in 1958 not so much by the Germans, who had market. Nevertheless, the ECB has pur- of the European Economic Community their hands full with the merging of East chased sovereign debt during the cur- (EEC). Ultimately, the EEC was assimi- and West Germany, but in fact by the rent crisis, to the consternation of many lated into the EU. French, who saw it as an opportunity to critics. Interestingly, the ECB recently Already, without looking too far back expand their infl uence within Europe has worked around the prohibition by into history, we see that peace fi gures and contain a newly unifi ed Germany. expanding its long-term refi nancing as a primary motivation for European France likely abhorred the prospect of operations (LTROs).5 economic cooperation. All the pre-EMU being sidelined by the broader spec- On February 7, 1992, to the sound cooperative markets were supported by trum of European politics. So, while of classical music, all members of the European political elites who believed Germany remained preoccupied with European Union signed the Maastricht that economic ties could lessen the like- its reunifi cation, France provided much Treaty in Maastricht, the Netherlands. lihood of military confl ict. In the 1950s, of the behind-the-scenes political impe- As a condition of joining the the destruction that had been caused by tus leading up to the February 1992 EMU, the Maastricht Treaty required two world wars still was visible through- Maastricht Treaty (a.k.a.