The wolf returns to the eurozone’s door

MoneyWeek has been around long enough to see several big trends recur. Most of them have been fascinating to cover. But one key theme of the past decade fills me with dread, because it was like watching a slow-motion car crash: the euro crisis. It may now be making a comeback.

The launch of the euro coincided with the start of a global upswing, so the currency’s intrinsic flaws were overlooked. Everyone was getting used to the conversion rates (an irksome 13.76 schillings to one euro in Austria). Because the eurozone encompassed most EU members it was trumpeted as a giant leap forward for European integration.

A sub-optimal currency area

Many analysts, however, pointed out that there had never been a successful single currency without a single government, and that the euro was far from what economists call an optimal currency area. The basic idea is that groups of structurally similar economies, who often tend to experience similar business cycles, are best suited to sharing a currency. A similar approach to money management helps too, as it pre-empts fights about any joint budgets and potential debt issuance.

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Benelux, Germany and Austria would arguably be an optimal currency zone: wealthy manufacturing-based economies with a shared instinct for sound money. What we got instead, of course, was northern Europe plus the inflation-prone south’s less healthy balance sheets. The prospect of sharing a currency with people who can’t budget, and would probably need a bailout at some stage, unnerved many northern Europeans, but such objections were steamrollered by the integrationist tide.

When the financial tide went out after the crisis, investors’ fears over the sustainability of the southern countries’ debt duly proved justified and bond yields soared. Since bond yields are implied long-term interest rates, that exacerbated countries’ solvency problems.

In the absence of a central fiscal authority to send money to poorer parts of the currency area to temper the impact of a downturn, only painful reforms and a clampdown on prices and wages would restore competitiveness and fuel confidence in stricken states’ ability to grow out of debt.

Cue endless wrangling between the European authorities and southern governments, and a cascade of market panic attacks focused on different countries until ten years ago this week Mario Draghi promised to do “whatever it takes” to keep southern bond yields low. The prospect of the European Central Bank hoovering up enough bonds to keep the yields down kept the wolf from the door, and a similar mechanism, the Transmission Protection Instrument, was launched last week, again against a backdrop of turmoil in Italy.

The wolf is still there, however. There is still ample scope for market panics and political clashes between Brussels and the member states, while the EU’s construction of a fiscal union (with an incipient banking union and a Covid-19-induced recovery facility allowing the EU to borrow collectively) is proceeding at the speed of a hungover giant sloth. More broadly, the eurozone is still stuck with a structure that acts as a deflationary straitjacket for much of the south, a recipe for recession and rancour. Until there is a European government or the euro is dismantled, the eternal crisis can only be managed or fudged – never resolved.