Reasons to Like the Euro Again
France's vote is the latest sign that the currency's future looks better than its past.
It’s always worth re-evaluating one’s views, and my latest revision is that the euro currency is better and less vulnerable than I had thought. I still believe its creation and later expansion were mistakes, but I now see them as much smaller mistakes than before. Many of the biggest costs lie in the past, so the euro might be a net plus moving forward.
What’s the new evidence? For one thing, geopolitics seem to be favoring the euro. France, the Netherlands and (soon) Germany are rejecting at the voting booth far right and populist parties that oppose the European project.
One of the original goals of the euro was to tie countries to the European Union and its rules for free trade and free migration. The major EU country that eschewed euro adoption, the U.K., has now voted itself out the union altogether, to its detriment. Estonia and Latvia, which adopted the euro in part for political reasons to tighten their bonds with the EU, still seem secure against potential Russian aggression. The biggest political trouble spots seem to be Hungary and Poland, neither of which are euro members. That may be a coincidence, but it may also reflect a very real psychological tie resulting from the currency adoption.
Economically, the euro is looking better too. Europe is bouncing back from its slowdown, but the broader evidence suggests a revisionist take on the 2008-2012 period, when the euro got tagged with such a bad reputation. Many European economies took major hits to employment and output, and indeed the euro was partially at fault. It was especially a problem for Greece and Cyprus, where a solvency crisis induced euro-denominated deposits to flee the country, contracting credit and ratcheting up deflationary pressures.
I now think of the 2008-2012 period as unwinding a long-term bubble of overinvestment in the EU periphery, and thus those were special circumstances when virtually all economic policies were radically underperforming. Given that a recurrence of such conditions is unlikely, the euro will do much better in the future.
Along related lines, compare the performance of fiscal austerity now with that earlier period. Greece has been going through an unprecedented fiscal adjustment, with a primary surplus running at 3.9 percent of gross domestic product; yet Greek output, while ailing, has remained roughly stable. Portugal has been cutting back drastically on public sector investment, dropping its public sector deficit from 4.4 percent of GDP to 2.1 percent. Rather than imploding, the economy grew by 1.4 percent.
Of course, fiscal austerity didn’t perform nearly as well in the earlier part of this decade, and neither did the euro. The economic implosion from the unwinding of the bubble was simply too strong, so we should not overgeneralize from the very negative performance during those years.
Another factor: The changing nature of international trade is lowering the benefits from flexible exchange rates. In standard economic theory, a country in trouble can limit the costs of a recession by allowing its currency to depreciate, thereby boosting its exports. Euro membership has limited that remedy. But as supply chains cross more borders, depreciation is less effective. If Italy imports raw materials from emerging economies, and then exports finished kitchen products to the world, a weaker currency won’t help much. It boosts exports, but some of those gains are given back when Italy must pay higher prices for the imported materials.
It’s also instructive to consider the recent debate in Iceland, a country that may eventually adopt the EU currency and in the shorter run peg to the euro. With a population of about 330,000, Iceland is wary of external capital flows whipsawing a floating rate currency up and down too easily. However, tourism is now Iceland’s most important economic sector and a euro adoption or peg would make it easier for both visitors and natives. The euro may be flawed, but Iceland seems to be concluding that the alternatives would be worse.
I still think that Greece never should have entered the eurozone and that Italy remains a serious problem because of its debt, slow growth and potential bank insolvencies. The euro isn’t the main cause of those problems, but in some scenarios it could make a comeuppance far worse, especially if euros flee the Italian banking system for neighboring countries, as happened with Greece. That’s not an easy problem to fix, and I do wish Italy still used the lira.
Yet French voters on Sunday recognized what economists ought to be seeing too: The best days of the euro probably lie ahead of it.