A second chance for Europe’s currency?

The euro is a child of Germany’s unification and of the need to solidly anchor Germany to the European Community. The crisis triggered by the pandemic and the abundant geopolitical tensions today can breathe new life into Europe. Perhaps the time is finally right for Europe to emerge at long last from the quagmire in which the Monetary Union has been bogged down for years, thanks to the introduction of novel economic policy tools.

At the European Council meeting in Hannover in June 1988, a committee chaired by the then European Commission President Jacques Delors was set up to study “the concrete steps leading to Monetary Union”. That committee, comprising all the member states’ central bank governors along with a handful of experts, got the job done rapidly and was able to submit a conclusive report to the European Council in April 1989 which was unanimously approved by the Council’s members.

The European Council that met in Madrid the following June took the report on board, yet without deliberating any operational follow-up to it.

It was obvious that the concrete transition from project to single currency raised complex political and operational issues and therefore demanded decisions that Europe at the time was not ready to address.

It was the sudden fall of the Berlin Wall in November 1989 that led to an unforeseeable acceleration in the story of the single currency and dispensed with the intermediate negotiation and development stages. If we reconstruct that story, we can better understand the unresolved problems that have been besetting the euro from birth.

The great fear of Germany’s unification

In the aftermath of November 9, 1989, when public sentiment was still riding high as a result of the pictures coming from Berlin – in which West and East Germans were embracing over the ruins of a Wall that had split the city in two for almost thirty years – the most widespread feeling harbored by Europe’s elites was concern at the prospect of Germany’s unification. French President François Mitterrand summoned a special European Council meeting on November 18 to discuss the new situation.

The real reason for the summons was to delay Germany’s unification for as long as possible; if possible, the idea was even to prevent it altogether. Margaret Thatcher revealed in her memoirs that Mitterrand – with whom she had clashed memorably on several occasions – called her to say that “in times of grave danger” France and England needed to forge a common front. Italian Prime Minister Giulio Andreotti, for his part, resorting to one of those ambiguous quips that fueled his reputation as a man with a sense of humor in certain circles: he repeated the bon mot uttered by a French politician who said he loved Germany so much that he actually preferred to have two. Aware of the Europeans’ unavowed wish to slow unification down, Chancellor Helmut Kohl hastily organized a meeting with US President George Bush, asking him to facilitate the start of direct dialogue between himself and Mikhail Gorbachev.

Receiving a positive response, he apprised the Bundestag of a plan for immediate unification.

So when the European Council met on November 18, it was obvious that unification was not just inevitable, it was imminent.

This prompted Mitterrand to set himself a different goal: no longer to delay unification but to find a way of indissolubly binding Germany to the European Community, to prevent it from single handedly ruling the roost in the countries of Central and Eastern Europe that were no longer under the Soviet Union’s thumb.

The Euro’s (more or less) inexorable march

The Delors Report outlining the path toward a single currency was sitting idle in the European Commission’s drawers. Demanding that Germany give up the Deutsche Mark ended up giving unification the green light. The report, which had gotten such a chilly reception at the European Council meeting in Madrid only a few months earlier, was dusted off and submitted to the Council meeting in Strasbourg on December 8 and 9, 1989. The decision was made at that meeting to speed things up. Two conferences were convened, one to debate the monetary unification project, the other to examine the political conditions that should accompany the single currency. Kohl warned the Bundesbank, which had openly voiced its reservations regarding the convenience of moving toward Europe’s monetary unification, not to raise any objections.

The Delors blueprint also gave Germany the guarantee of an approach to economic policy very close to that espoused by the German central bank. So the process got under way. England was offered the option of joining the single currency whenever it wished. Denmark got into line behind England. And clauses – the Maastricht parameters – designed to ensure that member countries subscribing to the move had converging economic and financial situations were introduced.

The conference on political union, on the other hand, made no progress at all, merely declaring that the single currency project was a step on the road to political union. And thus, with the Maastricht Treaty signed in February 1992, the euro was born.

Thirty years have gone by since then. What kind of entity is the euro, and what is the political nature of the European Monetary Union (EMU)? Is the euro the currency of a federal state like the US dollar, or is it something different? If some form of progress had been made toward political union in all this time, it would be right to consider the single currency as a “foretaste” of that political union. But the member states have made it quite clear with their actions to date that they have no wish to go any further. Thus, Europe is treading water, midway across the fjord between an international, intergovernmental entity and a federal, supranational one.

The EMU resembles an inflexible version of the fixed exchange rate mechanism set up in Bretton Woods. In other words, the system provides not for full solidarity among its member states (other than through the action of the European Investment Bank and various European funds) but for a set of rules that are supposed to ensure that those member states’ paths are not (too) divergent. At Bretton Woods, Keynes insisted on the rules necessary for the proper functioning of a fixed exchange rate system and argued that the burden of keeping the system going should not rest solely on the shoulders of debtor countries but should be eased by the action of creditor countries. In particular, he envisioned a mechanism that assigns the effort to recreate the stable balance of payments on which the maintenance of preset exchange rates naturally depends, not only to those countries that have a deficit but also to those that have a surplus.

The United States, whose balance of payments was in the black at the time, refused to countenance the introduction of such a mechanism, dumping the burden on the shoulders of countries with a deficit, and thus rendering the system inflexible.

However, it did have a degree of elasticity, in that exchange rates among member systems could be reviewed should the need arise.

With the single currency, exchange rates can no longer vary and thus the problem arises of making adjustments without an exchange rate safety valve. That is why the manner in which the burden of rebalancing the balance of payments is apportioned between countries in debt and countries with a surplus is of such crucial importance. The EMU took this consideration on board and agreed that the burden should not fall solely on debtor countries’ shoulders. The Commission keeps an eye not only on those balances of payments that are in the red but also on those that are too much in the black. But while it provides for penalties in the event of deficits – which are, or may be, a sign of excessive demand – it failed to introduce effective remedial action or sanctions for excessive balance of payments surpluses. Member countries are forced to show a certain stringency in their budgets under the threat that those budgets may not be approved, but in the event of an accumulation of balances of payments in the black, only a verbal reprimand is issued. Such a reprimand, for example, might take the shape of a warning from the European Central Bank to those countries with the margins to pursue expansionary policies.

Europe has constantly repeated that the problem will be resolved with the “completion” of the EMU and with political union. But that would mean, in one way or another, pooling debts and having an economic policy. That is a move that was not adopted either at Maastricht or in the years and decades that followed.

The turning point of the ECB and of the pandemic

Things have changed recently, due to the changing economic situation. The first change came in 2015 when the European Central Bank was forced, somewhat belatedly and only in the wake of a change of direction on the part of the us Federal Reserve, to wake up to the fact that inflexible compliance with the rules of conduct in force until that time was condemning the euro-zone to an unsatisfactory economic performance. A danger was perceived of seriously undermining grassroots support for the European project as a whole. The words that Mario Draghi famously uttered in July 2012 to the effect that the European Central Bank would do “whatever it takes” to save the euro (which might initially have sounded as though it heralded a call for stringent monetary policies) led in fact to the quantitative easing of 2014. In other words, it led to recognition of the fact that maintaining grassroots support for the construction of Europe undoubtedly entails complying with the rules, but that it also demands that Europe’s economy perform satisfactorily.

The outbreak of the pandemic in 2020 further reinforced that position. Not only did the ECB offer explicit support to the policy of expanding the public debt with which the Monetary Union’s member states decided to address the economic consequences of the lockdown, but the Commission and the Council also modified their previous posture. Not only were the Stability Pact and agreements on the process for slashing the public debt previously thrashed out with the member states suspended, but the NextGeneration EU plan – basically the first concrete instance of a budget policy in deficit in the European Union – was launched. These postures and decisions were the product of an emergency, of course, but they still mark a change of direction compared to that pursued after the Maastricht Treaty’s approval.

It remains to be seen what shape the Stability Pact will take in 2022 and 2023—a development of crucial importance for Europe’s future.

Are the decisions and temporary tools adopted to tackle the pandemic going to become permanent? 

It is obvious that there are going to have to be rules for governing the public debt. But for the first time, there is an opportunity to define a different Stability Pact in which reference to growth is not simply the verbal embellishment of an embryonic, semi-permanent policy of austerity. The conditions are ripe for change. There is a different political balance in Germany; there is the weight carried by Emmanuel Macron’s France; there is the greater authority now enjoyed by Italy.

Change, in the sense of a strengthening of economic and political Europe, is required also by developments in the field of international relations, with China’s growing clout and Russia’s return to the scene, with a considerably more aggressive stance. If not now, then when?


This article appeared in Aspenia.it.

Aspenia international 95-96, “Money and power”, May 2022. www.aspeninstitute.it

Giovanni Farese

is professor of Economic History at the European University of Rome.

Giorgio La Malfa

is an economist who completed a fresh Italian translation of John Maynard Keynes’ magnum opus, The General Theory of Employment, Interest and Money, in 2019.

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