The problems have begun
Is the euro about to topple? Photo: Adam Gault/ Getty Images
FOR months, European politicians have been expressing worries about their sagging economies and the rising euro. They have been calling for a weaker currency to help boost exports. Yet, when in the first week of February 2010, the euro dropped to $1.36 (a significant drop from $1.50 in November, last year) the news was received with concern in Brussels and other European capitals. This time, the concern was not about a temporary rise or fall of a currency in the foreign exchange market but about the growing speculation in the financial market over the future of the 16-member euro area's common currency -- the euro. The immediate reason for all this speculative attack was the suspicion that debt-ridden Greece -- a member of the euro area -- would not be able to meet its financial obligations. In mid-January, it was revealed by the statistical office of the European Commission that Greece had been deliberately fiddling its books to hide its real budget deficit, which was 12.7 % of the GDP instead of 3.7 % as reported before. The speculation was strengthened by the widespread belief that besides Greece, there were other more important members of the euro area who were also hiding their real budget deficits which, according to the European Central Bank regulations, can not exceed 3 % of their GDPs in any given year. Worries about a domino-effec,t covering countries like Portugal, Spain and Italy, intensified, as fear grew that these countries' governments were not capable of taking drastic measures to bring their public finances under control and therefore, would eventually default. Any such default would not only affect the countries concerned, but also severely undermine the credibility of the euro as a globally accepted currency for trade and commerce. Making things worse, the cost of insuring the debts of Greece, Portugal and Spain rose to record levels causing stock markets to tumble and the borrowing costs in the most vulnerable countries of the euro area to soar. The return of the infamous "credit default swaps CDS," which very nearly destroyed AIG and forced the American government to intervene with massive financial help to avoid an international chain reaction of bank failures, created a panic situation in the international financial market. Now that the credit default swap market has turned against Greek, Portuguese and Spanish government debts, their governments will have to pay even larger premiums to finance their debts. This phenomenon will also affect perfectly healthy companies in the private sector in a perverse manner by forcing them to pay higher interest costs, which in turn will make their products less competitive in the export market. As a result, it will be more difficult for these southern countries of Europe to get out of the recession. The 16-nation common currency has removed the possibility of devaluation by any one single country. Unable to increase taxes and at the same time, unwilling to adopt drastic austerity measures because of possible strikes and social unrest, some nations may even think of abandoning the euro to achieve economic growth. But trying to leave the euro would also create huge legal, financial and exchange rate problems because it was not contemplated that a member would ever try to leave the euro club. So, what can the European Union do to avert a situation like this? The European Union is not a sovereign entity. As Floyd Norris of the New York Times pointed out recently, "At the heart, the problem is Europe's unwillingness to choose either unification or separation. It wanted economic unification, with continued independence of nation-states." As a symbol of economic unification, sixteen European nations share a common currency. But all these nations have divergent economic and fiscal policies. So the ultimate problem is the non-existence of a political union, which can exercise centralised control over economic policies. Since it is inconceivable that Europe will ever have a political union like that of the United States, will the euro eventually disappear? The euro has brought enormous benefits to the euro area nations. Therefore, it's highly unlikely that core members of the euro area -- Germany, France, and Netherlands -- will allow the euro to disappear or allow sovereign default of a euro member. The EU will somehow muddle through as it has done before. The head of the European Central Bank is already playing a discreet but influential behind-the-scenes role to arrange a conditional rescue package from a yet-to-be-constituted European Monetary Fund, with restrictions on further reckless borrowing and profligate government spending for countries like Greece and Portugal, which will not only help these countries to get out of the current debt crisis but also strengthen the position of the euro in the long run. However, this does not necessarily mean that the euro will not come under occasional attacks from the speculators in the future. Given the structural weakness of the organisation -- it is merely an economic union and not a political one -- the European Union should take this opportunity to put in place adequate mechanisms as soon as possible to fight them off. Chaklader Mahboob-ul Alam is a Daily Star columnist.
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