Long before the UK referendum, many argued that monetary union was undermining the European Union. Many had expected Greece to be forced out not once but twice.
There is a cottage industry of books forecasting the demise of EMU. Johan Van Overtveldt, the former Finance Minister of Belgium, penned “End of the Euro” in 2011 and its captures the spirit of the genre. Jen Nordvig, a currency strategist, authored “The Fall of the Euro: Reinventing the Eurozone and the Future of Global Investing” in 2013, and anticipates the of EMU. The same year Dimitris Chorafas’s, “Breaking up of the Euro” was published.
Not to be outdone, a couple of months ago, Nobel Prize-winning, a former economist at the World Bank Joseph Stiglitz brought us “The Euro: How a Common Currency Threatens the Future of Europe.” He anticipates that Greece and Italy will leave the monetary union. He has also advocated that Germany leaves as well. He calls for an amicable divorce and the subsequent creation of a northern and southern currency bloc.
To the contrary, we were among the few that did not expect Greece to leave the monetary union or be expelled. Paul Krugman, another Nobel Prize winner, sought to explain why he was wrong about Greece leaving, admitting that the political will was not sufficiently appreciated. We have long argued that Europe, the EU, and EMU are political constructs. The monetary union itself was an economic solution to a fundamentally political problem: Under what conditions can Germany be reunified after the Berlin Wall fell?
We make two points here. First, many observers compare monetary union to some perfect model that they dream up rather than ground it in the historical record and existing conditions. In this, they are utopians Second, the EU that exists today is not the same EU that existed before the crisis.
European Economic and Monetary Union is almost 17 years old. Consider where the US was 17 years after declaring independence from the greatest empire at the time (and the first and true Brexit!). It was not clear that the new republic would survive and indeed another war with England was around the corner (1812). The colonies fought the Redcoats under Articles of Confederation, which required unanimity in decision-making, a weak central government with no power for the federal government to tax or raise an army.
There were two decisive events. First, the Continental Congress was to reform the Articles of Confederation. However, rather than reform the document, they pulled an end run. It did not revise the Articles. It replaced them. And rather than the Continental Congress accepting the changes, the Constitution would be ratified by the rules within the Constitution itself. Second, Hamilton devised a plan that in essence nationalized the state debt. Some states, whose territory saw greater conflict, were more in debt than others. This generated claims that it was nationalization was unfair. A large compromise was eventually worked out, which included the location of the capital itself.
The founders of the European project understood that countries would be loath to sacrifice sovereignty unless it was the more expedient path, which means in a crisis. They might not be disappointed by what has happened over the last several years. This has been a crisis of historic proportions and out of it has come new institutions and a new capacity of old institutions.
Consider as an example what happened earlier this week. The EC has pushed back against eight countries draft 2017 budgets. No, Europe does not have a fiscal union. However, it has developed a mechanism to enforce some broad agreements on deficits and debt reduction. This did not exist before the crisis. Members submit draft budgets to the EC prior to securing parliamentary approval.
When pressing Italy, for example, the EC says it is not sufficient that it keeps its deficit below 3% of GDP as mandated by the Stability and Growth Pact. That agreement also requires countries to keep the debt level below 60%. Prime Minister Renzi argues that the migration crisis and the earthquake meet the definition of exceptional circumstances. The EC is not convinced that Italy will spend the sums it suggests to address these developments, which lifts the structural deficit to 1.6% from 1.2%. It gave Italy 48 hours to defend itself.
Spain has been without an elected government since the end of last year. It simply rolled the 2016 budget into 2017, which means no progress. Rajoy is likely to pass the vote of confidence over the weekend as at least 11 Socialists will abstain. Rajoy may have found breaking the political logjam was difficult, but his troubles will likely intensify. The EC expects him to correct the budget, which means something on the magnitude of 5 bln euros in savings as soon as possible, which means in the language of EC euphemisms by the end of the year.
The EC oversight is not the same as fiscal transfers or a fiscal union. However, to ignore the reforms, new institutional capacity, and practices is to miss the important evolution that has and continues to take place. This is not unique to the EU. When the US was as old as the EMU, only white men with property could vote. Political parties, which are not even mentioned in the Constitution, were just crystallizing.
The territorial integrity of the United States was questionable as former Vice President Arron Burr demonstrated by trying to form another country west of the Appalachian Mountains. And like EMU, the US was not an optimal currency zone as it would have three distinct economies (growing manufacturing and shipping in the Northeast, plantation slavery in the South, and commercial farmers in the Midwest) into the middle of the 19th century.
Europe, like the United States, is still a work in progress. Our bullish dollar view has been predicated on the divergence of monetary policy and financial conditions broadly conceived. In addition to these economic considerations, the saliency of political factors increase next year with elections in Netherlands, France, Germany, and possibly Italy will rise. Although nearly every European country has an anti-EU or anti-EMU party, none have wrested the reins of power (In the UK’s case, it was a faction within the majority party that campaigned for Brexit). France’s presidential election (Spring 2017) and Italy’s parliamentary elections (scheduled for 2018) pose the biggest risks to this pattern.
Plenty of grist for more jeremiads on Europe. Stack them next to the ones from the past two centuries claiming the end is nigh for America.