The euro is an unnatural animal and deserves to die

When the Greek crisis first came to the fore in early 2010, the question asked was whether or not the euro would survive. The answer then was that it was unthinkable that such a thing could happen just because a peripheral nation like Greece was on the verge of a default.

Since then there have been several rescue packages that have been implemented even as the list of rogue nations (those with unmanageable debt) increased. The reason was that ensuring the continuance of the euro was held sacrosanct by all the 17 nations.

But things have changed now as the system just does not seem to be working and this question does lead to a more meaningful engagement among experts who see merit in the break-up of the euro.

The euro was a case of monetary union where several countries got together and decided to increase overall growth in output and trade through a single currency. To make this happen, all the participating nations had to adhere to certain rules that were agreed upon such as (limiting) fiscal deficit, inflation, government debt, current account deficit and so on.

The idea was that a single currency was feasible if all nations played by these rules. The beauty was that once this was accepted it was possible for member nations to have fiscal and political autonomy as the interest rate would be fixed by the European Central Bank (ECB).

The concept worked well for almost a decade but the fissures showed when it was found that Greece had understated its numbers to join the euro club and had consistently fudged accounts until a point was reached when it could not repay its debt. This was the starting point of problems in the currency union.

Normally, when a country runs a huge balance of payments deficit, it depreciates its currency as dollars are rationed out. But in the eurozone, countries cannot do so because they do not control the euro. As the ECB printed euros, Greece or Ireland could not print more currency to repay debt. If the debts had been held domestically, then it would not matter as the other nations would not be affected.

But this was not the case as between 30-60 percent of these ailing nations had their debts held by other euro countries. Hence the panic. Greece’s problems now became the euro problem as the 17 nations were in it together.

A logical thing to do would be for the European Commission to say “let Greece collapse”, or “let us throw Greece out”. But the issue is that government loans are held by banks in Germany, France, Netherlands and Belgium. Letting Greece collapse would mean that they would take a major hit and probably go down. This is how Germany, which has by far been most conservative in its economic behaviour, has had to literally pay for its neighbours’ faults. Hence the question: should the euro break up?

The more fundamental issue today goes beyond just supporting Greece, Portugal, Italy, Ireland, and Spain - the so-called PIIGS. The idea of a common currency across nations driven by differing economic and political pressures is not really workable. A common currency works within countries where we have federal structures.

In India, for instance, the Central government owns the currency and the state governments have rules to abide by as the Finance Commissions lay down the terms of engagement with the Constitution in the background. While some states are weak, the Centre supports them in times of crisis, and, as the control of money is centralised, states cannot play truant. After all, they cannot print their own notes. In the US, as dollars are centralised, an almost bankrupt California does not bring down the system even as it struggles to maintain its economic well-being.

Therefore, unless other policies-fiscal in particular-are also centralised, no country can have an independent economic policy. To make the euro work, the eurozone has to be more or less a single nation with divisions of countries analogous to the concept of states in a federal set-up. If Greece wants to pay more to its employees, then it has to necessarily increase income tax to support it in this structure as the euros are being rationed out across the 17 nations.

In a system where freedom to print currency is given up, if Greece runs a deficit, there will be no support from other nations. Without the ability to print notes, it would necessarily have to fall in line.

While there is some talk of dividing the euro group into north and south and having two currencies, the basic thought is that even if the good guys are getting together there is no assurance of non-recurrence of such an event in future. Therefore, it is better to let each nation go its separate way, unless countries give up their economic and political freedom, which is just not feasible.

In fact, a Germany exiting the currency is feasible, given its size; it has been holding the currency union together by making the biggest sacrifices. Theoretically, the compromise that it has made so far could, in a way, compensate German banks that would stand to lose on account of sovereign defaults by other nations of the community. The deutsche mark will appreciate, leading to a loss of trade advantage, but it may be worth it for the larger good.

Germany’s departure will lead to the other nations moving out as Belgium, Luxembourg, Netherlands or Austria may not like to be left with a weak currency.

The important lesson learnt is that while currency union is theoretically a good idea, it is difficult to sustain the same given the varying degrees of commitment of member countries to the rules of engagement. Evidently, such a situation was not foreseen in 1999 when this idea became a reality, and in 2002, when the single currency substituted national ones.

Countries have to give in a lot, which affects the politics of the realm. While, to begin with, countries may agree with the idea, changes in circumstances will call for compromises and hence deviations. This is the harsh reality.

The author is Chief Economist, CARE Ratings. The views are personal