Euro zone lacks strong leadership as it flags at core

BUSINESS OPINION:The common currency area acts like a collective in policy turmoil

JUST OVER two years ago, marking a decade from the creation of the euro, European Central Bank president Jean-Claude Trichet was hailing its success and its durability in surviving the crisis triggered by the collapse of Lehman Brothers. It seems scarcely credible.

Addressing the European Parliament, Trichet assured MEPs that the euro had overcome the key challenges of its early years – the establishment of a sound and credible central bank and the creation of a stable new currency which inspired confidence.

“These challenges were overcome successfully and the euro is today firmly established,” he said.

But, in their rush to further European integration, the creators of the single currency now appear to have been almost quixotic in their failure to recognise obvious shortcomings in the design of the project.

Central to these is the role of the ECB itself. Trichet, and the bank’s leadership in general, has been resolute in seeing its core function as twofold – establishing a monetary policy “firmly geared towards price stability”, and overseeing that policy independently of political interference. In effect, it is a mirror of the focus of the former German Bundesbank.

Unfortunately in the context of the current crisis, we now have a central bank that does not see itself as a lender of last resort.

More critically, we have a decision-making structure which requires any fundamental policy shift be approved separately by each of the new 17 members of the currency union through their own parliamentary process. The current hiatus shows just how impractical the arrangement is.

Given those inherent fault lines, the refusal of member states to address those matters within their control from the outset of monetary union was always going to present opportunities for those looking to test the structure. In that Strasbourg speech in 2009, Trichet cited “a set of sound economic policies” as the “second pillar” determining the solidity of the single currency. But member states have refused to undertake the sort of structural economic reforms the ECB has been calling for over its lifetime to ensure the stability of the euro zone.

The failure of states to work within the rules that were agreed and in place – most particularly the Stability and Growth Pact – was a second error. The fact Germany and France, the two core members of the euro, were among the first to breach the rules (and without censure) gave other, less disciplined economies little reason to fear the penalty of transgression.

Finally, the drive to inclusion meant the euro zone took on board members with borderline economic performance. Chief among these was Italy, whose achievement of the necessary budgetary deficit target was both timely and extraordinary. Its inclusion without deeper analysis of how the target had been achieved and whether it was sustainable was political.

Others over whom question existed on inclusion in the first wave of members until the closing months included Spain and Portugal. France itself needed sanction for some unusual, once-off budgetary arithmetic to hit the target. And then there was Greece, whose budgetary arithmetic should not have survived the most routine oversight, particularly in light of its historic penchant for default.

Now – most especially if the French fail to get their economy back to viable growth – the ability of the euro to recover from its travails rests in the short term on Germany. Either the Germans agree to underpin the financing of the necessary package to restore confidence in the currency or they risk the prospect of it being fatally undermined.

That is a big ask. Germans were among the most sceptical about the wisdom of surrendering their currency back in 1999, unsure whether monetary union would help or hinder their economy. Many of those fears have proven correct, albeit partly due to the rigidity the Germans themselves imposed on the system’s design.

But it is a Hobson’s choice. For Germany, any break-up of the union would inevitably mean a massive economic shock from its replacement by a hugely overvalued D-mark, undermining much of the work undertaken in the past decade by the Germans to improve their competitiveness. As a country that remains the world’s second-largest exporter, with a strong manufacturing base, a rapidly strengthening currency would be distinctly unwelcome.

It is in this sense that the current crisis is not simply an issue for the peripheral euro states. The fact that the turmoil has now spread to two of the five largest EU economies – and the speed of contagion – illustrates the dangers for all euro-zone states, Germany included.

Possibly Europe’s biggest challenge in its current difficulties is leadership. Where political giants of the stature of Helmut Kohl and François Mitterrand lent their weight to the formation of the euro project in the 1990s, their successors across Europe in 2011 are altogether less imposing.

Angela Merkel’s innate caution makes her ill-suited to the task of persuading Germany of its need to be bold in assuming leadership of the euro project for its own longer-term self-interest. While French president Nicolas Sarkozy remains more committed to marketing himself as a world leader than to letting his action prove his case. It’s time for someone to step up to the plate . . .