A Euro theory

f it were not for the euro, Germany’s trade balance would have caused a revaluation of the Mark, which would automatically have reduced the exchange rates of the other "European currencies", thus favouring them on international markets. The single currency was not created to stimulate exports and improve productivity.

In fact, for the first time, the then President of the European Economic Community, Roy Jenkins, proposed a common currency which, however, was also based on a common budget, equal to 10% of the sum of all Member States’ GDPs.

Initially the Euro was based on the "optimum currency area" theory developed by the Canadian economist, Robert Mundell, in 1961. It also rested on the fact that an economy open to international trade always tends to a low exchange rate.

Furthermore, as assumed by Mundell’s group of economists, in a highly diversified national economy the exogenous shock is always very limited.

This would lead a country open to trade and with a diversified economy to accept, in principle, a currency common to other countries.

Provided, however, that there is flexibility on the capital and labour markets and that its economy is very diversified and open to international trade.

However, to what extent can an economy be "diversified"? Does excess of diversification not lead - as natural - to a different and sometimes negative gain margin between products?

In Mundell’s model, the national currencies were described by the economic theory as simple barriers to international trade, as well as limits to productivity and finally obstacles blocking commercial transactions.

At that time, Jacques Delors and Romano Prodi theorized that - rebus sic stantibus - with the mere introduction of the Euro, the European economy would grow 1-1.5% per year.

Later Perrson and Nitsch proved that the econometric model used for those predictions was wrong, while other academics and experts studied the influence of the European monetary union on international trade.

Once again the analyses carried out on macroeconomic data demonstrated that the assessment of the benefits resulting from the single currency had been greatly exaggerated.

Obviously, for political purposes, economics is not so much a "sad science", but rather rhetoric used to convey political and social messages and choices.

According to these more realistic models, the monetary union was responsible only for a 4.7-6.3% increase in foreign trade, while the most pessimistic forecasts of the first analyses on the Euro-induced growth pointed to a 20% or even a 200-300% increase in international trade.

We have always known that economics is ideology in disguise.

In other words, the Euro does not change international trade transactions, but rather tends to change competitive pricing.

Furthermore, there is no factual evidence of a stable structural difference between foreign trade and exchange rate.

Moreover, according to the International Monetary Fund, a 10% decline of the exchange rate leads to a 1.5% average increase of GDP.

Yet another demonstration of how a healthy and sound devaluation is good for international trade.

The persistently "high" single currency has also hampered recovery in the Eurozone countries, while other European countries, such as Sweden, could quickly rebuild their economy.

This implies that the Euro could do nothing to avoid the crisis, except in Germany, where the per capita GDP has been growing incessantly since 1999.

As to investment in fixed assets, only France, Belgium and Finland have been successful.

Portugal and Greece have fallen to the levels of fixed capital investment of the 1980s, while per capita fixed capital investment (housing, infrastructure, roads, railways, airports, machinery, etc.) has levelled off since 1999.

With the Euro introduction, investment in infrastructure was put to an end.

Furthermore, as repeatedly noted, the crisis of the single currency and of the Eurozone began with Greece’s tragic situation.

Greece is worth almost 3% of the Eurozone GDP and the banking crisis following tension in Greece, at first, and later in Spain, Germany and Italy, cannot be solved with the EU banking union, but only with the action of individual governments.

The signal to international markets is clear: if the Euro is hit with a speculative action, the Eurozone individual countries shall try to solve it, with their limited resources.

With its crisis Greece has later demonstrated that monetary and credit tensions in each country of the single monetary area are never supported by the rest of the Eurozone - as would happen in any real monetary union - but the country in trouble is blamed for being "spendthrift". The result is that the other Eurozone countries buy the assets of the nation in crisis below cost.

In fact, the single currency works only in really federal States, such as India or the United States, where the internal market and financial networks are wide and can manage the income gap between the various regions of the country.

If we were to support the economies of Italy, Greece, Spain and Portugal, the cost of recovery for these four countries would be 260 billion euro per year for ten years.

Hence the issue does not lie in Germany being wicked, but in the fact that the Euro has been conceived and designed badly and leads to crisis the countries which do not adjust their domestic economy to a structurally and unreasonably overvalued currency.

And in these cases, monetary expansion combined with economic "austerity" does not solve the problems.

Public spending and discretionary spending, as well as wages and salaries and, in some respects, even profits are now regulated by the Solidarity Pacts of 2011, in addition to the Treaty on Stability, Coordination and Governance signed in 2012.

They are inter-European agreements prohibiting the redistribution of funds within the EU. They were signed upon German pressure and it is worth recalling that Germany cannot objectively take upon itself the cost for restructuring Southern countries’ debt.

Indeed, we could devalue the Euro.

Nevertheless the relations between the Eurozone members would not change and Germany would gain even more from a devalued Euro.

Therefore the only way then to change the exchange rate between the various countries of the single currency is not to devalue the Euro, which is based on fixed exchange rates established ne varietur in 1999, but just leave the Euro area.

Furthermore, considering the differences of economic integration in the Eurozone, if the single currency were devalued, the least integrated country, namely France, would gain much more than the others.

It is worth making clear that it would be a gain at the expense of the Euro Mediterranean countries.

It would be tantamount to go back with the Euro to the old gold standard of the 1930s, with the Euro: either it is fully dissolved or you decide to leave.

In this sense, the single currency is a severe loss of economic flexibility in the relationship between inflation, productivity and public debt.

Relations between macroeconomic values which can be manipulated for the better only in a national context, given that the EU still records very significant micro and macroeconomic differences.

It should be noted that the impasse resulting from the gold standard led to the Great Depression after the 1929 crisis.

At the beginning of the Great Depression, Germany and Great Britain tried an internal devaluation, but in these cases, if there is a fixed monetary standard, devaluation only means domestic deflation.

Considering price rigidity, unchanged financial costs and the money supply restriction, any policy of this kind finally makes both politics and society unmanageable.

What about leaving the single currency?

Meanwhile, it is worth recalling that, in international financial law, what matters is not the lender’s nationality, but rather the law applicable to the contract.

If, for example, the debt were regulated by French law, regardless of the parties’ nationality, the payment should be made in the French national currency.

Moreover, statistics throughout the single currency EU tells us that the private debt would not be affected by the transition to the new Franc, Lira, Peseta, etc.

According to the studies of the Bank for International Settlements, which has already analysed these issues, the cost to be borne by EU countries for leaving the single currency would be approximately 5 billion euros - a figure that can be easily managed by everybody.

Hence, after the end of the Euro, the EU countries could appreciate or devalue their currencies, by offering competitive prices and thus recreating precisely those competitive advantages which had been basically removed by the single currency.

In this way the German Mark would surely appreciate as against the Lira and the Peseta, thus favouring the Southern countries’ currencies and making the huge German trade surplus disappear, as if by magic.

Probably this is the best prospect and the best way forward.

Giancarlo Elia Valori

Advisory Board Co-chair Honoris Causa








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