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EMU changes will be global

by John C. Kornblum, Advisory Board

EMU changes will be global

The European debt crisis will be resolved one way or another. While we cannot predict the outcome, we can be sure that, when it is over, the European Union as we have known it during the past half a century will have ceased to exist. This will lead to a fundamental change in the way European and North American partners deal with each other across the Atlantic and globally.

Myriad questions abound. They are as much about politics and national culture as about economics. Are austerity and budget cutting the right solutions for underperforming economies? Can the relatively new democratic systems of countries such as Greece, Portugal and Spain bear the political and social burden of months, if not years, of declining standards of living? On the other hand, will the richer, more successful euro members be willing to subsidise the poorer-performing countries?

All of this has the makings of a major restructuring in Europe’s political and social systems, in a delayed result of the 1989 fall of the Berlin Wall. Pre- 1989 Europe was a protected island of relative prosperity shielded from global pressures by American protection and the self-censorship engendered by the fear of thermonuclear war. European leaders had lost the habit of thinking and planning strategically. ‘Building Europe’ was virtually their only goal. Only after 1990 were European societies slowly but steadily exposed to the full force of global change. Germany has done better than most, because it is more developed, but also because it had the discipline and the incentive to make important changes. The challenges of reunification ultimately proved positive by pushing Germany towards modernisation rather than simply imposing a financial burden as most Germans still seem to believe.

But until last year Germany had not begun the important psychological changes needed to accompany a global economic role. In particular, the country had not understood that post-Cold War Europe will become more rather than less diverse. Europe’s new diversity requires a new sort of governance, which more resembles an ever-changing political matrix rather than the strict treaty relationships of today’s EU. Angela Merkel seemed to be abandoning Germany’s long attachment to European federalism by stating recently that Europe would move from a Commission-oriented structure to a community-based approach in which the member states would have the major say. Her proposals for a new concept of governance for competitiveness – even though they are hotly contested by some member states and also by her Free Democrat coalition partners – appear another step in this direction.

The complex cultural background of the euro crisis underlines the importance of an historical perspective to help put the full drama of what is happening into the correct perspective. The US is not free from subjective judgments about the very existence of the euro. Among the most exciting of my jobs as a young American vice consul in Hamburg in the mid-1960s was, for example, the counting of the gold coins. Every embassy and consulate in Europe had a stash of such coins, which had to be counted regularly. They were to be used in case of war or catastrophe to hire a car, bribe invading Soviet soldiers etc. As late as the early 1970s, the US State Department believed in gold as the common European currency. Gold had the same value for everyone. You could feel and even taste it. A perfect currency for Europe.

The American faith in gold tells us a lot about some basic differences between the US and Europe. The Americans certainly did not consider that, in Cold War Europe, the D-Mark was sound enough to take over a European role. Had the euro existed then, American doubts would have been even stronger. This distrust of ‘artificial’ money has permeated American public opinion for most of the history of the Republic. Symptomatically, last year the Tea Party movement was calling for abolition of the Federal Reserve on the grounds that it violated the Constitutional Provision against assigning the right to coin money away from direct control of Congress.

For similar reasons, after an initial burst of enthusiasm, by the mid-1970s the US Government and even most well-informed Americans had lost interest in the European unification movement. Once it became clear that Europe was not going to form a ‘United States of Europe’, patience for the complex steps towards reconciliation began to wane.

When the idea of economic and monetary union (EMU) rolled around, American scepticism was already entrenched. The case was settled by the joint declaration from Chancellor Helmut Kohl and President François Mitterrand that the euro was necessary so that war would never return to Europe. Not having shared the scars of two world wars, America could never understand how such an important project could be founded on this kind of emotional certainty.

In addition, most academic economists recalled America’s own difficult experience with a common currency, and wondered loudly how such a process could succeed. Doubts focused on the difficulties in harmonising the economies of such different countries; on the complexity of managing the European Central Bank and the organs which supervise it; and the sheer difficulty of replacing national currencies with a single unit. One highly respected economist, Martin Feldstein, even predicted that the euro, far from preventing war among Europeans, could even cause one.

By the time the EMU was nearing completion in 1997, there was considerable danger that leading American monetary authorities would come out against the project. As Assistant Secretary for European Affairs, I played a small but important role in preventing this from happening. I adopted the classic diplomatic stance that such criticism would not be helpful: it would not succeed in derailing the project, but could harm relations with Europe. I suggested to Deputy Treasury Secretary Larry Summers and Federal Reserve chairman Alan Greenspan that they should reserve comment. They told me to discuss the issue with Europeans and then to make a proposal.

So, without fanfare, I embarked on a mission to Europe in early 1997 and met monetary officials from several countries. These included people from the French Foreign Ministry and Treasury, Dutch parliamentarians and senior German officials such as Jürgen Stark, then state secretary in the Bonn Finance Ministry, now a member of the executive board of the ECB. I asked for an explanation of their goals and asked also how US reactions would be received. Without exception, all these people warned against expressing doubts or criticism. Such an approach would be a disaster not only for trans-Atlantic relations, but also for joint management of the global financial system.

I also wanted to hear their point of view on how a monetary union could function without political unity and in particular how the Stability and Growth Pact would keep things in balance. Before my trip, I had not considered myself well enough informed to have a view on the project. When I returned, I was a sceptic. But whatever my personal views, I worked hard to convince US officials not to oppose the project.

Larry Summers reflected my ‘guidance’ in testimony before Congress on 22 October 1997 when he said, ‘Today an ambitious European project seems close to becoming a reality and is attracting serious attention in the US. The administration has never thought it fitting to enter the debate over whether economic or monetary union is right for Europe, nor over the details of how it should be structured…. Yet no one doubts that Europe still faces serious economic challenges that will have to be overcome if the EMU is to succeed.’

Alan Greenspan was less ready to stick to the agreed points. In an interview with the International Herald Tribune on 2 May 1997, he said: ‘The euro will come, but it will not be sustainable.’

Until recently, this scepticism had seemed ill-founded. Now the old doubts are resurfacing. Writing in late 2009, Adam Posen, an American who joined the Bank of England’s Monetary Policy Committee in September that year, noted: ‘It is revealing that even in the midst of the worst financial crisis in 70 years, one widely…believed to have begun in the US economy and resulting from US policy mistakes, the flight to safety of world savings was to the US Treasuries, and not noticeably to the euro.’

Since the full force of Greece’s debt problems burst upon us in March 2010, even strong supporters of EMU have had to admit that the system is in crisis. Rather than adjusting their economies to meet the stability criteria of EMU’s strongest members, weaker countries used the high credit ratings induced by euro membership to borrow money from commercial banks to covering deficits generated by their lower productivity. In a globalised financial system, where traders measure their advantage in milliseconds, there is no hiding place for underperformers. The pressures have become virtually impossible to resist. It is these pressures that are driving the Europeans to select a new form of political and economic governance. The world is waiting to see which direction they choose.