Photo Credit: Getty Images/Hannelore Foerster
Here follows an edited version of the paper delivered by Edmond Alphandéry to the Blouin Creative Leadership Summit on September 24, 2024 in New York City.
The euro is certainly, in the monetary realm, one of the most ambitious, innovative projects in the history of mankind. It was supposed to complement the European Union single market and to prop up its economic dynamism. After ten thriving years, it entered into a deep crisis which led some people to believe in its demise.
Last year, at the Blouin summit, I told the audience that they should not be too pessimistic about the euro. I even exhorted investors to come back. To no avail.
Today, you can observe a complete reversal of the climate. The feeling of international investors has dramatically improved. There is now a sense that the worst of the euro crisis is over. Investor sentiment on the euro zone economy survey this month moved into positive territory for the first time since the summer of 2011. A recent Sentex survey showed that the optimism on the outlook six months from now has risen to its highest level since before the start of the global financial crisis. No wonder in this context that capital is again flowing en masse into the euro area.
How do we explain this complete change of outlook? I see mainly three reasons in which I think useful to go in more detail because they give interesting insights into our subject:
The most important one, in my view, is the act of faith of Mario Draghi, the president of the European Central Bank, with respect to the European currency, when he solemnly declared in the summer of last year that he “would do whatever it takes to save the euro.” He gave credibility to this commitment by announcing that the ECB was ready to launch OMT operations, which means buying sovereign bonds of a member state falling victim to speculation, if necessary without limit, though, of course, under strict conditionalities.
The European currency has been a formidable (political) construction which has induced skepticism since its inception, not least in the U.S. But money is just about confidence. The value of a currency is undoubtedly based on trust. When the institution which issues the currency says that it will do whatever it takes to protect it, then everyone becomes aware that this currency is here to stay. Since then, market participants who were betting on the demise of the euro started to doubt the success of their gamble. Markets eventually realized that we will not let the euro zones explode and the euro break apart.
Second reason for this dramatic change of mood: the lasting resilience of the euro area to the economic and social drawbacks of the crisis. The main danger for the euro zone (if not the only remaining one) when we have implemented a full banking union and therefore prevented any financial systemic risk is certainly the political risk which would come from a member state which democratically decided to leave the euro. In this respect, the course of political events in the euro area since the beginning of the crisis is heartening. Through many elections where all of the outgoing governments were ousted (except in Germany last Sunday), there as never been any majority in any member country, despite all the social suffering and economic damage due to the crisis, asking to exit the euro — neither in Greece, Ireland, Portugal, Spain, France nor in the Netherlands. Even more comforting, since the start of the crisis, three new countries have joined the euro area.
In order to understand the third reason for this new appraisal, one has to enter into the intricacies of the euro crisis: after a period of trial and error, in 2012 European authorities finally started to grasp the root causes of the crisis, and therefore to undertake the appropriate response.
When in Greece the euro crisis started to unfold, it appeared as a fiscal problem in the first place. It spread out to Portugal, Ireland, Spain, and Italy through sovereign debt markets where interest rates with the core countries (mainly Germany) widened dramatically and sometimes dangerously. To the minds of policymakers, the violation of the Stability and Growth Pact by France and Germany in 2003, 2004 appeared as the original sin at the root of the crisis. Hence in its first phase, the implementation a the European level of plans and rules to enhance fiscal discipline to force member states to abide by more fiscal constraint. But in doing so we probably overreacted, contributing to the worsening of the economic activity in peripheral countries, making even more difficult the solution to their fiscal equation.
In early 2012, the President of the European Council himself, Herman Von Rompuy, started to question the mechanisms underlying the functioning go the euro zones compared with a true currency area (like the U.S.). In a report whose first draft was published in June 2012, he clearly outlines that EMU (Economic and Monetary Union) was an unfinished construction and that we had to take the right steps to go “towards a genuine economic and monetary union” — the title of the report.
What is at the heart of the crisis? We have put into place a unique currency between countries which kept hold of all of their economic and financial prerogatives (to the exclusion of monetary policy). Therefore, when the euro was introduced in the framework of a single market of goods and services and full liberalization of capital, we simultaneously observed during a decade a mismatch between on the one hand convergence of interest rates on the financial markets, and on the other hand discrepancies of economic, financial and wage policies between member states, some of them mainly in the South spending more than what they produced (hence a deficit on their current account) while others, mainly Germany, were posting a surplus. We could therefore witness deep current account imbalances inside the euro zone.
In a fully fledged currency union, like the U.S., nobody cares about current account imbalances between states. Automatic mechanisms take care of these imbalances, either through financial markets, or in the longer term though the mobility of the factors of production.
In the euro zone during a whole decade (1999-2009), financial markets inside the euro area helped finance these imbalances. Countries with a surplus were transferring their net savings towards those with deficits. During all these years, we all behaved as if we were living in a “genuine” currency union, when in fact it was not the case.
Compared to the U.S. where we have fully integrated markets in the real, financial and monetary sectors, we lived in the euro area during the first ten years of the euro with markets which had become integrated in the monetary field due to the inception of the euro, and which appeared to have become integrated in the financial capital markets. Concerning the markets of goods and services, they were on an ongoing process of integration on the demand side, thanks to competition policy carried out in Brussels and also due to the catalyst impact of the introduction of the European currency. But they were far from being integrated on the supply slide, due to wage disparities and discrepancies in environment in terms of tax, infrastructure and bureaucratic constraints.
The euro crisis revealed that the euro area was not as integrated as it appeared during the first decade. The first warning occurred precisely in the monetary realm itself in August 2007 when the interbank money market abruptly dried up, forcing the ECB to provide liquidity to banks on a large scale.
Later on, financial markets followed suit. After the Greek upheaval and the following chain reaction in other peripheral countries, the widening of interest rates in sovereign debt started to imp ace spreads on bank credits to firms and households: suddenly the financial market appeared fragmented.
In fact, during the first 10 years of the euro, the financial sector was not fully integrated. This point was brilliantly outlined in a report prepared for an informal meeting of E.U. finance ministers in Vilnius on September 14, “The neglected side of banking union: reshaping Europe’s financial system“ by André Sapir and Guntram B. Wolff.
Contrary to the U.S., inside the euro area cross-border financial activities have remained limited: in retail banking but also on the stock market, on bond markets and in bank mergers and acquisitions as well, market participants continued to proceed mainly inside their own national borders.
During the first ten years of the euro, if retail banking and therefore bank credit have remained largely fragmented along national lines, thanks precisely to the introduction of the common currency the interbank market rapidly became highly integrated while shares of foreign government bonds and of foreign corporate bonds increased, as Sapir and Wolff note, “by 23 and 29 percentage points, reaching 47% and 51% of the total holdings of government and corporate bonds respectively.”
Nevertheless, a move towards more fragmentation started again with the burst of the euro crisis. These shares (of total holdings of government and corporate bonds) have fallen 24 and 10 percentage points, standing at 22% and 41% respectively. There was therefore not enough financial intermediation to help reduce the impact of bank credit fragmentation enhanced in Europe by the relative importance of banks (about two-thirds) compared to financial markets.
The European Union was born under a sign of a common market ( the treaty of Rome in 1958), and that one of the main goals of the European construction over more than half a century was to complete its unity. In this respect, the return to fragmentation of markets was a step backwards that had to be overcome. This is what has been accomplished with some results already visible:
- it was necessary first to re establish better conditions of competition for firms, notably thanks to an increase in flexibility of the labour market : the pick-up of exports in several peripheral countries (Portugal, Ireland, Spain) is in this regard a first positive outcome;
- it was also necessary to reduce the fragmentation on financial markets for attracting investors back to countries in Southern Europe. Their public finances consolidation, even though far from being completed, has contributed to restoring confidence and to reduce dramatically spreads. Furthermore, financial “cross-border activity has either stabilized or has slightly rebounded;”
- last, but not least, it was necessary to resets list confidence in the euro. This is what was achieved with the announcement of the potential use of OMT operations.
Does this all mean that the euro crisis is over and that the euro zone is now out of the woods. Certainly not. Even if the euro area is on its way out of the recession, even if the climate in financial markets is improving, even if the feeling that the euro is doomed has largely faded out, much remains to be done to put the euro on he road to prosperity on a sustainable and solid basis. In this respect, let me look at three topical aspects which seem crucial to me: the first has to do with the current economic outlook of the euro zone, the second with what is needed in order to increase its potential growth, and the third is about the unavoidable (at least in my eyes) march towards greater political integration among its member states.
Current economic outlook of the euro zone.
Concerning the current economic context, I shall recall that he euro area is the only region in the world which while in recession has adopted a restrictive policy mix: on its fiscal component since it was necessary to put an end to the public spree which was one of the root causes of out doubles, even though the fiscal restraint has been recently relaxed in order to limit its pro-cyclical impact. As for its monetary component, monetary policy seems to be accommodative when one looks at the level of the ECB intervention rate. But compared to the course of monetary policy of the other major central. Asks, it is clear that aggressive unconventional quantitative easing conducted by the Fed and followed by its counterparts in the U.K. And Japan has left the ECB lagging behind. Hence the value of the euro which remains relatively too strong with respect to the state of the euro area economy. Furthermore in the aftermath of the global financial crisis, requirements in Europe in terms of capital and liquidity (the so-called Basel III) have been strengthened, and due to pressure of the markets they are being put in place by banks well ahead of the planned schedule, which has greatly contributed to the deepening of the downturn in economic activity. At a time when the business climate is improving, I think that it would be appropriate to relax monetary policy and banks’ regulation schedule as well.
A last comment on this financial aspect of the euro crisis exit: in order to prevent the risk of contagion, to overcome financial fragmentation of the banking sector, and to foster confidence in the European banks, the European Council decided to launch under the heading of the European Banking Union, a three-dimensional European-wide project (for supervision, resolution, and guarantee of deposits.)
Next year, an Asset Quality Review and stress tests will be conducted buy the ECB and the European banking regulatory body. It is highly probable that some banks will need to be recapitalized. According to the discussion underway, funds should come from shareholders and creditors first, but it is important in my view as a show of solidarity that the bailout fund, the ESM, should be used to contribute to their funding.
Raising Europe’s potential rate of economic growth.
The second challenge ahead for the euro zone and more broadly for countries of Europe consists of raising the level of its potential rate of economic growth. According to some estimates, it is only about 0.5%, a weak figure compared to other OECD countries and with regard to the necessity to improve the well-being of the population, and to reduce the rate of unemployment. This task is daunting. Reading Ned Phelps’ new book “Mass Flourishing” should give European policymakers the clues they need.. In this rears, they have tonight against vested interests which often remain powerful, to foster integration of markets at the European level following the Monti Report recently submitted to the European authorities.
The program to put in place in order to promote dynamism defined by Ned as “the will and aspiration to innovate” includes more flexibility, mainly in labour markets, enlargement of the scope of the private sector, the creation of an environment more favorable to business opportunities, through they implementation of a fiscal and financial environment which encourages private entrepreneurship, and greater priority give to education, R&D and also innovation, in new high quality products in the first place.
Let me highlight this point, too: too many European countries are developing their economies through the production of goods and services which are not of the highest standard. They therefore suffer competition of emerging countries which are capable of producing these goods at a much lower cost. Comparison between Germany, which has a yearly surplus on its current account of about €180 billion, and France, which has a deficit of about €60 billion, is telling. In Germany, small and medium-size companies have been able to expand their activities in high technology niches (machine tools, high-end equipment) which allow them to respond to ever increasing demand abroad. To be sure, France maintains some economic strongholds. But their weight in its economy is not sufficient. It is in the high-end products that a mature economy can make sure it will be able to reach lasting and profitable markets. In order to enhance the quality of their products on sale, European countries have to define a comprehensive policy which includes the improvement of their venture capital markets, encouragement of grassroots innovation, and better qualification of workers.
Above all what Europe needs is the enhancement of economic culture and stimulation of the spirit of entrepreneurship. Economic dynamism rests in our minds, in our capacity and willingness to innovate while giving all people the opportunity to do so.
Greater political integration among member states
The third and last challenge which I will quote in a concluding remark is about the absolute obligation, at least in my opinion, for European countries to make decisive progress in their political integration. There is no doubt in my mind that the long-term future of the euro rests on out capacity to build a federal Europe.
Throughout the history of money, currencies have always been anchored to strong political powers. Even though the proposals put forward by the highest European authorities,s the President of the Council of Europe in his reported dated December 2012, calling for “a genuine economic and monetary union” have not yet borne fruit, the banking union plan underway which will lead to more financial solidarity amongst member states is a first stage which should not be underestimated.
Once more, the prediction of one of the fathers of Europe, Jean Monnet, who famously said 40 years ago “L’Europe se fera par les crises et elle sera la somme de la solution apportée à ses crises” (“Europe will be constructed through crises and it will be the sum of the solutions to these crises”), is slowly coaming true in front of us. Banaking union is only one step: there will have to be others. We just have to take inspiration from the building of the U.S., which shows us the right path to follow.
— Edmond Alphandéry, president-elect of the Centre for European Policy Studies, and a former French economy minister.
