THE EURO´S DEBATABLE FUTURE / THE WALL STREET JOURNAL OP EDITORIAL ( A MUST READ )

OPINION EUROPE

MARCH 8, 2011.

The Euro's Debatable Future

Where does the single currency go from here
Europe's leaders convene in Brussels this week to debate the future of the euro. Four experts—Barry Eichengreen, Martin Feldstein, Pedro Solbes and Steve H. Hanke—weigh in on the common currency.



Fix the Banks, Fix the Currency


Still an Economic Mistake


A Decade of Success


A Political Currency




Fix the Banks, Fix the Currency


By Barry Eichengreen


For the euro to grow into a happy and healthy adult, many things must happen. Most importantly, Europe needs to fix its banking system. Many European banks, starting with Germany's, are dangerously over-leveraged, undercapitalized and exposed to Greek, Irish and Portuguese debt. Rigorous stress tests followed by capital injections are the most important step that governments can take to secure the euro's place.

Since European leaders seem fixated on what to do after Greece's rescue package runs out in 2013—often, it appears, to the neglect of more immediate problems—they should also contemplate transferring responsibility for supervising their banks from the national level to the newly created European Banking Authority. The mistaken belief that a single currency is compatible with separate national bank regulators is, at the most basic level, why Europe is in the fix that it's in.


Europe's budget deficits are largely a result of the continent's festering banking crisis. Greece may be an exception, but it's one of a kind. The euro area would clearly benefit from stronger discipline on borrowers and lenders. However, it is fantastical to think that this can be achieved by imposing Germanic debt ceilings Continent-wide.


The only discipline guaranteed to prevent fiscal excesses is market discipline. Reckless borrowers and lenders must be made to pay for their actions. Governments with unsustainable debts should be forced to restructure them, damage to their sovereign creditworthiness or not. The banks that lent to them should similarly suffer consequences, as should the bondholders who provided those banks with funds.


Mr. Eichengreen is a professor at the University of California, Berkeley. He is the author of "Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System" (Oxford University Press, 2011).


Still an Economic Mistake


By Martin Feldstein


I continue to believe that the creation of the euro was an economic mistake. It was clear from the start that imposing a single monetary policy and a fixed exchange rate on a heterogeneous group of countries would cause higher unemployment and persistent trade imbalances. In addition, the combination of a single currency and independent national budgets inevitably produced the massive fiscal deficits that occurred in Greece and other countries. And the sharp drop in interest rates in several countries when the euro was launched caused the excessive private and public borrowing that eventually created the current banking and sovereign-debt crises in Spain, Ireland and elsewhere.


But history cannot be reversed. Despite these problems, the euro will continue to exist for the foreseeable future. One reason for the euro's likely survival is purely political. The political elites who support the euro believe it gives the euro zone a prominent role in international affairs that the individual member countries would otherwise not have.


There is also an economic reason that the euro will survive. While hard-working German voters may resent the transfer of their tax money to other countries that enjoy earlier retirement and shorter work weeks, the German business community supports paying taxes to preserve the euro because it recognizes that German businesses benefit from the fixed exchange rate that prevents other euro-zone countries from competing with Germany by devaluing their currencies.


The euro will not only survive but will likely continue to increase in value relative to the dollar. Investors had been quietly diversifying their investment funds to euros before the crisis began in Greece. They stopped temporarily because of uncertainty about the future of the currency. But they eventually came to recognize that the problems of the peripheral countries were not a problem for the euro and should be reflected in country-specific interest rates rather than in the euro's value. The result was a rising euro and a renewed shift of portfolio balances to euros from dollars. As that process continues, the relative value of the euro will continue to rise.


Mr. Feldstein, chairman of the U.S. Council of Economic Advisers under President Reagan, is a professor of economics at Harvard University.


A Decade of Success


By Pedro Solbes


After 10 years with the euro, the economic crisis and its consequences in some countries of the euro zone have reopened the debate about the suitability of a single currency in the absence of a high level of political integration.


But the euro has been a great joint success, which has allowed for a long period of growth and price stability in Europe. It has had a different impact in each country, but its benefits have been seen across the board. The euro has permitted more coordinated action in Europe and has prevented competitive devaluations. This has been key not only for the euro zone, but also for the rest of Europe and even for the global economy. Without the euro, we would have witnessed an increase in protectionism, which would in turn have aggravated the impact of the crisis in Europe and elsewhere.


Quite a few countries of the euro zone already faced significant risks before the crisis, both real (real-estate bubble, public and/or private debt) and financial (inadequate risk management or excessive dependence on external funding). The crisis has brought to the fore the lack of a mechanism to help troubled countries before their problems end up affecting the entire euro zone.


As is often the case with the European construction process, the problem resides not only in diagnosing the problem. There is an urgent need for clear and quick solutions, backed by the political will to comply with what has been agreed, something not always easy to achieve when dealing with 27 different countries.


Even though it has not been adopted by all EU member states, the euro is today, as German Chancellor Angela Merkel has recently expressed, an inherent element of the European integration process. The euro is here to stay and the real challenge is how to make it more efficient.


Mr. Solbes is chairman of the Executive Committee of FRIDE and a former Spanish minister of economy.


A Political Currency


By Steve H. Hanke


Since its inception in June 1998, the European Central Bank (ECB) has been error-prone. An initial and significant design flaw appeared when the ECB latched onto the fashion of the day: inflation targeting. In consequence, the ECB has displayed a propensity to either tighten or loosen monetary policy at precisely the wrong moments.


One of those inauspicious episodes occurred during the summer of 2008, when the ECB pushed interest rates upwards. By blindly embracing inflation targeting, the ECB ramped up interest rates, even though Europe had been in the grip of a recession for two quarters. More ominously, the biggest financial crisis since the Great Depression was brewing—a fact that had bubbled to the surface in the summer of 2007, when Europe's interbank markets seized up.


Rather than correctly diagnosing Europe's interbank malfunctions as a symptom of sovereign and bank insolvencies, the ECB and Europe's political elites instead pushed the button marked "liquidity deficiency." This placed the euro on center stage and took the public's eye off the source of the problem: too much debt and associated insolvencies. The heart of the problem is simply too much borrowing that can never be paid back on the terms promised—not a euro problem per se.

The best antidote for over-indebtedness is a good haircut. But haircuts are not in the political cards. Instead, the ECB has morphed into the euro zone's "bad bank," taking on enough questionable credits to sink a battleship.


The euro remains a creature of politics, not economics and finance. Indeed, most of the economic arguments—both pro and con—have been, and continue to be, either wrong or irrelevant. The hallmarks of this project have been more politicization, more centralization and more "harmonization."


What does the future hold for the euro? If history is a guide, the French will provide the direction and the Germans will foot the bill. But history is not an infallible guide. Everything depends on Europe's politicos, whose priorities are unknown. There are good reasons for the skeptics to remain, well, skeptical.


Mr. Hanke is a professor of applied economics at the Johns Hopkins University in Baltimore.


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