A PSEUDO SOLUTION TO THE EURO´S FAILINGS / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( RECOMMENDED READING )

A pseudo solution to the euro's failings

By Martin Taylor

Published: March 21 2010 19:44

It was in Calabria, on New Year’s Day 2004, that it came home to me that southern Europe was set for serious trouble with the euro. Walking round the village to work off the excesses of the night before, I noticed that all the prices had been raised by 10 per cent. Why? Because it was January 1, silly. But in Germany they were not raising prices at all.

I had always supposed that the euro would hold together because the misery of unravelling it seemed likely to exceed the pain of soldiering on. But when both partners in a marriage seriously question the arrangement, divorce is only a matter of time. This is a marriage with 16 partners and domestic violence is hotting up.

Piecemeal defection for any weak country is dangerous, unpredictable and costly. Germany could do it unilaterally, but the political damage to the European Union would be immense. Better for all concerned to revisit the project and rectify the mistakes made in the first place.

The fundamental problem with the euro project was overambition. The difficulties of monetary union without political union were much discussed in the 1990s, and then simply ignored, except in Britain and Scandinavia. The risk of a single currency was probably manageable with a small group of countries that had a decent chance of remaining competitive with Germany. Bringing in all of southern Europe dramatically raised the stakes. The marriage partners were, and alas have remained, incompatible.

In the irrevocable currency union, the southern countries were supposed to acquire discipline over their finances, while the northern countries would be encouraged to loosen up a bit. Exactly the opposite has occurred. Everyone has reverted to type and is now blaming all the other parties. She has run up all these debts without telling him; he always lectured her and has begun to shout at her. For her, the sunbed; for him, the gym.

The financial crisis, of course, has brutally exposed the economic differences between north and south. As the Calabrian story shows, the divergence has been going on throughout the decade since parities were locked. The chance to change behaviour in the Mediterranean countries to justify monetary union with Germany was missed in 1999. To put things right now requires the correction of 10 further years of sliding competitiveness in the south at a time when the world economy is struggling with aggregate demand. Nothing in previous experience suggests this is likely to happen.

The introduction of the euro was meant to end squabbling over the disadvantages supposedly accruing to a single-market participant from exchange rate movements. The abolition of these inconvenient prices, it was felt, would remove the underlying sources of friction. It may be, instead, that the absence of exchange rate information within the eurozone has fostered a complacency about sharply diverging competitiveness.

The least damaging solution now might be a north/south split of the currency. Imagine a “neuro” and a “sudo” (pseudo in Greece). For every €100 you would receive 50 neuros and 50 sudos. Countries would from then on opt to use one or the other. Existing obligations – including the national debts of all current eurozone members – would thus have a hard and soft component. Readers can amuse themselves by guessing which currencies some of the more ambiguous countries might choose.

Before you reject this contemptuously as a spoof in poor taste, consider what the neuro/sudo exchange rate might be. The recent behaviour of sterling gives a clue. The sudo could be expected to go to a substantial discount which would, if present behaviour patterns continued, widen over time. Ask yourself whether you believe that the tensions reflected by such a discount – at the moment suppressed – can really be managed away under the existing arrangements? Failure to address the problem soon risks producing a truly catastrophic mess.

And think of the advantages. The benefits of monetary union would be to a large extent preserved: better two effective groups than one dysfunctional currency. (Or: we liked it so much, we had two of them!) Millions of southern Europeans would become employable again. The financial markets, in working through the consequences, would have something socially useful to do. And Axel Weber and Mario Draghi could each have a central bank to run.

The writer is chairman of Syngenta and former chief executive of Barclays

Copyright The Financial Times Limited 2010.