Currencies | Dec 15 2010
By Greg Peel
There are 27 countries in the European Union but only 16 have adopted the euro as a common currency. Within the eurozone, clearly there is a wide gap between economic powerhouses such as Germany and France and economic strugglers such as Greece and Ireland. There is also a couple of thousand years of mutual disdain between any combination of neighbours.
The EU was intended as a mutually beneficial trading bloc which could compete more effectively with the US. The euro was intended as an alternative to the reserve currency of the US dollar. But the euro's effectiveness was already undermined from the outset given the refusal of members such as the UK and Sweden to abandon their own currencies.
The common currency has had the effect of drawing each eurozone economy towards a centre. Thus, for example, Germany enjoys the benefits of a currency weakened by distressed economies such as that of Greece, such that it can compete more effectively on exports. Greece, on the other hand, enjoys greater but clearly destructive spending power as a result of a too-strong currency.
There are those who believed the euro was destined to ultimate failure from the start.
So if it has failed, why not abandon the euro and return to individual currencies? Well aside from losing export competitiveness, the ramifications of a sudden sharp revaluation or devaluation of individual assets, including sovereign bonds, would throw the European banking and corporate worlds into chaos. Whether or not the euro is “working”, it has basically reached the point of no return. And no matter what each member might privately think, all members have been standing shoulder to shoulder in insisting the eurozone, as a concept, is in no way under threat.
Which is why the speaker of the parliament of Slovakia sparked anger last night.
The tiny economy of Slovakia – considered the poor cousin to the Czech Republic post the break up of Czechoslovakia – is the most recent member to join the eurozone. And as last in, it is now threatening to be first out. While small, Slovakia's economy is nevertheless stable but aside from being hampered by a relatively too-strong currency, as a eurozone member Slovakia was forced to contribute to the E110bn bail-out fund for Greece. More bail-outs may lead to more mandatory contributions.
The Slovakian finance ministry was quick to distance itself from the speaker's remarks. It is not so much a case of the speaker threatening a pull out as it is one of considering a Plan B were the crisis to worsen. This would be a return to the Slovakian koruna which would immediately devalue after exiting the euro.
It seems a simple enough plan – a small economy not in trouble simply does not have the wherewithal to support other economies which are in trouble. And there are concerns the standing EU-IMF emergency fund may not be enough to cover all potential bail-outs, particularly if the larger Spain, or the much larger Italy, hits the skids.
Nevertheless speculation surrounding a potential break up of the eurozone has most often centred around the bigger economies wishing to cut the distressed economies loose for the IMF to deal with. Germany has already moved to reinstate the Deutschmark alongside the euro. But Germany also knows that a breakaway mark would revalue strongly, impacting on export competitiveness. Moreover, banks across Europe, including Germany, holding various sovereign and corporate paper would see chaotic and potentially destructive revaluations.
A Slovakian defection might seem simple enough, but the mere threat would see Slovakia's sovereign bond yield blow out to Greek/Irish levels as traders and investors prepared for currency devaluation. Stocks would be slammed. In short, Slovakia would bring upon itself the risk of much greater individual economic distress in attempting to cut itself loose from collective distress.
Which is no doubt why the Slovakian finance ministry has denied any departure plans.
Aside from the complete loss of international face a failed euro would imply for Europe, any attempt to dismantle the system can only bring more chaos at this chaotic time. If ever the euro were to be abandoned it would have to be once problems had settled down and a long, slow extraction program could be put in place.
Such a program is not in sight.
