23 January 2019

After 20 Years, is the Euro a Failure?

20 years ago, the Euro was launched to great fanfare, at least in Europe, as much of that region’s hopes and ambitions were pinned on the new currency.  For some Europeans, the euro was a key step in the complete integration of the continent, a currency that would unite long-time neighbors and rivals. For others, the euro was a means to lock the region’s most powerful economy, Germany, into the European project, a key consideration in the wake of the unification of Germany just a few years earlier.  

Many Europeans hoped the euro would prove to be a much needed boost for a region that had seen economic growth rates trend downwards after 30 years of post-war recovery and expansion.  For more ambitious Europeans, there were hopes that the euro could challenge the US dollar’s position has the world’s dominant currency.  However, Europe’s economic performance has not improved since the euro was introduced, nor has the euro emerged as a serious challenger to the US dollar’s dominant position in the world economy.  Worse, the euro’s very future is uncertain, as the economies of the countries that use the euro (henceforth the Eurozone) face a difficult future, while the currency’s inherent contradictions could yet bring its demise. 

As a currency, the euro suffers from two primary problems.  The first of these problems is the overall sluggishness of the Eurozone economy.  An unfavorable demographic situation and a declining presence in many high-growth industries and services has dampened the outlook for economic growth in the Eurozone and this has subsequently weakened the outlook for the euro.  A struggling economy that is considered a safe haven can have a currency that can overcome these disadvantages (such as the Japanese yen), but investors do not consider a flawed currency such as the euro as a safe haven investment.  As such, the Eurozone’s weak economic outlook further drains confidence in the European common currency.

The euro’s other primary problem is the fact that the creation of the euro was a deeply flawed process.  Simply put, the creation of the euro took away its users’ ability to use exchange and interest rates to adjust their economic policies to best fit the needs of their individual economies, but new institutions that could have been used to allow the users of the euro to adjust to this new reality were not created.  Thus, the euro exposed the competitiveness divisions within the Eurozone, without having any means of reducing these differences in favor of less competitive economies such as Italy and Greece.  Meanwhile, the European Central Bank has mistakenly focused its efforts on restraining inflation in the Eurozone, rather than promoting the economic growth that the Eurozone has been sorely lacking.  Finally, the decision to allow less competitive countries to adopt the euro early on in the currency’s life was a mistake, something that became painfully evident less than a decade after the launch of the euro.

The flaws of the euro can be easily seen when one looks at the Eurozone’s economic performance in the periods before and after the launch of the euro.  Since the launch of the euro 20 years ago, the Eurozone has performed much worse than any other large economy in the world, apart from Japan.  Worse, the least competitive economies in the Eurozone have suffered the most, recording little or no growth in recent years. A look at the economic performances of Italy or Greece since they adopted the euro makes it clear that the currency’s set up is stacked against its least competitive users.  For more competitive Eurozone economies such as Germany or the Netherlands, they have managed to export their way to moderate growth in recent years, as their higher-end exports are often in greater demand outside of Europe, but their growth also trails behind many developed economies outside of the Eurozone.  For the rest of the Eurozone, the past 20 years have been a period of very disappointing growth.

The Eurozone’s poor economic performance and its lack of economic stability have proven to be a serious drain on trust in the euro.  Over the past five years, the euro has experienced an unusually long period of weakness, having lost nearly a quarter of its value against the US dollar during this period.  Meanwhile, the euro’s champions had expected the currency to become a rival to the US dollar.  Instead, while the dollar’s share of global currency reserves has held steady, the euro’s has fallen by more than 20% over the past decade.  In fact, while the US dollar, Japanese yen and the Swiss franc have retained their status as safe haven currencies among investors, the euro has failed to achieve this status, despite the Eurozone having an economic output that is larger than all other economies apart from the United States and China.  Worse, it is hard to envision trust in the euro’s future rising much, given the Eurozone’s poor economic outlook and the flaws in the currency.

Make no mistake, despite its weaknesses, the euro is unlikely to disappear at any point in the near-future. Moreover, it is highly unlikely that any current user of the euro will drop the currency in the coming years, as Brexit has shown just how difficult leaving a European Union project can be. Still, the poor long-term outlook for the economies of the Eurozone bodes ill for its common currency.  For one, the ability of the euro to challenge the dollar’s global dominance is lower now than when the currency was launched, and the only long-term potential challenger to the dollar is likely to come from China.  Worse, as other countries’ currencies rise in importance, it is the euro’s global position as the world’s number two current, not the dollar’s leading position, that is likely to be challenged, given the euro’s dangerous flaws.  Without a much greater degree of economic harmonization, and without the creation of legitimate institutions that can safeguard against the type of crises that befell the Eurozone over the past decade, the potential for even more destabilization in the Eurozone will remain great.  The fact is that, the euro was a rushed creation, one that served more of a political purpose than an economic one.  This reality has caused a great deal of trouble for the Eurozone, and without major changes, more troubles are likely on the way as internal and external economic pressures mount.