Dumping the euro to save Europe seems harsh – and the outcome uncertain

We can't make the euro work. We are unwilling and politically unable to complete monetary union, to mutualise debt, to create either a system of significant fiscal transfers or the political integration such a union would require. Faint signs of growth mean European Central Bank president Mario Draghi may have given the single currency a breathing space of three years or so, but it is still doomed. And the danger is that it will bring down the European Union with it.

The gloomy prognosis, I hasten to add, is not mine but that of Prof François Heisbourg, a former French diplomat and chairman of the International Institute for Strategic Studies and the Geneva Centre for Security, who was in Dublin this week to talk to the Institute for International and European Affairs.

"The dream has given way to nightmare," he says in his latest book, Le Fin du Rêve Européen (The End of the European Dream). "We must face the reality that the EU itself is now threatened by the euro. The current efforts to save it are endangering the union yet further."

Breaking up the euro
His solution – seen as heresy by fellow Europhiles and federalists – is radical surgery to save the EU, an operation, he acknowledges, with all the dangers of separating Siamese twins, to cut out the "euro cancer" by preparing a complete "orderly" break-up of the euro and a return to national currencies.

The parallel, he says, is war – Europe’s leaders face the choices that a general overwhelmed in battle does: to continue fighting until obliterated, to break out and at least save the bulk of the army – in this case the EU itself – or to give up the battle for lost. “You cannot create a federation to save a currency. Money has to be at the service of the political structure, not the other way around,” he argues.

Perhaps in 10 years, in a different political/economic climate, when the member states really appreciate and can embrace all the political consequences of a single currency, the EU could have another go. A case of, as the French would put it, "reculer pour mieux sauter" – stepping back to get a better run . . .

But, freed of the constraints of the euro zone, not least the deflationary Stability Pact and its German-inspired stifling one-size-fits-all austerity philosophy, he believes states such as Spain and Italy could restore their competitive advantage fast through limited devaluation of their restored currencies. Such a policy if adopted in Greece, he argues, could have allowed it to avoid the worst of the crippling cuts it is currently undergoing. But it’s a lottery – it could have made things even worse.

Floating currencies are by no means a panacea for growing our economies out of stagnation. While certainly cutting the price of exports and opening up opportunities for business abroad, a fall in currency values pushes up input costs, cuts living standards, fuels price rises and inflates external debt. The latter effect would be nightmarish for Ireland – a 10 per cent devaluation would push up what we owe foreigners by at least some €18 billion (this figure does not take account of non-financial assets). If a break-up produced an upward revaluation of the Irish pound our exports would be in immediate difficulty in key markets.

Moreover, the practicality of an “orderly” dismantling of the euro is deeply problematic. Heisbourg admits he is no economist and appeals to the profession to examine the idea critically, but points to the successful 1994 Brazilian replacement overnight of its national currency and to a number of smaller-scale orderly dissolutions of monetary unions including that between Ireland and the UK.

The suspicion must be that the euro would be infinitely more difficult and the danger of chaos substantially greater. And the idea presupposes a rationality in the money markets in pricing currencies in line with the real performance of their economies – Ireland’s nervousness in the face of its return to the bond markets at the end of the bailout, and its belief in the need for a backstop credit facility from the EU, is precisely a reflection of a deep fear of market irrationality and the inability of small players to take on speculative waves against their currencies. Monetary sovereignty for a small economy is a largely delusionary conceit – hence the appeal of monetary union.

The danger is that Heisbourg’s radical surgery would kill the patient, but his provocative analysis is an important contribution to the debate.

Most important are his warnings that the EU's preoccupation with saving the euro is contributing to the increasing marginalisation of the UK, and probably to its eventual and regrettable exit from the union, and his insistence that half a monetary union is no monetary union, or basis for the long-term survival of the euro. And that the currency will die if current procrastination over further integration continues.

psmyth@irishtimes.com