Why The Euro Is Not Likely To Last

In this article The Golden Investor explains why the euro isn't likely to remain the currency of Europe. Having one currency has benefits, but is unsustainable when European integration lacks.

The 21st century has brought us many groundbreaking developments, as we became increasingly dependent of internet, also the euro is adopted by a majority of European countries. This has had several positive effects, like less exchange rate risk and inflation risk, but the euro is increasingly becoming a liability rather than a uniting link between countries. The euro is product of European enthusiasts, but as the world experiences a rise in globalization this European monetary integration is becoming more and more under pressure due to several societal aspects which have to change in order for the euro to last. The euro can only function well in a fully unified Europe, but as European support drops in almost all European nations, this currency will go through some though times. The corona debt burden will be the last nail to the coffin of the euro.

When adopting the European currency a country gives up on his own monetary autonomy, national interest rate and exchange rate. The latter is the most notable, when used correctly, exchange rate management can increase competitiveness and makes it easier to overcome exogenous economic shocks. In order to stimulate exports a country can depreciate their currency to become cheaper for importers of other countries. In one European currency area, countries that experience different shocks due to differences in economic structures and characteristics are dependent of the same exchange rate. In order to be able to make up for different effects of the shock countries have to change prices, but as prices are sticky on the short run due to labour market policies European recovery of exogenous shocks is relatively slower. Interesting will be to see if the corona shock is a temporary one or if the negative economic effects will last. The European system is more likely to overcome a temporary shock as employment is guarded more than in the USA. However, if the economic pain will last longer the European structures will suffer more.

As European countries all have different economic structures not only this exchange rate unity poses a problem. For a currency area to work there has to be labour market mobility between countries. If a certain sector is hit relatively harder by a certain development, people have to be able to move to better performing industries. Labour mobility was already relatively low due to cultural and linguistic limitations of migration between regions. But as low skilled labour is valued less and less due to globalization, the inequality gap has significantly increased over the last fifty years. This inequality has resulted in the rise of populist parties across countries in Europe, of which most condemn free mobility, even between European countries. This has a negative impact of the functioning of the euro currency area.

Another important feature which is necessary for the euro to survive is the use of fiscal transfers to support less developed and under-performing regions. This is essential for the euro area to function, but as countries like Austria and the Netherlands tend to criticize these kind of fiscal transfers, the European strength weakens. Fiscal transfers to lesser developed regions also tend to lead to moral hazards. These regions become dependent of these funds and do not have a natural economic incentive to increase productivity within the region, but tend to twist policies in way which leads them to receive more of the European Structural funds. However, it is widely known that the more developed regions tend to benefit more of European integration than the outskirts of Europe. Fiscal transfers are made to make sure that regions which suffer under European integration also receive some of the benefits. But as this system is shaking and the board of the ECB diverges more and more, the euro is under high pressure.

The richest European countries are dependent on the income of the poorer countries in regions. Each year there are capital flows out of the south of Europe to the north due to differences in economic structures. In order for this to be sustainable fiscal transfers are necessary to keep this flow going. It feels counter-intuitive to support less productive regions, but it is vital to European economic engine. Rich exporting countries are dependent on poorer typically import countries, so in a system with one currency fiscal transfers are necessary to sustain the European economy. Having different currencies across Europe creates a more flexible and seemingly fairer economic system. However, weaker countries will face exchange rate speculation attacks like we saw at the end of the last decade. Traders will speculate against the one with weakest pockets, this creates a self fulfilling prophecy, damaging economic stability and thus also damaging to economic growth. And when weaker countries face lower growth, exporting countries with bigger pockets also lose economic prosperity.

As the most vulnerable countries in Europe also are the countries heavily dependent on tourism, where in Italy tourism is responsible for 15 percent of GDP, in Greece this number is 24 percent. As the corona outbreak is a killer to this industry, these countries will face huge debt burdens. European solidarity has to be higher than ever in order for the euro area to survive in the way we know it. It will be harder than ever, countries will face their own problems and under pressure of European skeptics the corona aftermath will prove to be the start of the end of the euro as we know it.

It would be great if we could coordinate as humans instead of nationalistic entities. This would lead to more equality, sustainability and overall prosperity, however such a world is far away in a world where there are minorities, oil tycoons and a wealthy minority with the majority of the power. Having a group of intellects with a majority of the power is not necessarily bad. Such a system would work as long as these people do not have personal interests, are absolutely rational and do not have preferences in any way. Stepping back in reality, if even the European Union does not function optimally, we are not likely to see this kind of governing board anytime soon.

Having the euro is a trade-off between solidarity and integration and individualism and autonomy. Economically speaking it is best to function as one big European country, but as cultures differ greatly and people don’t feel as connected with fellow European inhabitants, the euro area is not likely to survive. The best would be to take away all the borders and function as one world, with one nationality: Earth. But as people tend to value and hold onto cultures and old habits, which isn’t necessarily a bad thing, an economic system is more likely to work within identical cultural regions. This is the same reason why The Golden Investor thinks that on the short run the euro is not likely to survive.

Disclaimer: The Golden Investor is not a fortune-teller, be sure to make the right decisions in accordance to your own financial situation, this is not investment advise or anything like that.

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