Is the euro in trouble?
Source: Courtesy of INSEAD Knowledge , Author: Shellie Karabell
Posted: Fri December 17, 2010 3:04 pm

INTERNATIONAL. European leaders have been discussing the creation of a bail-out system for countries which are mired in debt, but is the euro in trouble?

INSEAD Professors Antonio Fatas and Douglas Webber talk to Knowledge Executive Editor Shellie Karabell about the outlook for the currency.

Knowledge : A country's money is the coinage of the realm. It's kind of like a national identity. So what about the euro? Now it was conceived as a way of uniting Europe's tiny little countries into a bulwark with one currency against the nation's other trading blocs. But the euro's been under pressure recently largely as a result of the financial crisis. What lies ahead? Well, here with us today on INSEAD Knowledge are two INSEAD professors, one on the economic side, the other on the political side, who can help us figure that out. Professor Antonio Fatas, thank you and Douglas Webber, thank you very much.

Let me throw this out for both of you. Is the Euro in trouble? Antonio.

Antonio Fatas : I think this is for sure, the toughest times for the euro. We knew that at some point there would be a crisis and the euro would be under pressure. I remain optimistic. I think the euro will stay with us for many, many decades ahead. But certainly there are lots of challenges and there are scenarios ahead in which we could imagine the euro falling apart. But again we think those scenarios still remain fairly optimistic and I think the euro will be with us for the decades ahead.

Knowledge : Now the euro is a financial institution but it's also a political institution. So let me ask, Douglas, politically what's holding the euro together today?

Douglas Webber : The euro is held together essentially by the strength of the political commitment of the member states especially most of the large European states that both economically and politically it makes sense to have a highly integrated or politically very integrated Europe.

If one goes back to the foundation or the origins of the euro, in fact I would see them more on the political realm than the economic realm. There may have been an economic case for the creation of the single currency in Europe. But it was really conceived initially above all by France, as a means by which to exercise greater European control of a German economic, especially monetary policy.

And of course its introduction was accelerated greatly at the time of the unification of Germany in 1989-1990, when although they weren't convinced by the economic merits of the case, the German political leadership, at the time Helmut Kohl especially, a very convinced and hardened pro-European decided essentially for political reasons that this is something which many want to

That means for example that if today if the euro were for any reason to actually collapse, the political fall-out of such a development would actually be very, very grave indeed and would raise again the question whether or not Germany is too large, too powerful, economically too mighty, to be able to be constrained by its neighbouring states in Europe.

Knowledge : Would it have been worse without the euro?

Antonio Fatas : My sense -- again this is a big debate and I'm sure you can find economies who would disagree with me -- but in my sense it would have been worse. And people have to remember how we lived through similar crises before we had the euro.

Obviously, times today are very tough. So you can look at any ofthese European countries and they're going through very difficult times from an economic point of view. But at the end of the day if you go back in time and you look at the crisis in the 80s when each of these countries had their own currencies, many of them went through crises that were significantly deeper than the ones we see today.

And we see countries outside of the euro area, whether it's the UK or the US are also having a tough time struggling with this crisis.

So it's not only about the euro. Obviously this is an economic crisis which is there in many, many countries, those that are part of the euro project and those that are not.

And my expectation is if we hadn't had the euro, we would have been in much more difficult time in the European Union.

Knowledge : Do you agree with that politically, Douglas?

Douglas Webber : Yes, if there weren't the euro, if we didn't have the euro, either there would be a system of floating exchange rates. Theoretically that's possible I suppose. There's never been such an exchange rate regime in Europe basically since the Second World War because immediately after the collapse of the Bretten Woods system in the early 1970s, there was a series of attempts made with great or lesser success to introduce some kind of a stable exchange rate system in Europe.

So in practice, the choice is either between the euro or the single currency on the one hand, or some kind of system of pegged exchange rates on the other, which as Antonio pointed out neverseemed to be viable over a longer period of time.

Now it so happens I think that the euro has bet against history in the sense that no multinational monetary unit actually has survived for any length of time, so one should expect based on history perhaps for the euro to fail.

I'm not myself so sceptical. I'm rather optimistic in the same way as Antonio is because it seems to me that -- again to differentiate between the debtor states and the creditor states in the current situation -- the debtor states are actually implementing austerity policies, the lack of which probably until very recently no one would have regarded as politically feasible on these countries.

And on the other hand, I think the degree of acceptance of the need to assist such countries on the part of the richer, stronger economies, notably Germany, is still very much present. And I don't see that in the political sphere in Germany that as things now stand, there is any very strong movement that Germany for example should not take part in such exercises, should not support such funds or even worse, or going even further, should actually exit from the euro zone.

In particular, in Germany, I think this is a very important political fact. Unlike in almost any other major European country at the present day there is still no strong, extreme right, anti-European political party or movement. And in the absence of such a movement, I think probably Germany can be counted on to carry on supporting the common currency.

The difficulty of course or one reason why the euro occasionally looks to be in very bad shape is that given the way in which decisions are actually made in Europe and the only way they can be made in fact is through a rather laborious process of negotiation between the various member states. So it's really hard for the political leaders to actually act as fast as the markets would like them to do so. So one is left with the impression essentially that our political leaders are muddling through as much and that's as far as they can actually do. But muddling through may actually
work for quite a long period of time.

For myself, I think one of the fundamental underlying problems of the euro zone is that there is still no common position between France and Germany when it comes to the relationship between fiscal and monetary policy. And until such time as there is such a consensus which I don't see developing very soon, I think there'll be an underlying instability to the euro which we're going to have to live with and which will give rise to occasional sort of crises and problems for which temporary solutions will be found, without the underlying root causes of the instability being attacked.

Knowledge : What would it take to unwind the euro?

Douglas Webber : Two things or two kinds of things I think could happen. Firstly, so far as the debtor countries are concerned, those countries that are right now implementing quite severe austerity policies, one could imagine in principle a popular protest against the implementation of these policies could reach the point where no government is any longer able to actually keep on practising these policies. And then there must be some serious discussion of whether or not the country should exit the euro zone.

Or political parties come to power which are really fundamentally hostile, not just to the single currency but to the European integration project full stop.

These are circumstances which I can't well imagine at the present time. But certainly in the medium term it shouldn't be discarded because if people in these countries don't see some light at the end of the government tunnel at some stage, this kind of momentum, this kind of movement, is likely to begin to develop I think.

Antonio Fatas : I think you would need to have to have a much, much deeper crisis than what we have today. If you have a situation where a few of the Euro governments start defaulting, which might lead to financial crisis in some other countries whether it's Germany or France, you'd end up with economic conditions that might be so
bad, that then you end up seeing some political parties starting generating like anti-European, anti euro platform.

And if that could continue -- but it would have to be a very deep economic situation. If that could continue for a number of months
or years, you would end up or you could imagine a situation where a country decides to pull out.

It's very hard to imagine a situation where many countries do it at once, but you could imagine some countries where the political process leads to a political party winning an election with the promise that if we win, we'll get out. I think that might be good from a political point of view. I think economically it might be
suicide for the country. But that's a possibility. That's something that I could imagine.

Knowledge : So let me end by asking you both your outlook for the euro. In the first half of 2011, what do you think?

Antonio Fatas : It's not going to be an easy year. But again compared to a scenario of a crisis where every country abandons the euro, I remain much more optimistic than that. I think the euro will be around for 2011, 2012 and probably 2080. But it's going to be difficult year because the economic situation is not going to be

Douglas Webber : I agree with Antonio. I think at this time next year, probably there'll be 17 member states of the Euro Zone, as compared to 16 right now, with the addition of Estonia from January 1. I can well imagine some difficult moments for the euro in the next twelve months.

There'll be a number of political dates and possible political events which could give rise to nervousness and some instability in the markets. For example, if no clear government emerges from the current political stalemate in Italy; as a consequence of a number of quite important state elections in Germany, particularly in the
very big state of Baden W├╝rttemberg at the end of March next year. So I could imagine there will be periods of uncertainty and if you like, crisis.

But as they've done so far and as the EU has always done, they'll manage somehow to muddle through. So this time next year, as I said, we'll still be paying our bills with the euro I think.

Knowledge : Professor Douglas Webber, thank you very much. And Professor Antonio Fatas, thanks for being with us on INSEAD Knowledge.

Douglas Webber : My pleasure.

Note. This article is transcribed by and republished courtesy of INSEAD Knowledge (

Copyright INSEAD 2010.






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