Will Europe Save the Euro?

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The Eurozone debt crisis will play a leading role at both the G8 and NATO summits. The great debate—austerity versus growth—has already led to the collapse of the Dutch government, the election of a Socialist president of France, and an austerity rejectionist government in Greece. In Chicago, the debate of NATO’s “Smart Defense” strategy will intensify as austerity reduces growth and squeezes defense budgets, which some fear may lead to the demilitarization of Europe that former U.S. Secretary of Defense Robert Gates warned against.

The crisis combines European sovereign debt, under-regulated banks, and trade imbalances, as well as high unemployment and anemic growth. Two years of European summitry, multilateral consultations, and innovative proposals have not ended the protracted Eurozone crisis.

How did the Europeans get into this crisis? Many analysts in America, seeing the European economy dragged through this financial crisis, have concluded that the euro faces collapse. As Princeton University professor Andrew Moravcsik recently argued in Foreign Affairs, Germany set the terms for nearly every agreement on monetary issues since the 1970s because it wanted a single European currency for its own economic welfare. 

I can only say that such analysis is nonsense. The current crisis quite correctly centers on Germany and is an existential crisis for the Eurozone; however, it is fundamentally about European Union political integration. “If the euro falls, Europe falls,” warned German Chancellor Angela Merkel without exaggeration. Former German Chancellor Kohl pleaded a few weeks ago that political leaders “[not] allow the current discussion and the crisis situation in Greece to lose sight of a unified Europe. The opposite is the case: we need—above all now—more and not less Europe. […] That means: Europe remains a question of war and peace, and the idea of peace the motivation behind European integration.”

Polish Foreign Minister Radosław Sikorski, who joins The Chicago Council for a public program on May 20, has challenged Chancellor Merkel to lead. “I fear German power less than I am beginning to fear German inactivity,” he said in November 2011. “You have become Europe’s indispensable nation. You may not fail to lead. Not dominate, but to lead in reform.”

Will the Eurozone crisis save or sink the global economy? I see two alternatives. Europe can jettison its monetary union or it can adopt a complementary fiscal union. Yes, the business of the thirty-year-long struggle to create a European Monetary Union (EMU) remains unfinished; however, the current set of negotiations is quite typical of EU politics. That is, the Europeans are crafting, piece by piece, the missing elements of political union.

The Economic and Monetary Union (EMU), adopted in the 1990s, created an institutional basis that expanded upon the Maastricht Treaty by combining monetary union, the euro, and the European Central Bank (ECB). Now, the unfinished business is to complete the EMU with a fiscal union, economic governance institutions, and meaningful coordination of structural economic policies. In the words of Chicago Mayor Rahm Emanuel: “Never let a good crisis go to waste.” The Eurozone crisis is a call to action for political leaders who recognize the catastrophic costs of a collapse of the euro.

The solution is becoming clear. The European Central Bank (ECB) and the European Stability Mechanism (ESM) are in place. The ECB or ESM will support the monetary union. Sovereign debt for the moment is being resolved by the ECB’s flooding of the market with banking liquidity, accepting sovereign debt as collateral, which in effect socializes sovereign debt. The shift to taxpayers is real, and it is not so subtle. A fiscal compact has been negotiated and is one of the key factors in resolving the crisis.

As Martin Wolf noted in the Financial Times, “[A]usterity is merely begetting more austerity.” Public debt to GDP will rise, not fall, with austerity. Fear of inflation has placed talk of stimulus and growth policies in the back seat, but, following the Greek and French elections, policies for growth will rebound to become stage two of the crisis resolution. The German finance minister suggested German wage rates could rise by 6.5 percent in the current wage negotiations, which would stimulate demand in Germany.

The elephant in the room is that the Eurozone problem is also one of trade balance adjustments in the surplus countries, particularly Germany, and not only austerity in the south of Europe. The gorilla in the room is political will. Will European leaders have the will to pursue austerity as governments fall? Can growth be achieved without exploding inflation? These are not new debates.

In the short term, the market is skeptical of these proposals—which, in the long term, is likely to make things worse. While European policymakers labor to guarantee the stability and survival of the euro, the crisis itself is being driven not only by economic policy makers, but also by global investors and banks, country-level central banks, and the ECB.

Considering the political and economic agents, stakeholders, interest groups, and exogenous forces affecting the performance and confidence in the euro, European policymakers have only limited leverage to resolve the crisis without the consent of the market. Nevertheless, the role of Germany and its politics are the center attraction in the drama. The world is watching Berlin.

Success of the euro is based on a longer struggle for European political union. This, in turn, demands political will to pool sovereignty on fiscal and monetary policy to forge a European Monetary Union with the institutions of a fiscal and monetary union. The Europeans still believe in the need for an integrated Europe. The Eurozone will survive.