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The end of the euro?

WITH THE recent defeats that France and the Netherlands dealt the proposed European Union constitution, the continent's grand unification project is obviously on life support, kept alive for the moment by brave but unrealistic talk about its revival.

The key question is, will the euro expire as well?

Certainly there's been no small amount of hand-wringing over the defeats the EU suffered this month. How did it happen? The French answer relates to Charles de Gaulle's famous question: How can you govern a country that has 246 kinds of cheese?

Economically, culturally, intellectually, France is beset by deep protectionist, antiglobalization instincts. Its electorate is a collection of fractious constituencies that have carved out special arrangements for themselves and are fierce in the protection of those uncompetitive deals. Faced with the obvious pressures that further integration and economic liberalization might impose, France rose as a nation and said no in the ballot equivalent of a general strike.

The situation in the Netherlands was complicated by acute fears about radical Islamic violence and worries that Dutch identity is being eroded by too liberal immigration policies, but there, too, voters rejected the elite idea of European unification in favor of an adamant reassertion of nationalism.

Similarly powerful forces may also come to imperil the euro.

In the aftermath of the twin body blows the EU suffered, a government official in inefficient, recessionary Italy has already suggested that it's time to abandon the euro and return to the lira. Meanwhile, a poll by the German weekly Stern shows that a majority of Germans want to move back to the German mark.

From an economic perspective, a unified currency makes eminent sense for the 12 nations that have adopted it. It reduces the hassle of business transactions, introduces predictability, eliminates the need for the endless hedging that once occupied legions of currency traders, and promotes capital formation. For travelers, a single currency obviously eases trips between the various countries of the euro zone.

And despite early worries that the euro couldn't compete with the dollar, as the United States has slid from the balanced budgets and surpluses of the late 1990s to an era of deficits and borrow-and-spend economics, Europe's unified currency has fared rather well, perhaps too well.

But those benefits have come at a cost. The pact that allows for a single currency also hobbles the members of Euroland by restricting their monetary and fiscal policies. Rationalizing those policies has required more discipline than some participating countries would likely have been able to muster on their own, given their domestic political situations.

Indeed, the European Central Bank has retained some of the character of Germany's Bundesbank, which used to be the de facto interest-rate-setting institution for much of Western Europe. That is, it is inflation-averse and favors a relatively strong currency.

But with the continental economy sluggish, countries like Italy want the cheaper money and lower interest rates that would promote economic expansion. Under the euro, however, they have lost control over the currency they use -- which means they can't devalue their way back to competitiveness -- as well as the interest rates they pay.

Fiscal policy is similarly constrained. One Keynesian remedy long applied to laggardly economies is deficit spending. By adding the demand of new spending to the economy, a government can create a pump-priming burst of economic activity.

To be part of Euroland, however, members have to keep any budget deficit within 3 percent of GDP, which obviously reduces their ability to spend their way out of recession. A further source of friction: While countries like Ireland, Finland, Belgium, and Austria have taken that rule seriously, Euroland's two pillars have not. When their own economies have hit tough times, France and Germany have flouted the budgetary requirements and gotten away with it.

With the EU process stalled, the subterranean tensions besetting the currency are now coming to the surface -- and at a time when some of the continent's biggest Eurocrats have lost favor.

That's a shame, because in many ways, the loss of the unified currency, with its concrete commercial benefits, would spell a more serious blow to Europe than the failure of the EU's constitution. Which is why, even as they discuss the possibility of salvaging the moribund constitution, EU officials should contemplate a related worry: how to ensure that the euro survives the populist backlash touched off by France and the Netherlands.

Scot Lehigh's e-mail address is

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