Euro Blues?

The euro's future is on shaky ground.

No sooner had one crunch point for the euro passed, than another, far more worrisome one sailed into view. On the September night that Denmark shocked the European Union establishment to the core by voting against membership in the euro-zone--but far more pertinently against the entire process of European political integration--a commentator from German radio was interviewed, a grainy photograph of Berlin's totemic Brandenburg Gate behind him.

He talked sternly about what might happen in his country in "one and a quarter year's time." It was not obvious, at first, to what he was referring. But then it became clear. He was warning that, before euro notes and coins become legal tender for ordinary people in January, 2002, the German people may decide that they do not want to give up their beloved Deutsche mark.

Even to British ears, attuned over years to the tones of euro-skepticism, this was stunning. It has been evident for months that the German people were becoming seriously disenchanted with the euro. Opinion polls before its launch in January, 1999, had shown that Germans were opposed to adopting the single currency by two to one but, in the absence of an offer of a referendum, they had reluctantly followed the lead of Chancellor Helmut Kohl (now badly tainted by a political funding scandal), who told them that the euro was the price for once again being accepted as "good Europeans." As good Germans, they accepted the decision of their government but they no longer seem inclined to go quietly. On the day after the September 28 Danish referendum, an opinion poll showed that 55 percent of Germans didn't want the euro. In eastern Germany, the anti-euro figure was 71 percent.

The euro has been a grave disappointment across the continent but to Germans in particular. They were promised a currency that would be at least as strong as the mark. Yet they saw the euro plunge by a quarter of its value, prompting Group of Seven central banks to intervene in September, the first time they had come to prop it up. They were promised a strictly independent European Central Bank (ECB) but have seen the bank subjected constantly to the threat of political control, particularly from France. With a collective memory of the social and political catastrophe that followed from hyperinflation in the 1930's, they were promised that the ECB would be as tough in controlling inflation as the Bundesbank had been. Yet the weakness of the euro--coupled with high oil prices--means that the euro-zone now has an inflation problem.

Germans were promised an equal partnership in Economic and Monetary Union (EMU) with France but have seen France take all the spoils, not least because France entered the EMU at a competitive exchange rate, while Germany entered with an overvalued currency. France has been creating jobs. Germany's job market is stagnant. It is France's cadre of brilliant bureaucrats who are running Euroland, not those of Germany. German Foreign Minister Joschka Fischer makes a major speech, proposing a federal European state along German lines. French President Jacques Chirac promptly uses the opportunity of an address to the German parliament to supplant his French vision of a federal Europe.

On top of rising popular discontent, there are doubts about the extent to which Gerhard Schroeder, Germany's current Chancellor, will defend the euro. He has never displayed a genuine ideological commitment to the euro or to the project of European integration, and he has mounting domestic problems, not least in eastern Germany. In September, there was a telling episode when Schroeder, fresh from a tour of the East--where unemployment is stubbornly high and neo-nazism is on the rise--said that the weakness of the euro should be a matter of joy, not regret, because it was helping German exports. This was a stunning piece of European political incorrectness that led to another bout of euro selling; but it also provided evidence that Germany's leader is more concerned with German politics than the European project.

The weakness of the euro in itself is not sufficient to justify speculation that the EMU could, at some stage, collapse, although some, including the president of the Federal Reserve Bank of Richmond, J. Alfred Broaddus, have at least posed the question. But, together with Germany's evident discomfort with a sliding currency and the political disarray that has followed the Danish no-vote, it could be decisive at some point in the future. It is conceivable that Germany could turn into the EMU's Achilles' heel. But still much depends on how the economics of Euroland and the politics of the European Union, inextricably linked, play out over the next year and beyond.

The immediate response of the EU establishment in the wake of the Danish vote was to redouble its determination to press ahead with the integrationist agenda in the euro-zone, leaving those outside the euro such as Denmark, and potentially Sweden and Britain, in what has become known--in the loaded language of European integrationists -- as the "slow lane" of a two-speed EU. It is by no means certain whether the drive towards "ever closer union" will make the desired progress, but it is certainly possible that something akin to political union may be formed by the eleven countries--twelve, when Greece joins next year--already signed up to convert to the euro.

If deep economic and political integration is achieved in the core, the euro ought to be assured a long-term future. Central bankers have long known--and argued--that a homogenous and centralized political system is necessary to run a successful single currency on the model of the United States of America. At present, the European budget accounts for less than 2 percent of EU gross domestic product. Put simply, there is not enough money to make fiscal transfers from rich regions within the euro-zone to poor regions that can act as an automatic stabilizer in the absence of macroeconomic flexibility. A far larger proportion of Euroland taxpayers' money would need to be dedicated to a federal budget if the euro-zone is to have a mechanism to correct regional imbalances in the single currency area. Even putting the fiscal argument to one side, a more disciplined and homogenous "economic government" of Europe is probably needed if the euro is to get over what is currently a chronic credibility problem. At the moment, the markets see eleven national governments with different national priorities running the euro and often arguing how best it should be run. This can never be a recipe for long-term stability.

It is, of course, precisely the logic that a centralized government is needed to run a successful single currency--that monetary union will only work with political union--that has turned off the electorate of Denmark and makes the euro a deeply unpopular prospect in Britain. It is now highly likely that, post-Denmark, there will be different classes of EU membership: Some countries will be part of a deeply integrated economic and political core, others will be full EU members in the European Single Market but outside the EMU. This changes the European dynamic profoundly.

At the moment, the understanding is that those states in central and eastern Europe lining up to accede to the EU will simultaneously join the euro. For the most part, the accession candidates want to join the euro but this is inspired purely by the perception that only by being a euro member is it possible to be a first class, full member of the EU. There is a desire to "belong" despite real concerns that joining the EMU will require deeply painful adjustment for economies at a far earlier stage of development, compared with the mature economies of western Europe, and that the accession of these economies may further--perhaps terminally--compromise the stability of the euro.

This high-risk, all-or-nothing route could now be sidestepped. After the Danish vote, it is evident that there will be different classes of EU membership: those in the euro and those outside. It now seems inevitable that accession candidates will start to argue that they should be allowed to join the EU without joining the EMU. EU integrationists talk of those countries that intend to stay out of the single currency as the "periphery," with the euro-zone as the "core." But in the long term, if enlargement happens on the new terms suggested, it is quite possible that members of the "periphery" may outnumber those of the core. A greater number of central and eastern European states could become EU members than would have been possible if all had to meet the demanding criteria of EMU membership. In addition, countries such as Norway and Switzerland may be more inclined to join the EU if EMU membership isn't part of the package.

The British and Danish euroskeptic vision of a Europe of nation states--moving together at different speeds, opting out of those parts of the project that do not command popular support among their electorates, and giving up sovereignty on some areas, such as the environment, where pan-European action is clearly desirable-would be far closer to being realized.

The question then is whether this type of Europe--a flexible collection of nation states committed to cooperation but not union--may prove so attractive to the electorates of the euro-zone that deep integration never achieves popular political backing and "enhanced cooperation" among EMU members never gets off the ground. It certainly seems conceivable that German voters' antipathy towards the euro could strengthen even more if a different European future were to come into view. Without Germany, the essentially political raison d'etre for the euro would disappear and, with it, one suspects, the currency itself.

European integrationists are, for all their sang froid after the Danish result, in crisis. They need a centralized state to run the euro but there is no solid political will among Europe's electorates for that centralized state. Denmark's ability to say no in the face of the unanimous recommendation of the political and business establishment can only further undermine support for a political union and leave the euro---even with Germany still on board--a synthetic and highly unstable currency for as many years as it takes for the politicians of Europe to, reluctantly, give up the whole idea.

Janet Bush, former Economics Editor of The Times, is now Director of New Europe, the cross-party campaign against UK membership of the euro.