Rumors of the euro's demise are greatly exaggerated, said Jim Adams, Arthur F. Thurnau Professor at the University of Michigan, in a keynote speech titled How Fragile Is the Euro?
It's easy to think otherwise following English-speaking experts. Adams pointed out that even though U.S. and U.K. economists of different political stripes diverge widely on many economic issues, they are mostly united about the euro--that it is "an idea whose time has not yet come." The Anglo-Saxon view relies on Optimal Currency Area Theory, which states that for a currency to function successfully, at least one of three conditions must exist. Economic migration must be free and easy, there must be a large central body that can execute fiscal transfers, and/or prices must be able to be adjusted downward quickly.
None of these three conditions holds true in Europe. Although people with a European passport can move into other countries, language and cultural barriers prevent migration from occurring at anywhere the rate that is needed to adjust economies that are moving at different speeds. It is not as if hundreds of thousands of Greeks are flowing into Germany. As for fiscal transfers, the European Union central body in Brussels is a minnow, comparatively speaking. It lacks the budget to effect major change. Finally, wages during downturns are sticky in Europe just as they are everywhere else. People are unwilling to take large pay cuts if their country's economy is struggling.
However, there is another side to this story. On the European Continent, economists maintain that the Optimal Currency Area Theory is incomplete. Yes the euro's failure to qualify under that theory is a problem for the euro, but what are the alternatives? International trading is much, much larger in Europe than in the U.S., with exports and imports amounting to 70%-80% of total gross domestic product for countries such as The Netherlands and Belgium, as opposed to 10% to 15% in the U.S. Floating currencies with the associated costs of ongoing exchanges and hedges are a poor solution. So too are fixed exchange rates, as capital flows quickly become uneven, with money moving to the country that offers the highest interest rate. So despite its imperfections, the solution of a single euro currency seems superior.
In addition, Adams pointed out, the U.S. dollar itself survived for many decades while failing to meet the standards of the Optimal Currency Area Theory. The dollar in its current form debuted in 1864. Yet until the New Deal, some 70 years later, the U.S. was not an Optimal Currency Area. There was little migration from the much poorer South to the wealthier North; the U.S. Fed issued relatively small transfer payments as the national safety-net programs had not been established; and wages were sticky then as they are now. Thus, it is not accurate to say that a currency cannot survive because it does not meet the current Anglo-Saxon standards.
The reality, said Adams, is that the euro will survive because it is better than the alternatives. Some of the smaller economies will likely drop, but the larger core countries will remain, as well the euro. Will the euro inevitably suffer a price decline as a result of the turmoil? Even there, Adams said perhaps not. Currencies do not decline in isolation; they decline relative to other currencies. The big offsetting currency for the euro is the U.S. dollar. And the problems in Europe are echoed in the United States--sluggish growth, political infighting, and high fiscal debt. So it is by no means clear that the euro's price will slide against the U.S. dollar.
John Rekenthaler is Vice President of Research for Morningstar.
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