The euro cannot survive unless Europe changes

Biggest global risks of 2017
Biggest global risks of 2017

Europe stands at a crossroads in 2017.

For nearly 70 years, it has known only one direction: ever stronger integration involving a steadily rising number of countries. Now a big economy and political heavyweight has turned its back and is leaving the European Union. Brexit will be seen as a turning point in history.

For the time being it is very uncertain how relations between the U.K. and the EU of 27 countries will develop. The wider fallout remains to be seen. Nationalist parties from right and left in other countries are using the British example to support their calls to exit the EU. However, the enormous complexity of Brexit and the potential for economic damage may act as a deterrent to others tempted to take that path.

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But it's not only the EU that's at risk. The euro is also at a crossroads. Writing this piece reminds me of the fact that I used this term in 2007 in the headline for the last chapter of my book, "The Birth of the Euro."

Alarm bells ringing

Does this suggest that my warnings were too alarmist 10 years ago and remain so today? Unfortunately not. The euro went through an almost fatal crisis after the global collapse of financial markets in 2008. True, this event triggered a number of badly needed reforms in some member countries. Yet, 10 years on, European monetary union is hardly in better shape.

Much more ambitious reforms are still needed. Unemployment has risen to record levels and, notwithstanding some recent improvement, remains very high in a number of countries. Some governments have become so heavily indebted that they depend on the European Central Bank's purchase of bonds to protect them from substantial increases in interest rates that would threaten their solvency.

Central bank balance sheets show capital is fleeing crisis countries to safe havens, in particular Germany, in record volumes. Greece is still teetering between needing another bailout and being forced to leave the euro.

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The currency can muddle through for some time to come. But it cannot survive indefinitely unless these fundamental problems are addressed.

By preserving a level of extremely low interest rates and compressing spreads on government bonds, it is the ECB that is holding the eurozone together. It's the only game in town. But the central bank is overburdened with this responsibility, and has had to extend its actions to the limit of its mandate and beyond.

What future for the euro?

How can we emerge from this critical situation and secure the future of the euro? One popular suggestion is to create a fiscal union, in effect transferring taxpayers money from richer countries to those in difficulty.

However, that proposal ignores the fact that the EU is a union of sovereign states. And sovereignty means responsibility for taxation and public spending rests with national governments, accountable to voters through national parliaments. It's hard to see this changing because it would require a corresponding change to the EU treaty, and in some cases such as Germany, national constitutions. Both are highly unlikely.

And who would plead for creating a fiscal union without democratic legitimacy, or taxation without representation?

The euro's existing institutional arrangement rests on the principle of the "no bailout" clause, a key element of the treaty. This principle must be respected and guide Europe's decision on which path to take. The only way forward is for countries to introduce tough reforms to boost growth and employment, combined with fiscal discipline. There is a long way to go.

-- Otmar Issing is president of the Center for Financial Studies at the Goethe University, Frankfurt. He was the European Central Bank's first chief economist. The opinions expressed in this commentary are solely those of the author.

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