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Workers maintain the huge Euro logo next to the headquarters of the European Central Bank in Frankfurt, Dec. 6, 2011. (RALPH ORLOWSKI/RALPH ORLOWSKI/REUTERS)
Workers maintain the huge Euro logo next to the headquarters of the European Central Bank in Frankfurt, Dec. 6, 2011. (RALPH ORLOWSKI/RALPH ORLOWSKI/REUTERS)

Ten years after the euro's launch: How could it have gone so wrong? Add to ...

WALKS WITH A LIMP

On the other side of the French political spectrum is Michel Sapin, 59, who was finance minister in a Socialist government from 1992 to 1993 and dealt with Europe’s foreign exchange crisis of the early nineties. He is likely to hold a senior office if Socialist Francois Hollande beats conservative incumbent Nicolas Sarkozy in the April-May presidential election.

To Sapin, the euro zone’s problems stem from a fundamental design flaw in the 1992 pact that created the European Union and led to the euro, the Maastricht Treaty.

“The Maastricht Treaty was built on two pillars. The monetary pillar has been an extraordinary success, because, say what you want, there is no monetary crisis - the euro is strong,” he said. “The second pillar was the economic government. We knew from the start we had to build a second pillar for economic, budget and fiscal matters, because countries cannot share the same currency if they have divergent economic policies.”

European Investment Bank President Philip Maystadt, a veteran of EU monetary integration, could not agree more. He took part in the Maastricht Treaty negotiations as Belgian finance minister from 1988 to 1998. He recalls that Germany at the time was suspicious of unified economic government, fearing it would impinge on the independence of the future European Central Bank. But protecting the bank’s independence was not a good reason to abandon the concept of economic governance, he said.

“(Former European Commission President) Jacques Delors said the single currency walked with a limp - it had one strong leg, the monetary part, and one weak leg, the economic governance,” he said. “Clearly, this ersatz economic government was utterly insufficient.”

TURNING POINT

European leaders were aware of the shortcomings of Maastricht. They spent two years negotiating the 1997 Stability and Growth Pact, which threatens escalating sanctions on states that fail to limit annual deficits to 3 per cent of GDP and outstanding debt to 60 per cent of GDP.

But the focus on these two indicators meant that other measures of economic health, such as private debt, wage costs and the current account balance, were ignored.

As a result, EU finance ministers overlooked the build-up of tensions in the Irish and Spanish economies. Their public finances looked to be in excellent shape by Maastricht Treaty standards, until Ireland’s banking crisis and the Spanish real estate collapse. Those implosions forced authorities to turn private debt into public debt, wrecking their nations’ finances.

Imperfect as it was, the Stability Pact was the one mechanism that could have kept the single currency on the rails. But it was discarded the first time it was tested.

When the 2002-2003 economic crisis pushed French and German public finance indicators beyond Maastricht limits, the two big EU nations cast it aside. Exceptions were made, and in 2005 the pact’s provisions were watered down further.

“That was a real turning point. When the other finance ministers saw what France and Germany were getting away with, that’s when they said, ‘Ah, ok, we don’t have to respect the Stability Pact’,” Mr. Maystadt said.

In the debt-fuelled prosperity of the first half decade of this century, this did not seem to matter. Euro zone interest rates were low, growth was fast, stock markets went up. At the start of the decade it looked like the lack of policy co-ordination would only cause member states’ economies to be a bit out of sync.

From around 2004 that changed. It became obvious that two very different models were cutting Europe in two: export-oriented manufacturing with strong wage control in the north, and debt-financed consumption in the south.

Books have been written about this trend, but a picture says more than a thousand words: the charts of net foreign assets and current account balances in north and south look like mirror images.

The combined net foreign assets of Germany, the Netherlands, Belgium, Austria and Finland grew more than fourfold to nearly €2-trillion by the end of the decade, as their current account surplus swelled to more than 6 per cent of GDP, according to figures from Thomson Reuters Datastream and French investment bank Natixis.

But net foreign debt in France, Italy, Spain, Greece, Portugal and Ireland grew to more than €1.5-trillion as the southern zone’s current account deficit widened to around 4 per cent.

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