It may be called the European Union, but at least part of that name is being called into question. The market convulsions of the past week are clearly about short-term concerns, about the balance sheets of countries like Italy, Spain and even France. But they're also about a problem with a more distant horizon: Does the E.U. still make sense in its current form?
As long as that question remains unanswered, uncertainty is bound to continue. Short-term measures, like the propping up of Spanish and Italian bonds by the European Central Bank "are quick fixes that smooth things over the short term," says Stephen King, chief economist at HSBC in London. "But they don't answer the questions the markets are asking: What are the political and fiscal arrangements that would create stability in the future?"
The trouble is one that was identified long ago. The E.U. has created a single currency, but it hasn't forged a deeper political or fiscal union. The result has been the creation of a system that yokes individual countries to a single unified monetary policy, without allowing for the transfer of funds that would allow the union's member states to ride out the distortions that setup can create. As a result, consensus is mounting that the current situation is simply not sustainable. The E.U., says a rising chorus of voices, needs either to be strengthened, or it will break apart. "What needs to happen is that there's an honest recognition that those two choices exist and that a choice has to be made," says King. "Pretending we're going to muddle through just won't work." (Read about how much worse the euro crisis can get.)
The E.U., as is stands, "is a fair-weather construction," says Emma Bonino, the vice president of the Italian Senate and a former commissioner at the E.U. "It works only in the absence of economic trouble." The solution, she argues, is the further centralization of political power. Such a move wouldn't have to be the creation of a single European superstate along the lines of the U.S. Bonino herself has proposed an intermediate solution, in which member states cede only some of their powers - such as foreign policy, defense and border control. Most crucially, it would include a Finance Ministry in charge of economic stabilization, and, when needed, transfers of funds from the central government to individual states. The common political identity, she argues, would make the necessary redistribution more palatable. "Help normally comes only if there is a shared feeling of belonging," she says.
The other possibility - argued most loudly in Germany, where anger is mounting about taxpayers being forced to bail out less-responsible countries like Greece or Ireland - is to start to break the union apart. "It is better for all concerned, in particular for Greece, if the country leaves the euro temporarily," Hans-Werner Sinn, an influential economist at the University of Munich, wrote in a recent essay. The weaker country would be free to devalue its currency and begin to regain its competitiveness. The rest of the E.U. wouldn't be forced to come to its assistance. Even Otmar Issing, a former member of the European Central Bank and one of the driving forces behind the single currency, has warned against the rushed strengthening of the union. A proponent of European integration who once famously cautioned that "there is no example in history of a lasting monetary union that was not linked to one state," Issing now worries that a bailout of Europe's less solvent members would lead to "fiscal indiscipline" and even unrest by taxpayers furious over being forced to sacrifice when others didn't. (Read "The New Battle for Europe: Bankers vs. Taxpayers.")
Both choices have historical precedents, says HSBC's King. After the collapse of the Soviet Union, countries that for decades were united under a single political authority suddenly weren't. Many of the newly formed, previously Soviet republics first tried to keep using the Russian ruble. But soon, in a development that should give pause to anybody watching the E.U., the economic discrepancies between the various economies became too great. And the single currency fell apart.
A model for the alternative scenario is the E.U. itself. Before the introduction of the euro, the European Community had introduced a currency mechanism intended to reduce the variability in exchange rates between the various member countries. In 1992, however, that system began to fail. In a sequence of events that would seem familiar to anyone watching the markets this week, speculation sent the market into a frenzy. The U.K., which had joined the mechanism two years earlier, hastily withdrew. The other countries drew the opposite lesson and pledged to move toward closer economic integration. "The single currency wouldn't have happened without that crisis," says King. "The crisis reveals the choice, and the choice has to be made."
See if the London rioters or stock-market traders are more destructive.
See photos of spooked stock traders at the New York Stock Exchange.
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