Many commentators see the euro as the logical successor to the dollar as the reserve currency. Yet the Financial Times’ Lex column points out that most currency unions fail. However, the dollar is the product of of that very type of arrangement. Nevertheless, the piece serves as an important reminder against blindly assuming current trends will continue. Lex sees differential inflation rates among EU member nations (always a problem, since it is impossible to devise a monetary policy to suit all) as a growing source of stress.
Some last longer than others but most currency unions end in collapse.
In the mid-1700s, Massachusetts, faced with devaluation and inflation, broke from a monetary union of four New England colonies. A century later, the French-led Latin Monetary Union, which included Belgium and Italy, struggled along before being subsumed into the gold standard. The East Africa Currency Area blew up at the same time as sterling in 1977. Germany’s Customs Union and the monetary union of the US were rare successes. So history suggests that the euro’s chances of survival are not terribly high. The question, therefore, is when it might implode. That is hard to say but, at the margin, the currency’s appreciation during the past few years is not helpful. That is because, for the first time since the euro’s birth in 1999, the strong currency appears to be having a negative effect on growth in the core eurozone countries of France and Germany.
The main trouble is that the European Central Bank’s benchmark interest rate of 4 per cent is probably too low, given the overall inflationary environment – and definitely too low for the eurozone’s “periphery” countries. Ireland and Spain already have huge asset price bubbles due to their inability to set appropriate monetary policy.
The economies of some Baltic states, and others such as Bulgaria with currencies pegged to the euro, are overheating. Whether the pegs hold until these countries are welcomed into the eurozone is now open to question. Failure here could shift attention to imbalances elsewhere in the union.
Potentially slower growth across the eurozone would also hit tax receipts, putting already strained budgets under further pressure. In Italy, for example, burdensome government debt and a widening fiscal deficit leave no room at all for manoeuvre. If fiscal discipline begins to lapse, that is when the real trouble could start. So far, the euro is seen as a triumph, but all currency unions are tested from time to time. Further appreciation could well herald one of those periods.