Interesting read from Bloomberg.
“Romano Prodi recalls how he persuaded Germany to allow debt-swamped Italy into the euro: support our membership and we’ll buy your milk, he said.
When Prodi toured Germany’s agricultural heartland after becoming Italian leader in 1996, he pitched “a big milk pipeline from Bavaria,” pointing to a three-year, 40 percent plunge in the Italian lira that was hurting dairy sales. “To have Italy outside the euro, a huge quantity of exports from Germany would have been endangered,” Prodi, now 70, said.
Germany got the message, allowing entry rules to be bent to create a 16-nation market for its exporters. Now, German taxpayers are footing the bill for that permissiveness as Europe bails out divergent economies lashed to a single currency with little control over national taxes and spending.
The consequences are an 860 billion-euro ($1 trillion) bill for a debt binge led by Greece, sagging confidence in the European Central Bank’s independence and mounting speculation that a currency designed to last forever might break apart.
“You have the great problem of a potential disintegration of the euro,” former Federal Reserve Chairman Paul Volcker, 82, said yesterday in London. “The essential element of discipline in economic policy and in fiscal policy that was hoped for” has “so far not been rewarded in some countries.”
German-led northern Europe, with its zeal for budget discipline, is attempting to fix the mistakes made by the euro’s founding fathers in the 1990s. It is squaring off against the governments of the south over who will control the euro and the ECB; whether the currency will be used to promote growth or squelch inflation, and ultimately, whether some countries should be disbarred from the monetary union.
European Club
What was conceived as a club for Europe’s strongest economies was expanded for political reasons, leaving the currency union with minimal powers to police deficit spending and no safety net for dealing with countries, like Greece, that veer toward default.
“There was no discussion of that at all, of a crisis mechanism,” said Niels Thygesen, a retired Copenhagen University economics professor who served on the 1989 group led by European Commission President Jacques Delors that mapped out the path to the euro. “It was believed that if countries adhered more or less to prudent budgetary policies, that would not or could not happen.”
Kohl’s Role
Former German Chancellor Helmut Kohl, seeing the euro as the capstone of Europe’s economic integration and Germany’s return to the European family after two world wars, opened the door to the deficit-prone southern European countries that the Bundesbank, haunted by the memory of hyper-inflation, wanted to keep out.
Returning from the December 1991 summit in Maastricht, the Netherlands, that kicked off the euro project, Kohl told the German parliament that he wanted “the greatest possible number of countries” in the euro. That gave Italy, Spain and Portugal the encouragement to meet the economic targets to join in 1999 and Greece to follow two years later.
Defenders of the German economic model knew the threat posed by countries such as Italy, whose budget deficit was 10.2 percent of gross domestic product in 1991, when they forced European leaders to set 3 percent as the limit for euro members.
“A well-known German financial leader told me: Fortunately for Germany, Austria is between Italy and Germany,” said Alfons Verplaetse, who oversaw the Belgian central bank from 1989 to 1999. The reckoning was that only Germany and its immediate neighbors would pass the economic tests, limiting the euro to a handful of countries, Verplaetse, 80, said.
Nobel Laureate
Today’s euro is far from what economists like Nobel laureate Robert Mundell call an “optimum currency area.” Gross domestic product per person ranges from 69,300 euros in Luxembourg to 18,100 euros in Slovakia, debt from 14.5 percent of GDP in Luxembourg to 115.8 percent in Italy, and unemployment from 4.1 percent in the Netherlands to 19.1 percent in Spain.”
Read the full article here.
Blog of Intellectual Capital 