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King Mario and the Holy Grail. Fifty years of European monetary integration

On Thursday 15 February 2018, the Hazelhoff Centre for Financial Law welcomed Roel Janssen, financial and economic journalist and writer, for the fifteenth Hazelhoff Guest Lecture.

Roel Janssen
15 February 2018

Background introduction euro

Roel Janssen reminded us of the Parisian student revolt of 1968. As a result of the great social unrest, a large French capital flight to Switzerland occurred. Confidence in the French economy fell enormously as a result and the franc's course was severely hit. The expectation that the rate would recover, did not come true.

Eventually, the franc was devalued by 11% to keep the franc competitive in relation to surrounding European countries. This led to financial tensions and ultimately a weakening of the entire French economy. The French realized that monetary competition with other European economies was undesirable.

In 1989, after the fall of the Berlin Wall, a European agreement was reached to come to a common monetary policy. As part of this agreement, the prices of the European currencies were linked to avoid the French problem in the future. In the end, all this was the prelude to the introduction of the euro in 2002.

Rational considerations for the introduction of the euro

In the now highly politicized debate regarding the euro, there is little eye for the original rational considerations for the introduction of the euro. Essentially, European countries wished to limit European monetary competition and consequently, monetary fluctuations. This practice led to hedge funds speculating on devaluations and in essence, causing financial instability through massive exchange changes. This instability was addressed by the use of a common currency. In addition, the somewhat weaker European countries were particularly interested in disposing of their weak currencies, as they wanted to 'import' financial stability from the stronger European countries in this way.

What went wrong during the euro crisis?

During the financial crisis, the euro zone was put to the test. No common economic policy was agreed upon when the euro was introduced. The idea was that the European economies would automatically integrate by the use of a common currency. Policy was however agreed upon with regard  to the maximum level of budget deficit and the national debt via the Stability and Growth Pact. During the crisis, this arrangement proved to be completely inadequate to guarantee stability.

The financial budgetary policy of the European member states turned out to be very divergent. Budget discipline was missing in some Member States. The majority of Member States' central banks also lacked monetary responsibility and were unable to properly address the crisis. They appeared to be very protectionist towards their national companies, and had no eye for the longer term.

Ultimately, the crisis led to a negative spiral: the loss of competitiveness meant that Member States could no longer finance the capital they needed on the capital markets.

How did the euro survive the crisis?

The survival of the euro is often attributed to the almost prophetic role that Mario Draghi of the ECB assumed during the crisis. The most famous moment is his speech in London: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” It appeared to work, as the euro zone stabilized.

A safety net was set up consisting of an extensive package of emergency support measures, eventually resulting in the ESM (European Stability Mechanism). The idea of ​​this mechanism was that Member States deposited money into a common fund that could be relied upon by crisis-affected Member States. This ensured that Member States in financial distress remained solvent. This guarantee reassured the financial markets so that the Member States in turn were able to finance capital on the financial markets.

Another solution was the Banking Union. This system aims to address the weaknesses inherent to national banking supervision and resolution. Financial supervision of banks in the euro zone was elevated from the national level to the ECB. The national symbiosis between the banking sector and governments was thus overcome by a more 'neutral' supervisor.

Economic criticism regarding the current system

There is a lot of economic criticism on the current system. In essence, this criticism means that monetary integration has addressed major economic differences between Member States. In fact, there is a situation of 'one size fits none'. In addition, the imposed austerity measures were extremely tough. Perhaps so much that, according to some, they caused more economic harm than gain. The emergency fund eventually proved to be the solution, but in the ‘northern’ Member States this led to political problem, because they were unwilling to finance the ‘southern’ Member States. This created a wedge between north and south.

There is also a lot of criticism regarding the role of the ECB. The use of the so-called quantitative easing (QE), in which government bonds from banks are bought up to provide them with more liquidity, is controversial. The aim of the ECB is to maintain an inflation of around 2%, which would ensure the best possible economic growth in the euro zone. It is disputed whether QE does actually contribute to this level of inflation, or that there are other circumstances that have caused this. In addition, it is not certain that banks actually use the freed-up liquidity for investments in the economy. The risks of this policy in the sense of the evaporation of pension funds and savings are also insufficiently recognized.

What’s next?

The euro zone Member States will have to ensure their own financial bookkeeping, so that the debt levels remain low. Janssen foresees that this will not be sufficient for the future. In the long run, an expansion of the monetary union into a political union is inevitable.

The EU was designed as an answer to nationalism. The euro has delivered what it promised, but the mistrust has not subsided. The mysterious attitude and opaque decision making of the ECB is partly responsible for this. According to Janssen, neo-nationalism is therefore the biggest threat to the EU. He denounces the fact that neo-nationalists trivialize the Union's interconnectedness. In addition, their appeal to the sentiment of the past is unjustified. One only need think back to the Parisian student revolt and know what kind of financial and economic instability that caused for France.

The future will show whether there will be political will to deal with the current problems. Germany and France seem willing to roll up their sleeves and work towards a further European unification; the position of the Netherlands is however still somewhat unclear in this respect.

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