FRANKFURT -- Forget the happy promises made by European politicians and corporate titans.
Operating a single currency is not going to be easy. European economic and monetary union will not function without hitches. Indeed, signs of stress have already appeared. And these political, economic and social pressures will almost certainly intensify in the years to come.
But EMU failure is a topic generally avoided in Continental Europe. And for good reason. The collapse of monetary union would almost certainly slam the
into political chaos and the world into financial crisis.
"It would be almost as bad as a war in Europe," says Uwe Angenendt, chief economist at
The optimists contend EMU failure is not possible. They fervently insist that the political will in Europe for monetary union is simply too strong to allow it to fail. But they are naive and ignoring a simple fact of logic: European politicians concocted monetary union, and therefore they can unconcoct it.
Some think the chances of EMU disintegration are highest before euro notes and coins go into circulation Jan. 1, 2002. Others say, no, it would take more time for pressures to reach the explosive levels necessary to burst apart EMU.
Whoever is right, here are a few of EMU's weak points.
One Size Does Not Fit All
The prime requirement for EMU -- one key interest rate for all 11 nations regardless of divergent economic cycles -- is potentially its most dangerous fault line. The
European Central Bank
has said it will set its key interest rate at a level for average Euroland economic conditions.
You don't have to be a chief economist to figure out that the right key interest rate for the majority of Euroland, expected to grow at just over 2% next year, will not be right for Ireland, seen growing nearly 7%. The only way for Ireland to adjust would be through tough fiscal tightening.
An even bigger problem will come when most of Euroland is humming along with solid growth, but, say, Ireland and Portugal are sliding into recession after their booms have gone bust.
The two nations would suffocate under the ECB key rate and would not be able to devalue currencies as in the past. Fiscal stimulus also would be tricky because of the
Stability and Growth Pact
, which was demanded by the Germans as an addition to the
. Germany was worried that once inside the EMU door, some nations might relax efforts to cut deficits.
The pact calls for automatic fines for nations whose deficits rise above the 3% Maastricht limit, although the rules are relaxed if a nation slips into recession. But as soon as the recession is over, the nation is expected to cut the deficit back below 3%. Cynics think the stability pact was devised by German politicians for home consumption and believe it most likely will never be properly enforced. "I think it is worth almost nothing," says Adolf Rosenstock, economist at
Money to Burn
A big fear is that euroland nations, after years of fiscal penny-pinching to gain entry into EMU, will now go on wild spending sprees. Central bankers have threatened to fight fiscal irresponsibility with tight monetary policies to protect both euro stability and low inflation.
Some economists maintain that if only one or two nations overspend, peer pressure would quickly force them back to fiscal responsibility. The worst-case scenario would be deficit spending by a majority of euroland nations. And chances of this happening have grown after left-wing electoral victories in Germany and Italy, whose governments are now more in line with the Socialist government of France.
With former conservative German Chancellor
now gone after his September election defeat, left-wingers across Europe now feel free to show their true colors. Their standard bearer is German Finance Minister
, who has unnerved many with his Keynesian, demand-push proposals and mutterings about tax harmonization.
Official forecasts put the 1999 deficits of France and Germany just below 2%, but some economists say this is wishful thinking. They contend the combination of an economic slowdown and increased government spending makes deficits around 2.5% more likely, with risk of near 3% quite possible.
Many Germans did not want the Club Med nations of Italy, Portugal and Spain allowed into Club Euro. The fear of Italy, with its large economy and history of huge deficits and political instability, was especially acute.
Rosenstock, of Nomura, thinks Italy could be the first nation to test EMU cohesiveness. "And this test might come sooner than we think," he warns.
He believes Italian growth is at risk of slowing at least to 1% next year from this year's tepid 1.6%. If correct, that would mean Italy in 1999 would experience at least a technical recession, which is defined as negative real growth for two quarters in a row. This could spark a "wholesale move out of Italy" by European investors, he warns.
If tensions rise and economic conditions get really bad, a country like Italy may choose to opt out of EMU so that it can devalue and release itself from strict fiscal constraints. If one goes, others would almost certainly follow in the crisis such an action would create.
The Pols vs. the Bankers
While plenty of fault lines exist between nations, one huge crevice is opening up between elected politicians and the bankers at the ECB.
Bad blood has already arisen between politicians and Euro central bankers. In response to the politicians' demands for rate cuts, central bankers have -- in essence -- told them to keep quiet and work instead on cutting structural deficits and reforming labor markets.
Gabriel Stein, senior international economist at
Lombard Street Research
in London, says that a tight ECB monetary policy might prompt politicians to turn to deficit spending in order to court the voters. This could turn into a vicious cycle, with central bankers retaliating by raising rates.
"The politicians might eventually say, 'We can't work with these guys,'" Stein says. The biggest risk would be a revolt by politicians and revision of the Maastricht Treaty, which would raise market fears of a central bank controlled by big-spending politicians.
Yes, the ECB is independent. But ultimate power rests with the politicians, who could rein in an independent ECB with one flick of a revised Maastricht Treaty.
Germany Renounces the Faith
Pundits often worry about the Club Med nations like Italy leaving the eurozone. But it's not inconceivable that a rich country might choose to leave.
Take Germany. True, discontent among the German people over EMU would have to be overwhelming to persuade the country's leaders to opt out of the euro. Being part of the single currency is at the very center of Franco-German efforts to keep the postwar
in place after Germany's reunification.
However, remember that Germany is giving up the mighty deutsche mark for EMU, and thus, arguably, has the most to lose. Former Chancellor Kohl, knowing this, forbade an EMU referendum, fearing Germans would vote against joining. If the euro turns out to be weak and budget deficits excessive, expect the Germans, still haunted by post- and inter-war hyperinflationary crises, to start fretting whether they should ever have joined EMU in the first place.
And coming from the opposite viewpoint, some think Germany, despite its economic might, will find it more difficult to adapt to EMU than the Club Med nations.
Per Hviid, deputy chief economist at
Den Danske Bank
in Copenhagen, says Germany's highly regulated and expensive labor market, high tax rates and generous spending programs will be jolted hard by EMU. "Of the EMU nations, Germany's economy probably has the most structural problems," he says.
That's why, at the first whiff of widespread German discontent with EMU, investors should liquidate their euro portfolio immediately.
Our advice? Seek a less risky investment option, like Russia or Indonesia.
This story was originally published on Dec. 10.