The New York Times

June 9, 2005

Europe's Latest Economic Scapegoat: The Euro


PARIS, June 8 - Is the euro in danger of dying before it reaches its seventh birthday?

A suggestion by Italian cabinet ministers that the country hold a referendum on withdrawing from the common currency drew denunciations from much of Europe, as finance ministers met in Luxembourg this week. But the fact that they were discussing the issue at all highlighted the notion that Europe's common currency is taking part of the blame for the Continent's economic woes.

Few, if any, think the euro will stop being the legal currency of much of Europe. But after French and Dutch voters stunned the political establishment by rejecting the proposed European constitution, those opposed to other European institutions have been emboldened.

"It is just inconceivable that a country could envisage dropping out of the euro," said Jean-Claude Juncker, the Luxembourg premier and current president of the European Union. Hans Eichel, the German finance minister, said the very idea of a country withdrawing was "nonsense," and Pedro Solbes, the Spanish economy minister, called the common currency "irreversible."

The row was started when two Italian cabinet ministers from the Northern League, which is tenuously allied with Prime Minister Silvio Berlusconi, suggested a referendum on returning to the lira. Mr. Berlusconi did not endorse the idea, but neither did he denounce it. For the last year, he has said the blame for many of Italy's economic woes lies with the European Central Bank, for keeping interest rates too high and for allowing the euro to gain against the dollar.

Nostalgia for national currencies has risen in the last year as European unemployment has remained stubbornly high and growth has trailed that of the United States and Asia. A poll taken late last month by the Forsa organization for Stern magazine found 56 percent of Germans preferred to return to the mark. The magazine said the margin of error was three percentage points.

On one level, the euro has been a great success. Travel among the 12 countries that use it is far easier, and companies in those countries can contract with others knowing there is no currency risk involved. The euro was officially created at the beginning of 1999, but actual euro coins and bills did not become legal currency until the beginning of 2002.

But economic integration of the euro zone has not come as rapidly as some had hoped and that has created stresses. "You cannot succeed over any length of time with one monetary policy and 12 fiscal policies," said Robert Barbera, the chief economist of ITG Inc.

Europe tried to finesse that fact with an agreement that no government using the euro would allow its budget deficit to exceed more than 3 percent of gross domestic product, but in fact a number of countries have exceeded that limit. Rather than levy fines, as was envisioned, the response thus far has been to weaken the rule while encouraging countries to do better.

To the extent that Europe does pursue excessively easy fiscal policies, the response would probably be a weakening of the currency, as has happened in recent weeks. That has aroused concern in Europe even though some, including Mr. Berlusconi, have been loudly calling for a weaker euro for many months.

When the euro was being designed, some economists forecast that European countries would be forced to liberalize their economies because devaluation within the euro zone would be impossible. In that context, liberalization refers to making an economy more flexible, with workers easier to hire and fire. Most European governments have tried to follow that prescription in one way or another, but anger from voters and unions has forced retreats, and in some countries liberalization has become very unpopular.

Before the euro was cast in stone, Italy periodically allowed its currency to depreciate against the German mark. Such devaluations were often turbulent, and were accompanied by pledges that it would not happen again. But they served to allow the Italian economy to regain competitiveness with other European economies where inflation was lower and productivity growth greater. Since the euro was introduced, those trends have continued, but devaluation is out of the question. Italy is now in recession.

Blaming Europe for national problems has happened in countries besides Italy and pressure has been growing on the European Central Bank to lower its short-term interest rate, now at 2 percent. Jean-Claude Trichet, the president of the central bank, has backed away from statements ruling out a rate cut, though he has not endorsed one.

Lower interest rates might help stimulate European economies, and a lower euro could help exporters, but neither would address issues of Italy's competitive position with other parts of Europe. Its position has also been hurt because some of its traditional industries, like textiles, have been damaged by Chinese competition.

It is not clear how Italy, or any other country in the euro, could withdraw if it wished to do so. The Maastricht Treaty that established the currency has no withdrawal provision.

If a country were to insist on withdrawing, presumably it could. But there would be the risk of higher interest rates and a greater reluctance of foreigners to invest. There would also be issues of whether debts contracted in euros could be converted to national currencies that might then depreciate against the euro.

For now, it is unlikely that talk of countries getting out of the euro will advance very far. But the talk highlights that the financial unification of Europe is a work in progress, one that has not advanced as rapidly as its advocates expected.

"We are proceeding too slowly," Mr. Trichet said this week in Beijing, where he was attending a conference of central bankers, "but we are proceeding with unifying the market."