Euro still vulnerable 20 years later

WASHINGTON — On its 20th birthday, the best that can be said of the euro — the European currency used by 19 countries — is that it has survived. Two decades after being introduced in 1999, it has not achieved its central goals: increasing economic growth and strengthening public support for European political institutions.

In many ways, just the opposite has occurred. The economy of the eurozone (all the countries that adopted the euro — Great Britain and some other nations declined to join) still lags the United States in growth. For 2019, growth is forecast at only 1.6 percent compared with 2.6 percent for the United States.

Even worse, the contentious negotiations over rescuing the eurozone’s weaker members — Greece, Spain, Portugal and Italy — have left a bitter aftertaste. Debtor countries feel they were treated badly by the wealthier creditor countries, particularly Germany. Meanwhile, the creditors resent having to bail out their poorer neighbors. Animosities remain.

All this looms over Europe’s present political crisis, its rising populism, its anger over immigration and the conflict over Brexit. Another euro crisis — a clear possibility — would make things worse. Italy seems especially vulnerable, with little economic growth and government debt at about 130 percent of its gross domestic product, notes Rebecca Patterson in a report for the Bessemer Trust, a financial services firm.

The euro’s appeal was simple. Eliminating separate currencies for the European Union’s member countries would reduce the nuisance of money conversions, promote stable exchange rates and stimulate trade. Faster economic growth would make the case for more centralized control — a more powerful EU.

At first, things went well. Interest rates dropped sharply, especially for weaker borrowers. In January 1999, rates on Italian 10-year government bonds were virtually the same as rates on similar German bonds, although the German economy and its repayment prospects were much better than Italy’s.

By contrast, Italian interest rates had been much higher before the euro (the gap, or “spread,” between German and Italian rates was 5 percentage points in early 1995). Other debtor countries got similar relief from higher interest rates.

The apparent justification for the lower rates was this: Investors believed that the discipline of a single currency would force many poorer EU countries to improve their economies; and — less optimistically — if they got in trouble, they would be bailed out by others. So the risk of lending had declined; more could be lent.

The result should have surprised no one. “There was a credit boom,” says economist Adam Posen of the Peterson Institute. German, French, Dutch and Belgian banks lent to Greek, Spanish, Italian and Portuguese borrowers. Money flooded into Greek bonds and Spanish real estate.

Everyone was happy. Greece, Spain and other debtors enjoyed the pleasures of easy money. Germany and other creditor nations benefited from strong exports, which in turn were ultimately financed by loans from these countries’ banks.

The trouble was that the creditors overlent and the debtors overborrowed. America’s 2007-09 Great Recession was fatal. Its side effects, including a steep fall in global trade, hurt many European borrowers and lenders. Some lenders were unwilling or unable to renew their loans. There were “sudden stops,” as Posen puts it.

To stay solvent, borrowers had to get government credit (from central banks and international agencies, such as the International Monetary Fund) or cut spending and raise taxes. It was here that the toughest negotiations occurred, as lenders and borrowers argued over terms.

One possible solution was for debtor countries to abandon the euro and revert to national currencies — and to do so at conversion rates that favored borrowers. This didn’t happen, though there was much speculation that it might. Almost everyone agreed that ditching the euro would have involved hugely difficult legal, political, operational and moral issues.

Still, it was a possibility. If a few countries had jettisoned the euro, what would have happened? Nothing? Many countries doing likewise? A deep global recession? None of this occurred, in part because no one could confidently answer these questions. Another reason is that the euro remains popular at home. By one survey, 74 percent of euro users support it. People favor the euro, though not the measures needed to make it workable.

In the end, the European Central Bank bought 2.6 trillion euros’ worth of bonds (nearly $3 trillion at present exchange rates) to prop up the currency, after Mario Draghi, president of the ECB, pledged in mid-2012 to do “whatever it takes” to save the euro.

The story continues. “Eventually, we’re going to have another U.S. recession,” says Patterson, author of the Bessemer Trust report. Then we’ll see whether Europe’s governments, banks and businesses can withstand the pressures created by high debt and low economic growth — and whether the euro can still survive.

Robert Samuelson is a columnist with The Washington Post.