The euro dropped further against the dollar on Monday, as fears grew that Portugal would soon follow Ireland down the path to an enforced bail-out. With Spain and Belgium also suffering, the time is right to consider a radical rescue option: creating a parallel currency system in Europe.
The idea is simple: uncompetitive countries, such as Portugal, would retain the euro for certain appropriate transactions but would at the same time recreate their national currencies, which would take part in a managed float against the euro. This would maintain the euro as a force for integration in Europe and the second most important world currency. But it would allow weaker European countries to regain some measure of competitiveness by establishing units of account in the old national currencies, effectively bank accounts denominated in national currency to be used for trading purposes.
Europe’s monetary union is beset by numerous problems: excessive debts and budget deficits, members facing default, weak banks, and the need for support packages that may be too onerous for the taxpayers of Germany and other creditor countries. Yet at the root of these difficulties is a lack of competitiveness among southern and western peripheral economies. Germany has virtuously succeeded in holding down costs and improving productivity, but other member countries have progressively faced losses of competitiveness of up to 20 per cent.
In a single currency there is no way that this can be cured, except by relatively high inflation in Germany and the other lower-cost countries, or depression in the uncompetitive countries. Neither outcome is desirable. The third option – breaking up the euro – would also be highly unpalatable from a political and economic point of view, as well as technically difficult to achieve. But while a new parallel currency comes with some technical difficulties, it would resolve the challenge of uncompetitive economies and preserve the euro intact.
The proposal would not involve the physical recreation of notes and coins, at least at the outset; the euro would continue to circulate as legal tender in all members of the euro area. At the same time, a managed depreciation of national currencies in uncompetitive states would follow the initial fixing of parities against the euro. Some may also see parallels between this solution and the so-called “hard ecu” plan, put forward by the British government during the run-up to the Maastricht treaty in December 1991. Under this plan European countries would have formed this parallel currency as part of an evolutionary process towards Emu. The transition today would be more difficult than the one postulated in 1990, but the costs would likely be smaller than the costs of proceeding with the present set-up – especially given a series of ad hoc solutions put together by politicians in 2010 did not succeed in damping the fundamental tensions at the centre of the system.
The new system would be devised in a way likely to minimise shocks. The European Central Bank, in consultation with euro area central banks, would manage the euro in such a way that none of the new national currencies would be allowed to appreciate against it. If and when the national currencies reached parity with the euro for an agreed period of time, the countries concerned would be in a position to rejoin the euro as fully fledged members. At least for an initial period of one year, the euro would remain the budgetary currency in which all governments would be obliged to tax and spend. Existing euro debts to foreign creditors would have to be honoured in euros and this would provide a strong disincentive against loose economic policies.
The plan would not be pain-free and some of the countries issuing national currencies could still have to restructure some of their debt. However, it would reduce the bail-out amounts required from the stronger European economies; both creditors and debtors would thus have a powerful incentive to make it work. Most importantly, the plan would preserve the euro, correct current market dislocations, and create a re-adjustment process for the re-integration of weaker economies: all essential ingredients for restoring trust and confidence in Europe.
The writer was UK permanent representative to the EC, 1979-85. He chaired the City European Committee, which proposed the idea of the “hard ecu”. The full article will be published in the January edition of the OMFIF Bulletin