sign up log in
Want to go ad-free? Find out how, here.

Oliver Hartwich argues the Eurozone crisis started on the day the Euro currency was introduced

Oliver Hartwich argues the Eurozone crisis started on the day the Euro currency was introduced

This is the seventh chapter of eight covering Oliver Hartwich's essay "Why Europe Failed", an analysis of an ageing Europe, burdened by the size of its welfare state. He draws cautionary lessons for New Zealand's policy makers. You can read the full version here.

This seventh section is titled "The Euro fallacy". Part I is here. Part II is here. Part III is here. Part IV is herePart V is here. Part VI is here.

By Oliver Hartwich*

A discussion of Europe’s problems would not be complete without a look at the failings of Europe’s monetary union. When we talk about the euro crisis today, we immediately think of Greece, which has been on the brink of default since late 2009. However, the euro crisis is not just a crisis of Greece.

In Europe’s monetary union are all the hallmarks of Europe’s integration failings. Monetary union was a project designed by Europe’s elites against the wishes of their peoples. It was a political power play designed to weaken Germany (only to see it strengthened). Finally, it was an undertaking that has damaged Europe’s economy and competitiveness.

To understand how Europe’s monetary union happened, it is worthwhile to remember what Europe looked like before the introduction of the euro. There had always been structural differences between Europe’s economies. Before the euro, such differences in competitiveness were reflected in long-term adjustments in exchange rates. However, such devaluations were considered a sign of weakness and a national embarrassment, and were unpopular in the countries that had to devalue.

Consider this: In the 35 years before the introduction of the euro, all major European currencies progressively lost value against the Deutsche Mark. In 1963, DM81.36 could buy 100 French francs compared to only DM29.82 on the eve of the euro’s introduction on 1 January 1999 – a devaluation of 63.3%.

It was even more extreme for the Italian lira. In 1963, 1,000 lire cost DM6.41 compared to only DM1.01 in 1998 – in other words, the lira had lost 84.2% of its value against the Deutsche Mark.

Similar developments occurred against the Greek drachma, the Portuguese escudo, the Spanish peseta, and other currencies.

The massive devaluations of other currencies against the German Mark indicate the very tight monetary policy of the old German Bundesbank and the high competitiveness and productivity of the German economy compared to the rest of Europe.

European economies like Italy, Spain and France thus regularly devalued their currency to remain competitive with Germany. It was humiliating for the French, the Spanish and the Italians – the very reason they had pushed Germany into monetary union backfired spectacularly on them.

Germany had resisted monetary union since it was first proposed in the 1970s. However, it needed the support of its neighbours for its reunification project after the Fall of the Berlin Wall in 1989, and France used this leverage to push Germany to relinquish the Deutsche Mark and adopt the euro.

Germany’s unification was a diplomatic balancing act, which played out in the ‘two-plus-four’ negotiations (between the two German states and the four allied forces – Britain, France, the Soviet Union and the US) that paved the way for Germany’s reunification in October 1990.

It was difficult to reunite Germany – not least because the British and the French had to be reassured that they had nothing to fear from this new and bigger country in the heart of Europe.

British Prime Minister Margaret Thatcher was horrified at the prospect of a united Germany. “We beat the Germans twice, and now they’re back,” she allegedly told a meeting of European leaders at the time.19

Thatcher even invited historians to a seminar at Chequers to discuss how dangerous the Germans really were. Her trade minister, Nicholas Ridley, was forced to resign after he compared German Chancellor Helmut Kohl to Adolf Hitler in an interview with The Spectator.

French suspicions of the rise of a new evil German superstate were equally strong, as previously confidential memos released by the British Foreign Office reveal. President François Mitterrand was convinced that the prospect of unification had turned the Germans into the ‘bad Germans’ they used to be. He saw them as behaving brutally in pursuit of their new national interests, thereby upsetting the political and security settings of Europe. In a conversation with then US President George H.W. Bush, Mitterrand remarked, “I like Germany so much I think there should be two of them!”

Tensions were deep between Germany and its neighbours around the time of reunification. Even the Soviet Union was more open to the idea than West Germany’s old allies. France especially needed to be convinced that it had nothing to fear from a reunited Germany.

There had always been rumours that in the ‘two-plus-four’ negotiations, the French had demanded Germany to give up its beloved Deutsche Mark in return for a French ‘oui’ on reunification. More than once, the dominance of the über-solid Deutsche Mark had caused the French and other European nations pain. Forcing the Germans to abandon their currency was thus an appropriate way to weaken them so they could not become a threat to other nations, the French probably thought.

Then World Bank President Robert Zoellick, who was the US lead negotiator in the ‘two-plus-four’ negotiations, confirmed in 2011 that France had demanded the Germans sacrifice the Deutsche Mark. According to Zoellick, the euro currency is a by-product of German reunification and was meant to calm Mitterrand’s fears of an all-too-powerful Germany.20

The great historical irony of this story is, of course, that if the French had really planned to weaken the powers of the newly reunited Germany through monetary union, the plan completely backfired. In strategic terms, Germany’s influence has never been greater. With the continent relying on Germany’s AAA rating, Berlin can now effectively dictate fiscal policy to Athens, Lisbon and Rome – perhaps in the future to Paris, too. This was most definitely not what Mitterrand had planned.

Perhaps an even greater irony is that the Germans are not at all happy with their new hegemonic power within Europe. As opinion polls show, they have not the slightest interest in ruling the European periphery. In fact, the Germans would be content being just a bigger version of Switzerland – prosperous, a bit boring, and vigorously unengaged in international affairs. It is the very role the West Germans learnt to play to perfection between 1945 and 1990. This also means France and Britain had nothing to fear from the Germans at the time of reunification. If they had known the post-war Germans better, they would have been more relaxed about a larger Germany.

As it turns out, the euro started as a French insurance policy against German power. But even as an insurance policy it has failed. Instead, it has turned the Germans against their will into the new rulers of Europe. And it has consigned France to be the weaker partner in the Franco-German relationship.

European monetary union thus has a colourful political history but it has failed to weaken Germany’s economic influence. Unfortunately, that is not the euro’s only failure – far from it.

The euro crisis is now more than five years old. It was in late 2009 when then Greek Prime Minister George Papandreou admitted that his country had a fiscal problem. Many now see this as the beginning of the euro crisis.

The truth is the crisis started much earlier – namely on the day the euro was introduced, first as an electronic currency in 1999 and then as coins and paper in 2002.

To see why the euro was in crisis even then, when many politicians still claim that all was well before the global financial crisis, one needs to look behind the façade of monetary union. It is true that before 2009, few people spoke of a euro crisis, yields on government debt were low, and the exchange rate of the euro was by and large stable. But beneath this seeming stability, something was clearly wrong in European monetary and economic affairs.

The first problem was the divergence in competitiveness, which started immediately after the euro was introduced. Where previously such competitiveness differences would have resulted in exchange rate adjustments, they now resulted in diverging unit labour costs. Put simply, German products became cheaper on the world market, whereas, say, Italian or Portuguese products became more expensive.

The introduction of the euro had kept a lid on wage increases across the German economy because Germany had entered the EU with a too high exchange rate. This led to high unemployment in Germany, followed by dramatic economic reforms, especially of its labour market, and a policy of wage restraint. Both the wage restraint and economic reforms were painful, but combined they ensured Germany became more and more productive and competitive over time. Unit labour costs fell substantially in Germany.

Meanwhile, the southern European economies, who had entered monetary union with the competitive advantage of low exchange rates, enjoyed a sudden economic boom made possible by lower interest rates than they had previously known.

However, the chronic inability of southern European countries to implement the kind of tough economic reforms Germany had meant that countries such Greece, Spain and Portugal slipped further down the European competitiveness ladder. Their products became more expensive, and their governments more indebted. The consequences were substantial deficits in the current account and high unemployment in countries with excessive wage increases.

But these competitiveness developments were not the only thing wrong with the euro. The euro’s official interest rate reflected the circumstances of a struggling Germany but not the boom in periphery countries.

The unrestrained building boom in Spain and Ireland was bound to end in a fiasco. The collapse of the construction sector not only triggered a rapid rise in unemployment but also plunged the banking sector, faced with huge write-offs on related real estate lending, into a deep crisis – with devastating effects on the fiscal situation.

Finally, the euro also failed to impose fiscal discipline on its member countries, so nobody played by the rules that were supposed to govern the monetary union. No country was supposed to enter the EU with debts of more than 60% of GDP – yet Belgium, Italy and Greece did. No EU country was supposed to run deficits higher than 3% of GDP – yet France and Germany did in 2003/04 without being punished.

The political independence of the European Central Bank (ECB) was also damaged right from the start. Its first president, Wim Duisenberg from the Netherlands, had been elected for a full eight-year term. However, political pressure from the French government forced him to resign his position after four years to allow his colleague Jean-Claude Trichet to take over.

Take these three issues together – diverging competitiveness, property bubbles in the periphery, and a misgoverned Eurozone – and it is clear the EU was dysfunctional much before the global financial crisis. In fact, the crisis acted as a catalyst to alert markets to rethink risk – and when they took a closer look at Europe they realised the mess it was in.

If the monetary union did not work well before the euro crisis, it is even worse now.

Since the euro crisis erupted around 2009/10, Europe has witnessed years of bungled crisis management, explicit and covert bailouts, and imposed austerity budgets to enforce ‘internal devaluation’. None of these have managed to end the crisis.

The only thing that has slowed down somewhat is the acute market panic over Europe – but only because markets have become used to a constant flow of bad news from Europe. Europe’s crisis is the new normal, and everybody seems to be accepting it. At least, European policymakers are doing so by proclaiming current policies to be “without alternative”.

It was a mistake to introduce the euro before Europe was ready for it. But it is an even bigger mistake to pretend that this badly designed monetary union must be defended at all cost. It would be far better for the Europeans to cut their losses and give up on the euro.

If Europe continues with its current policies, the result will be disastrous for everyone involved. Forcing crisis countries to continue devaluing internally by cutting wages, pensions and prices will increase their already high unemployment rates. It will condemn their young generations to misery and destabilise their political systems – and there is no guarantee that this recipe would ultimately improve their economic fortunes and make their products competitive internationally. Meanwhile, the financial commitments of those countries underwriting the bailout guarantees will eventually exceed their ability, let alone their willingness, to pay for their neighbours’ economic mismanagement.

Of course, any exit path from the monetary union will be painful for all. But at least there will be hope that once Europe’s countries return to currencies suited to their respective economy, they would be able to generate growth and employment. Breaking up the Eurozone would also help deal with the persistent trade imbalances in Europe, help crisis countries to export more, and make stronger economies such as Germany import more. It would also create a badly needed mechanism of exchange rate flexibility between European countries.

Although the end of the euro’s reign and a return to national currencies may be good economics, it is highly unlikely to happen. Europe’s leaders would lose face if, after decades of propagating the benefits of monetary union, they allowed a new monetary diversity of Europe – as desirable as it may be.

So what’s going to happen next? Is there another solution at all?

Unfortunately, there is no positive solution in sight. Most likely, the ECB will inflate the problems away.

The ECB has been intervening in bond markets since the beginning of the euro crisis, and even more so with its ‘quantitative easing’ programme in early 2015. It is no doubt due to such interventions that the euro is still alive.

This is an utterly absurd situation. Bailing out other countries (and their banks), pooling Europe’s sovereign debt, or issuing Eurobonds may be incompatible with the German Constitution. Such tactics may well violate EU treaty law. They lack any meaningful democratic legitimacy. They are certainly unpopular in those countries most likely to foot the bill.

In theory, such measures should be impossible to implement.

But disguised as monetary policy, these quintessentially fiscal arrangements not only become possible, but they almost look legal. Simply claiming that the monetary transmission mechanism is broken is used as sufficient justification to save the whole of Europe from bankruptcy.

Even better is that while fiscal measures are necessarily limited to the funds countries can raise in taxes or through running deficits, monetary interventions in a fiat money world have no such limitations. They can run for as long as tree trunks can be turned into paper money or zeros added to electronic accounts.

But perhaps the biggest ‘advantage’ of Europe’s current malaise is that not a single national parliament needs to be consulted before the ECB finally opens the floodgates. No European government needs to be involved in the process, and even if opposed to the measures, parliaments and governments have no realistic chance of stopping them.

Of course there is a lot to be said for central bank independence. In the case of the ECB, however, one may well wonder whether its actions are still covered by its independence in monetary affairs or, indeed, whether the ECB has moved into the terrain of fiscal policy for which it is not responsible.

The way Europe is dealing with the crisis of its monetary union is exactly the way it has always dealt with its challenges: in the most undemocratic way imaginable (see also Appendix 2 for an account of the international crisis management around Greece since 2010).

Whether this will be enough to save the euro in the long run is nevertheless a different question. It is often said that if something cannot go on forever, it will stop. The euro is such a thing. It cannot go on forever, and so it will eventually fail. In fact, it would and should have failed already because of its inherent weaknesses. The only reason it is still with us is the political support it still enjoys. But even such political support may turn out to be a weak life insurance.

19. Carsten Volkery, “The Iron Lady’s views on German reunification: ‘The Germans are back!’,” Spiegel Online (11 September 2009), http://www.
20. Oliver Hartwich, “A euro power play that backfired,” Business Spectator (17 August 2011),

Oliver Hartwich is the Executive Director of The New Zealand Initiative. Before joining the Initiative he was a Research Fellow at the Centre for Independent Studies in Sydney, the Chief Economist at Policy Exchange in London, and an advisor in the UK House of Lords. Oliver holds a Master’s degree in Economics and Business Administration and a Ph.D. in Law from Bochum University in Germany.

This is part VII of a serialisation of his essay "Why Europe Failed". Part I is here. Part II is here. Part III is here. Part IV is herePart V is here. Part VI is herePart VIII tomorrow concludes with: "European lessons for New Zealand".  You can read the full version here.

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.


Spot on. Interesting to learn some of the background on how they got into this crazy mess. Thanks Oliver
Fortunately for them, EU members, Croatia, Czech Republic, Bulgaria, Denmark, Hungary, Poland, Romania, Sweden and the UK, did not adopt the Euro. Ultimately it must fail, so they would be far better dismantling it in a controlled manner, rather than continuing with a fundamentally flawed concept that will continue to damage the economies of all involved.


leaving aside Olivers preoccupation with EU failure this article is a great illustration of the power of high productivity and discipline that has typified the German approach. No matter how much jiggery with QE and other financial magical thinking, the fundamental equation of producing more than you consume just pays works for you.
China now, and Japan before, generated surpluses, which they turned into ownership of assets.
As for New Zealand ? Trade deficit since ? 1972 I think. Look where it gets us.


Six degrees of seperation

Doctor Oliver has a doctorate of Law and a Masters in Economics - good - Olivers articles have been written in the form of a thesis - where the foundations are laboriously laid out in the early pages and the conclusions are drawn in the final chapter - A thesis is written to prescription under the supervision of a supervisor who is chosen for their knowledge of the subject and is progressively supervised - the Supervisor knows what the end result should be from the outset - and their job is to ensure the doctoral student arrives at the end result

However, Doctor Oliver and David Chaston

In the world of news and information it works the other way around

The opening chapter is better delivered by presenting the conclusions at the outset and the subsequent chapters set about establishing the facts claimed at the beginning

So, the Six degrees of seperation

Doctor Oliver has set about establishing the frailties and failures of the Eurozone and European union. The final chapter will outline the risks that New Zealand faces in not avoiding similar courses of action

I'm left wondering if that's an indirect way of delivering a serious message that his pay-masters may not want to hear

It has been very interesting - so far - can't wait for the final conclusions