Fixable flaws

The European monetary union has suffered from a faulty design from the start. It was clear to the architects of the eurozone that a common currency could only function properly if the participating national economies performed similarly. But the convergence criteria that were meant to ensure members were on an equal economic footing before joining the eurozone were insufficient and therefore ineffective. The criteria established in the Treaty of Maastricht were selected haphazardly, and only covered factors like inflation, long-term interest rates, annual public deficits, and the total debt situation of the entry candidate.

For that reason, misguided development was pre-programmed. Mediterranean countries with weak currencies were given the possibility to shoot for a bull's-eye: At the time they adopted the euro, they more or less fulfilled the criteria. Certainly, a blind eye was turned in some cases, and at least one country manipulated their books – but the main thing was they made it into the eurozone. After that, they were free to revert to fiscal carelessness.

Even worse is the fact that the convergence criteria didn't mention anything about the structural strengths and weaknesses of a country, let alone its competitive capabilities in international comparison. Admittedly, these factors are difficult to quantify, and they don't lend themselves well to being tracked in an index. But they should have been taken into consideration in one way or another when deciding whether a country was suitable for eurozone membership or not.

Misguided ambition

That's how structurally-weak and uncompetitive countries secured their place in the eurozone, and didn't do themselves any favors in the process. Quite the contrary, in fact: While weak nations enjoyed a small economic boom fueled the lower interest rates of their northern European neighbors, they only hurt themselves in the long run. The longer the monetary union existed, the more obvious their structural weaknesses became, and the gap separating them from disciplined eurozone countries only grew. In the past, this wouldn't have been so tragic - the Greek drachma and the Portuguese escudo could have been devalued in small steps. But that wasn't possible anymore because the various nations shared the common currency called the euro.

Politicians aren't ready to answer for these fundamental flaws. They are treating the symptoms, bogging themselves down in less important arguments like the role of US-based credit rating agencies, buying themselves time with bailout packages - without addressing the basic problems. A complete overhaul of the monetary union is by all means possible, albeit only with definitive and radical changes.

First, the creditors would have to allow a reduction of debt. The opposing argument that such a move would cut Greece and Portugal off from the capital market doesn't hold because those nations are already unable to borrow cash. The banking system won't collapse either, because most banks have already sold most of their risk - to the European Central Bank (ECB).

A buyout

The virus doesn't necessarily need to spread to countries like Spain, Ireland or Italy as long as the aim of the overhaul is made clear to the market from the get-go. The second step, would be to gather enough money to buy Portugal and Greece out of the euro. In other words, use financial means to soften the blow of the devaluation that would follow if the drachma and escudo were brought back.

At the end of this process, a healthy and strengthened monetary union would remain. It would then have to perform the third crucial step of creating an overarching institution that would issue euro bonds. These bonds would be connected to the average interest rate of the remaining member nations.

"We'd have a real emergency brake for debt," says ECB board member Lorenzo Bini Smaghi, adding that if a country's debt begins to reach its limits, it would either have to consolidate its debt or ask the European stability mechanism to finance the difference – a move that come with strict conditions.

The trouble is, the creation of a common euro bond would make raising capital more expensive for disciplined nations like Germany than it currently is when they go it alone. Weaning German Finance Minister Wolfgang Schäuble off cheap debt will be easier said than done.

Author: Rolf Wenkel (mz)
Editor: Sam Edmonds