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Analysis & Opinion
28.05.10 Is The Euro Dead And What Does That Mean For Russia?
Introduced by Vladimir Frolov

Contributors: Vladimir Belaeff, Ethan Burger, Vlad Ivanenko, Alexander Rahr

With Greece barely saved from a sovereign default by a massive bailout package from the EU and the International Monetary Fund (IMF) and other euro-zone member states like Portugal, Spain, Ireland and Italy teetering on the brink of bankruptcy, the euro, this marvel of the European integration, is hanging on for its life. Some observers say its days are already numbered. But how will the downturn be felt in Russia, for which the EU is a key export market?

The euro has dropped 18 percent against the dollar since November 25 because of investor concerns that policy makers may fail to contain Europe's debt crisis. Even the creation of the 750 billion euro emergency assistance fund, arduously negotiated by EU leaders in early May, did not calm down the markets, while Germany’s Angela Merkel and France’s Nicolas Sarkozy’s clumsy musings on the possibility of leaving the euro zone have only thrown additional meat to the “wolf pack” of global hedge funds now shorting the euro.

It is clear that the euro’s problem is the euro zone itself, where member states ceded control of their monetary policy to the European Central Bank (ECB) while retaining their sovereign control over fiscal and budgetary policy. This has led to excessive government spending and sovereign borrowing to finance it by some of the EU states, now known as PIIGS (Portugal, Italy, Ireland, Greece and Spain). Now, with the economic downturn cutting into government revenue, those nations have found themselves unable to refinance their debt on international markets. Being part of the euro zone, they can’t solve their debt problem through devaluation and are being forced into harsh austerity measures to cut soaring budget deficits.

The deficit crisis that threatens the euro has also undermined the sustainability of the European model of social welfare that provides generous cradle-to-grave social services to the population by “tax and spend” European governments. This is taking the luster out of the European model that sought to combine capitalist efficiency with socialist protections. The crisis is changing the mood both in nations across Eastern Europe and in Russia with regard to membership in the European Union (one exception is Estonia that is sticking to its plans to join the euro zone in 2011).

It is almost certain that the tightening in debt markets and mass investor desertion of government debt from the PIIGS nations will lead to a slowdown in a European economic recovery that has barely come out of the last recession.

Europe is the most important customer for Russia's energy and commodity exports. A major downturn in revenues from these will quickly be felt in Russia's current account and budgetary position. Another key factor is that the EU is a major provider of many products that Russia imports. The devaluation of the euro against the ruble – the rate has dropped from over 43 rubles to one euro to less than 38 to one in under two months – means that those exports are now more competitive against domestic products.

With markets pricing in a wider contagion, Russia could be affected by a return to recession after barely climbing out of the deep slump of 2009.

Are the euro and the underlying European project dead? Will the measures taken by the EU and the affected countries be enough to avert the collapse of the euro zone? Has the idea of a monetary union and a single European currency lost its appeal and can a monetary union function without a unified budgetary and fiscal policy in the EU? Will the euro crisis force the EU into more integration, including political integration, or will it lead to its unraveling? Can the EU survive without the euro zone? What are the implications for Russia? What are the implications for Russia’s plans to introduce a single currency for the Customs Union with Belarus and Kazakhstan? Will Russia slide back into a recession, were Europe to experience a protracted period of stagnation and deflation? Are there ways for Russia to avoid a repeat of the economic slump? How would the euro crisis affect Russia’s relations with the EU and the upcoming Russia-EU summit in Rostov next week?

Alexander Rahr, Director, Russia and Eurasia Program, German Council on Foreign Relations, Berlin:

That the political EU may be dead became obvious already five years ago, when Holland, France and Ireland rejected the Lisbon Treaty. The Treaty was then adopted in 2009 under questionable and manipulative circumstances.
What is dead and what is not dead? The euro is not dead. If the present euro zone collapses, hard-core Europe will survive as a smaller entity by getting rid of the PIIGS states. EU enlargement is dead. That is particularly bad news for Ukraine, Serbia and Turkey.

What else is dead? Probably Russia's entrance into the World Trade Organization. To defend itself from an increasingly weak euro, Russia will sharpen its protectionist tools.

The liberal economic model, which had supposedly won the Cold War, is dead. The present situation cannot continue in the way in which financial institutions and speculative capital dictate policy to governments.

The glorious social-welfare system which good old Europe was so proud of is dead. There is simply no more money to keep things running as before.
What else is dead? Probably development aid for Africa and other poor parts of the world. China will soon wield more influence in Africa. That will make China's rise to the status of second strongest superpower perfect.

What seems not to be dead is the former Soviet Union. The chances for serious reintegration policy on the post-Soviet space have never been so good.

The European belief in the United States as the world's ultimate leader is probably dead. The world will not sink into chaos as in the economic crisis 100 years ago, but the world will also be unrecognizable from today's in five years.

Vlad Ivanenko, Ph.D. in economics, Ottawa, Canada:

It is too early to measure the importance of the current assaults on the euro. Markets tend to be more volatile than underlying economic fundamentals in general and, besides, the EU has already introduced measures sufficient to render such assaults ineffective. An additional consideration that goes in favor of the euro is the fact that the world does not offer a better store of value. All other contenders for this role – be it the U.S. dollar, gold, or crude oil – are not particularly safe either. The lack of certainty is reminiscent of an episode from the play “The Shadow,” written by Russian playwright Yevgeny Schwartz in 1940. There the finance minister announces that domestic “business circles” have transferred all their gold abroad fearing political uncertainty at home and reassures the concerned prime minister that there is no reason to worry about the shortage: foreign business circles have their own troubles and are sending their gold in the opposite direction.

The implications of discord between the united euro zone monetary policy and its poorly coordinated fiscal policy are more disconcerting. Certainly, this is a period after which the EU will have to make a crucial decision either to split or to bring national economies closer. The emerging tendency is for the northerners to agree on bailing out their more profligate southern brethren in exchange for aid being conditional on giving the EU fiscal control over national public expenditures. Whether the Greeks and, later, the Portuguese and Spaniards will agree to lose an essential part of their fiscal autonomy or whether they will rebel against the north remains to be seen. By providing loans with few strings attached, the north does buy time, but there are nonetheless clear limits to this generosity.

Regarding the hypothetical currency union of Russia, Belarus, and Kazakhstan, all the decisions that the euro zone members are going to make will be educative. One should not forget that the EU is a unique political experiment that involves the construction of supranational layers of governance through voluntary concessions of power by national governments.

Among early lessons offered by EU monetary policy, the divergence of views indicates the need for better policy coordination. The haste with which the French have arranged the rescue package – that is, paying for matured Greek debt at face value – contrasts with the unilateral German decision to impose limits on short selling. This division amounts to a cardinal disagreement on the nature of the current predicament in the euro zone. Paris believes that the EU has a responsibility to provide insurance for its members in times of trouble, whereas Berlin thinks that sovereign bond markets should pay the price for being reckless creditors as well. Personally, I tend to concur with the German approach because in my opinion, modern financial markets contain a significant element of gambling-type activities. By separating financial “casinos” from markets for long-term investment, the German approach will reduce unnecessary volatility in markets.

The second lesson relates to the emerging realization that the center should gain more power at the expense of national capitals. It becomes evident that Athens and other southern capitals did not realize that by signing up to the euro they accepted limitations that went against their own deep-rooted cultural traits. The peoples populating the Mediterranean region, on average, consider local communities to be the locus of their economic wellbeing. For them national capitals are as foreign as Brussels and the rest of the world in general. “Why should we suffer for the problems that we do not consider our fault instead of sharing the costs with our European neighbors?” thinks an average southerner resisting the imposition of austerity measures. Likewise, Berlin and other northern capitals underestimated the appeal of the “beggar thy neighbor” response – not a valid argument in northern European cultures – in the south. The importance of this lesson for Moscow is limited, as Russia has deliberately excluded former Soviet republics other than its culturally closest neighbors from the integration program. Thus, EU problems related to cultural heterogeneity are less likely to repeat themselves in the Eurasian project.

Ethan S. Burger, Adjunct Professor, Georgetown University Law Center, Washington, DC:

While the economic benefits of the European Union having a single currency were potentially huge, the idea that sovereign countries would forfeit their rights to determine their own fiscal policies was politically naive. The day of reckoning seems to have arrived. It is no coincidence that David Cameron is Britain’s new prime minister (not that his country does not face major economic problems).

The euro survived to this point only because Germany and to a lesser degree France never required fiscal discipline of their other EU members. The euro had an “Alice in Wonderland” quality: rules were promulgated, but neither observed nor enforced. The existence of the EU meant that the German economic and political dominance of the continent would be politically palatable to the continent’s other countries, particularly France.

The decline in the euro’s value illustrates just how interconnected the largest of the world’s economies have become, as well as Europe’s dependence on Russia for a large share of its energy needs. It is not clear whether the EU having a single currency is viable or desirable at present or in the future. As the European population ages, the tax revenue needed to maintain the current government-provided social programs is inadequate. Furthermore, it is not clear whether political stability can be maintained with today’s high levels of unemployment throughout the EU.

If the euro continues to decline, it is worth considering whether EU countries will be able to continue purchasing energy from Russia or invest in its modernization. The need for European energy conservation will increase. If the euro continues its downward trend, will its banks cease lending abroad or call in its loans? If this occurs, what will the consequences be for Russia and the developing world? A decline in the value of the U.S. dollar may stimulate exports so long as other currencies hold their value or appreciate.

If the EU and U.S. economies do not bounce back, raw material suppliers like Australia, Canada and Russia will see the volume of their exports fall and a decline in the price of the commodities they sell. The same is the case with the demand for imports from China and other Asian countries. Consumption of goods will decline as their costs get higher,as greater efficiency in production is unlikely to lead to significant reductions in the real price of goods. In contrast, those exporting food and medicine will see less shrinkage in their markets.

If a single currency is unsustainable for the EU, in large part due to the disparate interests of its members, it is questionable that plans to introduce a single currency in Belarus, Kazakhstan, Russia and possibly Ukraine could succeed given the lower standard of living in these countries. If Germany could not sustain the EU’s weaker economies, is it conceivable that Russia could do the same with respect to its neighbors? I doubt it.

At the forthcoming Russia-EU summit it will become clear that there is no magic economic solution. The only silver lining to the situation in my eyes is that due to economic inter-dependence, there will be enhanced efforts of the countries at the gathering to resolve their political differences. I hope that those politicians who see international politics as a zero sum game will be discredited in the eyes of their electorates.

Vladimir Belaeff, Global Society Institute, Inc., United States:

Those currently voicing concern about the future of the euro (and by extension of the EU itself) can be divided into four categories.

Firstly, there are the sincere economic analysts who examine (with varying degrees of objectivity) econometric parameters of their choice (selectivity is quite common) and attempt to forecast the future of the euro.
Second come the speculators who make money from volatility in equities markets and from the short-selling of securities and derivatives – profits in short-selling happen only when the subject security drops in market price. Speculators are interested in attacking the euro to push its price down artificially, to make good on their short positions. They need to stimulate very pessimistic views of the euro, the EU and the so-called PIIGS, of which only Greece is in a recognizable financial crisis.

Third are doomsayers about the EU and the euro for reasons that are not primarily economic but geopolitical.
Fourth are the “commoners-in-economics” – the laypersons and amateurs who may feel a mildly perverse frisson from engaging in a kind of econometric Schadenfreude directed at Europe. The motives of this category are diffuse and generally pedestrian – many of such doomsayers may simply envy that the EU was well on the way to economic recovery from the Great Recession of 2008 to 2009 before the news that Greece had been “cooking its macroeconomic books” for quite a while.

Therefore, it is not at all clear how much of the current pessimism about the euro is based on reasonable and genuine econometric observation (by the first category mentioned above) and how much is due to the various self-serving reasons of the other three categories.

When established, the euro was to be valued at parity (one-to-one) with the U.S. dollar. Despite all the negative talk, at the time of writing the euro is still valued at a premium of about 20 percent over the American currency. And the drop in the euro’s value is an important stimulus for the growth of European exports and foreign earnings.

Those who propose the dismantling of the euro system as a result of the current crisis probably have not analyzed in full how complex this dismantling process would be and what kind of a shock to the global economy the result of such a collapse would be. One could argue that after so much time, the dismantling of the euro is not viable and would have economic consequences equivalent to a world war, except that in this case all societies, including the United States, would be severely damaged (America’s economy was the only one in the world that profited from both the First and the Second World War). It is clear that governments understand this, and on this basis alone there is broad support for the euro – even from such rivals in smaller matters like the IMF.

The economies of advanced societies are “definitionally” global and interlocked. Russia would be harmed by a collapse of the markets to the west of its frontiers – but so would the United States and all the large and small trading regions of the world.

The reluctance that some countries have demonstrated regarding their accession to the euro zone is not necessarily due to a lack of confidence in the euro. The current crisis is a catalyst for a new regime of economic supervision in the EU that weaker countries will not be able to endure, so they now act like “sour grapes.”

The European model will hold. There is nothing wrong macroeconomically with “tax and spend” – it is a governmental equivalent of the commercial revenue-expense model. Castigation of “tax and spend” is a low-brow political gambit used to exploit the gullibility of the uneducated.
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