Financial Times ...
SATURDAY JULY 25 1998
Columnists
BARRY RILEY - Euro's early honeymoon
But what chance is there of an enduring marriage?
First, the starry-eyed romance of engagement, then the brief and euphoric honeymoon (in europhoria, perhaps) and, finally, the long, tough business of marriage which can so easily end in tears, especially with 11 in the bed. Is this how European monetary union will develop?
Plighting their troth has proved to be the easy part for the cohabitants of Euroland. With only five months to go before the merging of the currencies, the economic and financial picture is generally rosy. Squeezing within the Maastricht limits last year proved to be the unpleasant bit. Now, Euroland is coasting towards the year-end on a wave of cheap money.
Securities markets love a theme, and monetary union is a cracker. Brokers can spin endless yarns about restructuring, economies of scale and heady growth. Euroland's bourses have dominated the global performance league table this year, headed by Finland with a 75 per cent gain (measured in D-Marks). Stock markets in some of the "bubble" economies, boosted by sharp falls in interest rates, led the way in the first quarter but the core economies such as Germany, France and Belgium have taken up the running lately. Average gains of the Euroland "ins" have topped 40 per cent, against less than half of that for "outs" such as the UK or Denmark.
Cyclically, everything about continental Europe points upwards. After years of sluggish economic growth, average unemployment in Euroland is 12 per cent and there is a large gap between capacity and output (whereas the US and UK are running at above sustainable output). A low exchange rate has been engineered, to the frustration of German companies such as BMW which thought the UK was a cheap offshore production platform. Inflation is almost unmeasurably low, and company profits are rising fast thanks to productivity gains in the cyclical upturn and low raw material costs. This is not so much Goldilocks as Aladdin's Cave.
Even so, some snags are beginning to appear. There is the Asian crisis which is damaging exports, especially of capital goods. The looming Russian problem periodically threatens Germany in particular, although the latest IMF bail-out has stabilised the situation for the time being.
Arguably, the kind of sharp, sudden economic slowdown that appears to have hit the US in the second quarter is also afflicting Europe, albeit less seriously. Germany has slowed after a good first three months and Italy is turning into a laggard, apparently overburdened by high taxes and employment costs imposed in order to leap the Maastricht hurdle.
The European Central Bank is preparing to assume power at the end of the year. But not only does it still have to decide precisely which mix of inflation and monetary growth targets it will adopt - it has the problem that useful Europe-wide statistics do not yet exist. In due course it will develop some monetary benchmarks, but to begin with it will be flying more or less blind.
Moreover, the ECB will have to play very tricky politics in dealing with national governments. If the one-size-fits-all monetary policy is not to prove a disaster, as the euro-zone disintegrates into an incoherent collection of variously booming and slumping regions, it will have to be co-ordinated with local fiscal policies. So far, though, the ECB's hints that "bubble" countries should raise their taxes have been rejected.
This is, most clearly, the new "Irish problem" (although much the same applies to Finland and Portugal). Short-term interest rates in Ireland are due to collapse by January from 6.5 per cent (already too low) to the common euro rate, probably above the present D-Mark rate of 3.3 per cent but below 4 per cent. However, the Irish government has a complex agreement with the trade unions over pay rates which, arguably, prevents it from putting up taxes even if it wished to. And all such bubble economies appear to be running prudent fiscal policies - small deficits, or even surpluses - because of the inflated level of tax revenues.
Adjusted for the cycle, though, the fiscal posture might not be prudent at all. And electorates are not convinced easily that they must pay higher taxes in order to compensate for their government's loss of control over monetary policy.
Ireland's boom could, within a couple of years, turn into a slump as inflation bursts through and destroys company profitability. Normally, recovery would be aided by a devaluation, but this option is to be closed off. Ireland, accounting for 1 per cent of the Euroland economy, could expect little help from the ECB, which will be preoccupied with the requirements of Germany, France and Italy, representing 72 per cent between them. Either Ireland's economic costs, such as wages and rents, become flexible in a downwards direction or the depression will become semi-permanent, with a resumption of net emigration.
At any rate, even some of the brokers are getting cold feet about the Euroland story. This week BT Alex Brown, for instance, warned that there was too much complacency about continued growth, and that a sharp stock market correction was in the offing. Perhaps the honeymoon is over before it has even begun.
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