Olly Russ

The winners and losers from 20 years of the euro

Olly Russ

The winners and losers from 20 years of the euro

As I write, the UK remains mired in a political quagmire over how, and indeed whether, to leave the European Union. Having dominated headlines in the UK for the last two years, the Brexit saga has led to another key milestone in European history slipping under the radar: the 20th anniversary of the euro. It is a significant moment in which to analyse how successful the single currency has been and to ask which countries have been its winners and losers.


The EU’s crowning achievement?


The European Union (EU), or the European Economic Community (EEC) as it once was, had long been planning a common currency, dating back to at least 1969. It took 30 years however before the prototype European Currency Unit (ECU) finally gave way to the creation of the euro on 1st January 1999, and a further three years before the notes and coins began circulating in physical form.


In many ways, this was the crowning achievement of the EU political project, and had been achieved only with significant argument and division along the way, led ironically by the UK, which was destined never to take part. It was not just the UK which had reservations, however. Denmark obtained the same opt-out under the Maastricht Treaty as the UK, and remains outside the euro zone to this day, having voted against membership in 2000 by a majority of 53.2% to 46.8% in favour of retaining the krone.


Similarly in Sweden, although in theory being obliged to join the euro, a referendum in 2003 saw 55.9% of voters oppose joining and the issue remains parked for the foreseeable future. Despite the euro being almost synonymous with EU membership, in fact only 19 of the current 28 EU member states actually use the common currency. In the wider geographical context of Europe, outside the EU, Switzerland and Norway of course both retain their own currencies. 


As the euro now reaches the age of 20, has the common currency been a success? Or were the Cassandra voices warning of trouble ahead right after all?


Compromises and consequences


The benefits of the euro were presented at the time as reducing friction in cross border transactions, reducing currency fluctuations, as well as improving economic stability and growth. On the political side, a dimension often not fully understood in the UK, it offered a ‘tangible sign of European identity’ to quote the EU themselves.


Even on paper, converting the various legacy currencies into a single unit would be no easy task. A much favoured investment theme at the time though was that of ‘convergence’, whereby countries who had previously paid high prices to borrow internationally saw their interest rates converge downwards to those of Germany. As is now history, this dramatic loosening of monetary policy in states such as Greece and Spain stoked economic booms, which proved ultimately unsustainable. Even before this was known, however, the dangers of a centralised monetary policy which could not be effectively controlled by member states were recognised. Two of the main problems were that the EU does not have a central Treasury to manage fiscal transfers between regions, as a normal central bank does. The second is that, without the ability to devalue its own currency unilaterally, a member state would be unable to reset competiveness in exports. This is an escape valve utilised many times by many states over the years, not least the UK.


The counterpoint to these arguments was that the euro would enforce collective discipline, assisted by the Stability and Growth Pact, which requires member states to maintain a maximum 3% limit on government budget deficits, and a total debt load of not more than 60% of GDP (interestingly these limits still apply even to non-euro zone countries). Policing of these limits would be via the Excessive Deficit Procedure, which is the EU’s enforcement arm, and was most recently waved in Italy’s direction last year when its budget looked too lax for Brussels to accept. Notwithstanding this regime machinery, it is widely accepted that a degree of ‘fudging’ went on in terms of countries meeting the original convergence requirements for euro membership, and once in, discipline was in fact not maintained.


Existential threat prompts “whatever it takes”


Nonetheless, the euro appeared to be working well until the onset of the Global Financial Crisis. Whilst the euro was not in fact at the epicentre of this initially, the after effects were most keenly felt in the euro zone crisis which subsequently followed from late 2009 onwards. Greece, Portugal, Ireland, Spain and Cyprus found themselves in various degrees of financial distress, and lacking the ability to print their own currency, were forced to turn to other EU countries, the European Central Bank (ECB) or the International Monetary Fund (IMF) in order to maintain solvency. The warnings of those who said the euro could turn into a burning prison for some came true with a vengeance.


Even as individual countries were bailed out, it soon became clear that the euro was facing an existential threat. If the crisis had fully spread to Italy, it was unclear if the ECB even had the resources to prevent a messy breakup. As a result, Mario Draghi famously stood up in a London after dinner speech and announced that he would do “whatever it takes” to save the euro. Whereas previous plans and budgets had quickly been crushed by the market as being inadequate, this totally unlimited commitment marked the beginning of the end of the euro crisis. If the ECB did not put a number of the amount it was willing to risk, the market could not say it was too small. Later it was revealed that the ECB Chairman’s remarks had been ex tempore, and had not been cleared by the ECB Council. Nonetheless, as a philosophical commitment it worked where billions of bail-out funds had failed. Word for word, it was probably the most valuable statement ever uttered to financial markets.

Italy and Spain: disparate performances from outwardly similar economies


The desperation of certain euro zone countries in the midst of the crisis may perversely have helped them. As a prerequisite for aid, supplicant nations had to submit to the ECB/IMF prescriptions for returning themselves to financial health. This usually meant severe austerity and pro market reforms, which in some countries it would be hard to imagine a popular vote ever agreeing to. These reforms have most clearly worked in Spain.


The winners and losers from 20 years of the euro 

The lack of such reforms in Italy helps to explain the disparate economic performances of outwardly similar economies. Prime Minister Renzi did begin to initiate some structural reform of the labour market, but managed to oust himself from power via a referendum gone wrong. As Italy never really got into the same level of difficulty as Spain (despite its high legacy debt load, Italy has actually maintained fairly good budget discipline, at 3% of GDP or below for the last 7 years and never had the housing booms and levels of personal indebtedness which burst property bubbles in Spain and Ireland), it was never forced into serious austerity and structural reform as some of the others.


As a producer of luxury goods and medium engineering, Italy is particularly sensitive to exchange rates. The strength of the euro against the likely strength of the legacy lire under similar conditions has clearly hampered growth. Moreover, had Italy had a normal level of growth over the last 20 years, its debt load would not look anywhere near as worrying. Since devaluing outside the euro is not in reality possible, is internal devaluation possible? The answer is yes, but it is a slow adjustment. Below is the change in unit labour costs by nation since the global financial crisis.

The winners and losers from 20 years of the euro 

Spain, Greece and Portugal have seen a marked reduction in unit labour costs, with Italy much less so, but still a decline. This represents an internal devaluation within the euro, and in theory should start to see jobs eventually move to the south. However, as the currency zone is yet to operate as efficiently as a single nation (language barriers, an incomplete single market in services etc), the market has been slow to correct. Also, the largely unreformed nature of the Italian labour market makes it a less tempting destination for external investment or for local firms to expand hiring plans except when unavoidable.


The euro: success or failure?

A recent study
[20 years of the Euro: Winners and Losers – An empirical study, Gasparotti and Kullas] suggested that membership of the euro has been hugely beneficial for Germany in terms of boosting trend GDP (most likely by artificially depressing the exchange rate versus the likely level of the Deutschmark and so boosting exports), but hugely detrimental to France and Italy. So the answer to the question has the euro been a success or not depends largely on where you live.


In many ways, the euro can be judged a technical success in that it is now the second most important reserve currency, representing c. 20% of global foreign exchange reserves, versus c. 62% for the US dollar and c. 5% for yen and sterling. Yet the euro dream has come at a significant cost to some members, not due so much to the euro itself, but the fact that being locked into the system cruelly exposes and exacerbates structural flaws in weaker economies that could previously be concealed by devaluation.


Whether the euro makes it to its 40th birthday party remains to be seen, but will be dependent on ever more centralisation and necessary but painful reform in those countries which have not yet done so. Whether this will first require a crisis in order to be achieved is also uncertain. In the ultimate analysis however, it should be remembered that the euro is a political project, not an economic one. If the UK has found exiting the EU problematic as a mere trading association member, think how much more painful it would be to unscramble a national currency egg from the euro cake. The euro effectively ensures members can never leave (there is no mechanism either to expel or voluntarily remove a currency from the euro).


In an echo of Draghi’s comments however, the euro will be saved whatever the cost, since a failure of this project will end the long-held dreams of euro integrationists, such as President Macron of France, forever. Also, if the euro were to fail, where would the employees of the ECB find jobs? For this reason if no other, we expect the euro to endure, but it remains a sub-optimal economic construct, while its political ramifications now appearing in Italy will also be interesting in the longer-term. It has undeniably made life slightly easier for European fund managers however, given fewer national currencies to worry about, and for that we are profoundly grateful.

For a comprehensive list of common financial words and terms, see our glossary here.


Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the European Income team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. Investment in the Liontrust European Enhanced Income Fund writes out of the money call options to generate additional income. These call options will be “covered”. Unitholders should note that potential capital growth of the Fund would be capped if these call options are exercised against the Fund and the Fund’s capital returns could therefore be lower than the market in periods of rapidly rising share prices.


The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Thursday, April 4, 2019, 10:15 AM