Monetary Union By Hook Or By Crook
European Union leaders bent on creating a single European currency are betting that politics can triumph over economics. Budget politics around the EU resemble a 50-yard dash toward meeting the Maastricht Treaty criteria for monetary union by the end of 1997. That's when the leaders will tally up a list of charter members and pat themselves on the back for a job well done. But in the race to meet the goal, fiscal rules are being broken left and right, setting the stage for disappointment and perhaps down the road another round of inflation.
When the leaders gather in Florence at the end of June for their semiannual summit, they'll no doubt proclaim how good prospects look for the European Monetary Union in 1999. Three years of low inflation and declining German interest rates have brought bond yields among Europe's disparate economies close together. In fact, the Maastricht Treaty and its tough budget criteria have effectively forced governments from Spain to Scandinavia to start reversing decades of deficit spending, subsidies, and high wage settlements. Markets are even seduced by the idea that if German Chancellor Helmut Kohl wants to unify Europe's currencies in 1999 as he unified Germany six years ago, he will make it happen, one way or the other.
There's just one problem. Despite enormous progress, governments are still far from meeting their fiscal targets. In France, social security deficits are proving far harder to control than the government had let on, making it unlikely France will get anywhere close to hitting the Maastricht budget-deficit numbers next year. Even Germany, itself emerging from two quarters of contracting gross domestic product, is experiencing a difficult time getting its levels of debt down to qualify by the end of next year.
So what's Europe's solution? Fudge it. Talk of liberally interpreting the Maastricht criteria is sweeping the Continent. A growing number of bureaucrats and politicians are saying that after the EMU is formed, they won't have to pay too much attention to hitting tough fiscal targets right on the nose. There is talk of efforts by the EU's statistical service to prepare revised economic statistics that include Europe's shadow economies in GDP calculations. Through this neat trick, the Belgian, Greek, and Portuguese economies might grow 20% bigger than current figures show. This would make their debt and deficit levels proportionately smaller, meeting Maastricht targets. All this, of course, is potentially quite inflationary and should scare the pants off Europeans, especially investors in Deutschemark-denominated assets. The strong mark could turn into a weak Euro if the new currency is born with an inflationary premium attached.
Getting to a single currency credibly will probably take more time than the 18 months Europe's leaders have allocated. At a minimum, it will mean continued fiscal restraint, and rules to ensure that discipline is followed after a single currency is formed.
It is time to roll back the deadline. European leaders say they can't possibly postpone forging a single currency because fragile sentiment for things European won't survive the political shock of yet another delay. They have a point. But resorting to statistical sleight of hand and other political gimmickry is a surefire way to create a single currency with such little credibility that it will collapse within its first year. It would be better for EU leaders to revise an approach that is too much about politics and too little about economic reality. Creating a single European currency is a good idea, but it must be born strong and viable.