01/12/2011 10:24 am ET Updated May 25, 2011

The European Crisis Was Predictable and Is Salutary for the Euro


Until the Euro was put in place, Europe was living through regular competitive devaluations: the same countries who are in trouble today were adjusting their economic imbalances by lowering the value of their currency. They included the French Franc, the Spanish Peseta, the Italian lira and the Portuguese Escudo. It was called "competitive devaluations" and infuriated their European business partners. Furthermore, it was creating intra-European uncertainties on the values of their imports and exports from their neighboring countries.

It was therefore essential to create a monetary zone that would get rid of those currency uncertainties. Hence the European Monetary Union followed by the creation of a full monetary zone with a single currency and a single central bank.

For those of us who participated in the development of this thirty-year process, the Euro was clearly depriving the countries of the Eurozone from that adjustment mechanism: the exchange rates. It was not only a consequence, but the purpose of the Euro. It was deemed to be the engine of the indispensable economic convergence between European countries to strengthen the member states' economies, and Europe as a whole.

To ensure that economic convergence would be applied, a Financial Stability Pact was enshrined that included sanctions and corrective measures for those countries that were diverging. That was essential, had it been implemented. Unfortunately, the corrective mechanisms had to be decided at the political level and were never applied. Several crises resulted in successions of complacencies, lack of courage and... complete disrespect of the Stability Pact. All the countries of the Eurozone bear the responsibility for this derailing of the Eurozone.

The reasons for that are triple: first, the usual lack of political courage (the traditionally missing ingredient in European politics). Second, the "Maastricht criteria" themselves were wrong. Rather than using sliding ratios over a period of three to five years, the annual criteria were leading to lack of decisions: it is indeed inept to expect every single Eurozone country to respect the Maastricht criteria every single year. The financial crisis washed those criteria all together. Third, the European statistical agency (Maastricht criteria) had no investigative powers to ensure that the numbers communicated by the members were actually correct. Greece was the most notorious cheater, but Italy was not far behind.

The economic divergence was therefore reflected in the only variable that remained free: interest rates. As countries were gradually taking liberties from fiscal discipline, the debt of the least compliant country started to bear higher interests; the market was not prepared to take Greek bonds with the same yield as Germany. As the situation deteriorated, the spread widened: today, Greece's 10-year yields are five times higher than Germany's.

This crisis, as unnerving as it seems to be, is in fact salutary: it was time that the Eurozone members realized that the Euro is a privilege, but that they have to act responsibly and that the Eurozone as a whole is bound by solidarity and accountability. This "discovery" took one year to translate into action, mostly because Germany could not come to grips that they actually had signed up for a system that was giving the benefits of the Euro and the absence of competitive devaluations at a cost: they are responsible for the health of the entire Euro area.

The Eurozone will never be the same again: this crisis has been a live demonstration of what a common currency is. It is the challenge of the European authorities to strengthen their solidarity and provide with serious preventive mechanisms. Nobody can ignore, any more, what they signed up when they joined the Euro. The Euro will remain, but member states will need to adopt converging fiscal discipline and economic and social policies. It won't happen overnight, but it is salutary for Europe and for the world.

US investors would be wrong, as they have been in the past, to assume that the Euro is a structurally weak currency and that European companies are structurally underperforming. The "shorters" might be unpleasantly surprised.