Eurozone break up – or – Estonia joining in 2011?

It’s make or break for the embattled eurozone. So many of us were surprised to hear that Estonia will join the single currency in January 2011. A minute later a top UK forecasting group announced that the eurozone needs to break up for the sake of the future economic health and success of the European Union.

Does the eurozone need to break up for the sake of the future economic health and success of the European Union?

Capital Economics’ conclusion is contrary to accepted wisdom that such a move would be a disaster. They are instead convinced a break up would lead to faster growth and spare weaker members of the single currency decades of depression and deflation.

Makes you wonder if the world has gone mad doesn’t it? Why does Estonia still want to join the euro? That they wanted to in the past makes perfect sense. But considering the flaws of the euro mechanism, I can’t help wondering if Estonia’s economy would be in as good a shape today as it is if they had already joined the euro?

Adding new member states to the eurozone is contrary to what Capital Economics ordains. It believes that the return of national currencies, far from being a potential disaster that would result in economic chaos, would enable Europe to break out of a prolonged period of weak expansion.

Christopher Smallwood, author of the report, believes the problem is Germany’s refusal to expand its demand to help countries such as Greece and Portugal grow their way out of difficulty.

He added, however, that a break up would still leave a problem for other core members of the euro area, such as France, which would continue to suffer from the “deflationary bias” in German economic policy unless Berlin agreed to restore the Deutschmark.

Smallwood is convinced that the result of such a move would be a rising currency (the Deutschmark) that would wipe out Germany’s trade surplus, forcing the country to boost domestic demand and hence preventing the country sliding into deflation. “Restoring the mark would lead to the rebalancing of the German economy which cannot occur as long as it remains in the eurozone. “This is the best option for Europe”.

Contrary to that belief, Estonians hope joining the single currency will encourage foreign investment in their economy, with growth falling by 14 per cent last year. It is forecast to grow by 4 per cent next year.

What do you think is the best way forward for Europe? A break-up of the eurozone or for the project to proceed and Estonia joining in 2011? Will more countries joining actually worsen the current problems of the eurozone? Is it worth taking the pain of going through depression and deflation to save the euro? Would reverting to national currencies put Europe on track for growth?

(photo: Flickr – erikasmussen)

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16 Responses to “Eurozone break up – or – Estonia joining in 2011?”

  1. Taavet Says:

    "I can’t help wondering if Estonia’s economy would be in as good a shape today as it is if they had already joined the euro?"

    Yes. Estonia runs a currency board, which means that the EEK is firmly pegged to EUR (and to DEM before that). Functionally, Estonia has been using common currency since it's inception. Joining the eurozone will add the benefits of it's membership to all it's downsides that we've already been subject to.

    Should the euro fail, we'll just boot up the board again and establish a peg to Neue Deutschmark;)

  2. catarinaalexon Says:

    Taavet, with respect, having a currency board and being pegged to a currency is different from joining the euro in the sense that it leaves you much more freedom. One central bank for all the member states of the euro has turned out to be a big problem. It means for instance that being a member of the euro you are not able to devaue.

    Or as Soros puts it: Flaws built into the euro from the start have become acute. Once Estonia joins those flaws will start having an impact on your economy.

  3. catarinaalexon Says:

    Hope so for your sake Lesa.

  4. Julia M Lindsey Says:

    I love your blog. You always have such thought provoking topics. I am not sure joining the euro would help Estonia's economy unless it would make them more attractive to other counties for trade and investments.

  5. Susan Oakes Says:

    Catarina,

    In your post you mentioned that Estonia is hoping for an increase in foreign investment. Has this been the case for those countries already in eurozone? If it hasn't then what is the benefit of them joining?

    Susan

  6. catarinaalexon Says:

    Susan, that's what the Estonian government wrote in their press release.

    Before the current euro crisis member states in former Eastern Europe got more investment once they joined the euro. However, with Europeans tightening the belt due to the crisis I don't believe Estonia will benefit the way they would have if they had joined earlier.

    We should also take into account the problems, for instance, Swedish banks, have had with their investments in the Baltic states. That will also have a detrimental affect on investment in the area.

  7. catarinaalexon Says:

    Thank you Julia. With Europe in crisis I'm not sure they will benefit the way their neighbours did before the Greek default. Currently spending power in the eurozone is severely diminished which will obviously affect investment not only in Estonia but the whole area.

  8. Patricia Weber Says:

    What an interesting question, Does the eurozone need to break up for the sake of the future economic health and success of the European Union? My husband and I just returned from a visit to Turkey and Greece. Turkey, for whatever reason didn't have their currency accepted in the eurozone. And yet, somehow now they have a largest shopping mall built in Instanbul built in Europe. Additionally, Donald Trump is building Trump Towers in Istanbul.

    I don't have an answer to your question – Would reverting to national currencies put Europe on track for growth? But I do know that some countries are healthy while others are trying to figure out how to be so.

    Thank you for such an in-depth perspective.

  9. Guy Says:

    Another interesting post, Catarina.

    To be honest I have mixed feelings about the Eurozone. There's no question of the power of a free-trade area like the EU, and that it benefits member states. The question, then, is whether the best way to handle this is with a common currency

    In my view, the Euro could work provided there a proper, enforceable controls in place to ensure all members adhere to the rules and don't drag other countries down. However, as we've seen, these are lacking. IF (and it's a big if) Brussels can put them in place (retrospectively, too), then the Euro should survive. Otherwise, I think they need to revert to sovereign currenices while keep the Free Trade bloc in place. This, though, will weaken the power of the Free Trade zone as there will be complexities around ever-changing exchange rates.

  10. catarinaalexon Says:

    You know Guy, we had a free trade zone long before they launched the euro.

    Another huge problem that is easier said than done to change is having one central bank for all the member states.

    Most likely the most intelligent thing would be to go back to national currencies.

    Catch is members of the eurozone probably regards that as a failure and will keep on struggling to keep the euro. The prize will be paid by citizens in countries outside of Germany affected by the austerity measures inflicted upon them.

  11. catarinaalexon Says:

    Patricia, Turkey is not part of the European Union. They want to be (at least some of their politicians) but that may never happen mainly because they are not really a European country. If they join then Lebanon, Syria, Israel and so forth will also want to join. But I guess the name could always be changed to World Union.

    Shopping malls are not popular in Europe, but they really are in the Middle East (have lived in Saudi, Kuwait & the UAE) hence the huge mall in Istanbul.

    A current fad in the Middle East is buildings such as Trump Towers. You have them everywhere. The tallest, so far is in Dubai and called Burj Khalifa. But Prince Alwaleed is building a higher one in Jeddah. In Dubai you will find dozens of buildings with famous names such as Armani building. Actually think a Trump building is planned for the UAE as well.

    Reverting to national currencies would facilitate for the different member states of the eurozone, including Germany, to fix their economies.

  12. VCG Says:

    I'm curious as to what you do for a living Catarina. I understand you'er in business but what specifically?

    I have a feeling Estonia is interested in the Euro because they have to contend with the large bear next door (Russia), which is always ready to pounce on them, as they did a couple of years ago, looting downtown stores and shops and with a cyber attack (going after Estonia's Internet infrastructure). They want and need other nations' help in this sense, because they are tiny compared to not only Russia but many other European countries.

  13. Elena Sorensen Says:

    I somewhat agree with the comment that VCG made. I think Estonia is more moved by the political aspect of becoming a member of the EU rather than thinking what kind of effect this move will have on the local economy. Estonia is like an angry child, who cannot do much about an adult telling him what to do and trying to press all possible buttons to get a quick effect without thinking about the consequences . As for the EU – well, in my opinion the union would be in much better shape now if the new members were picked more carefully. The members are too uneven in their contributions. I find it hard to understand why, for instance Germany, a big EU donor has to listen to the naughty comments and opinion of Poland, who is an obvious acceptor and has very little to offer. Countries like that are the drain for the EU money.

  14. catarinaalexon Says:

    Good points Elena. We do need the European Union for both political and economic reasons. To have peace in Europe was the idea that it started with and that is still a rprime objective. The problem with that is that member states will, as you put it, be very uneven in their contributions. For peace it will be essential to include all countries in the Balkans. There is no avoiding it but the price Europe is already paying for that is high.

  15. heey Says:

    I don't think that Estonia wants Euro more bcause of a pol reasons than economic ones. On the contrary – Estonia has shown that it makes well thought decisions and has acted as one of the most responsible one of the EU members. What adopting Euro does is it grows reliability towards Estonia, brings investments and Estonia has confidence in the Eurozone; Germany and France have made it quite clear that Eurozone has to survive.
    Yes you can think that maybe EU would be better off without some new members, but the crisis have also hit very hard old members. Yes it is clear that smaller and poorer member states can't contribute financially as much as Germany, but development and progress of those countries and Europe as a whole is much more beneficial to everybody and being in union every member has to be heard and considered with.
    Who said democracy was easy and inexpensive?

  16. catarinaalexon Says:

    The point here is if the Euro is a good idea or not. The mechanism is flawed and has been since the beginning. To have one central bank for a multitude of countries with economies as different as Germany and Greece simply doesn't work. Hence the current trouble. The only reason it exists is because Helmut Kohl drove it agressively to mark the unification of Germany. It's interesting to note that the EU countries that stayed out of the Euro is doing better than the ones that joined. Maybe it would be better to "lose face" and abolish the Euro? Wonder if 25 years from now the Euro will still exist?

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