The Future of the Eurozone (Futures Perspective Series)


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Three years ago, the then President of the European Central Bank, Jean-Claude Trichet, gave a lecture to the European Parliament celebrating the first decade of the Euro. The single currency, he argued, “protects incomes and savings and helps bring down borrowing costs, thus promoting investment, job creation and prosperity over the medium and long term.” It had, he said, created greater “dynamism within the European economy.” That was in 2009. From the perspective of February 2012, it looks very different.

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The Future of the Eurozone (Futures Perspective Series)

  1. 1. Future Perspectives The future of the eurozone How the eurozone crisis could end – and the opportunities for business 1 The future of the eurozone
  2. 2. Future Perspectives The futureare thought pieces withconcise, focused insights of the eurozoneinto important issuesof interest to marketingand business strategists.For more information please visit Three years ago, the then President the European Central Bank, Jean-Claude Trichet, gave a lecture to the European Parliament celebrating the first decade of the Euro. The single currency, he argued, “protects incomes and savings and helps bring down borrowing costs, thus promoting investment, job creation and prosperity over the medium and long term.” It had, he said, created greater “dynamism within the European economy.” That was in 2009. From the perspective of February 2012, it looks very different. © 2012 The Futures Company. Some rights reserved. 2
  3. 3. After the eruption of the By 2020, the eurozone crisisGreek debt crisis in 2010, 2011 will have resolved itself.turned into the year of the Either the currency will havecrisis summit, with European stabilized, or some peripheralleaders locked in an endless members will have peeledseries of late night meetings away, or, just possibly, it willin Brussels working on plans have split up save the Euro. Far frombeing a force for stability, But whatever the eventualthe euro had (by general outcome, the Europeanagreement) become an agent economy will look veryof instability. Far from lowering different—for consumers,borrowing costs, it had driven workers, governments andthem up in countries such companies. Some of theas Greece and Portugal as changes could be dramatic.well as Italy and Spain. Andfar from encouraging greaterdynamism, in 2012 the debtcrisis looked as if it wasthreatening a fresh recession.Clearly something had gonebadly wrong. Whether the euro Real effective exchange ratessurvives or not, somethingneeds to change. No currency 2000=100system can stagger along in 130perpetual crisis. Ireland 125This report won’t attempt to 120 Greecereview the entire euro crisis inevery detail. Nor will it attempt 115 Spainto predict precisely how the 110 Italy Portugallatest rescue plans will workout. Instead it aims to give 105 Francea simple, clear and easy-to- 100understand account of the 95structural flaws in the singlecurrency. And it attempts to 90 Germanylift people’s sights, to look at 85how the crisis in the eurozonewill reshape the European 80economy. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: European Commission 22 3 The future of the eurozone 21
  4. 4. The roots of the eurozone crisisThe roots of the eurozone Eurozone macroeconomics explained Norwaycrisis are not the Sweden Finlandgovernment deficits thathave received so much Estoniapublicity. These are only Russia Denmark Latviaa symptom of far wider Lithuania U. K.imbalances that have Neth. Poland Ireland Byelarusgrown up since the single Loans Belgium Germanycurrency was launched. Lux. Goods UkraineThe real issue is the Austria Hungary Moldova Switz.massive trade deficits that France Slovenia Croatia Italy Bosniahave opened up across Serbia Montenegro Bulgariathe eurozone. Macedonia Portugal GreeceSince the launch of the Turkey SpainEuro, the hyper-competitiveGerman economy has Tunisia Cyprus Syracked up big surpluses, Source: The Futures Company/Strategy Economicswhile the GIPSIs—Greece,Italy, Portugal, Spain and Ireland—have all racked up huge trade deficits.The trade deficits are financed by borrowing. In effect, Germany lends the money tothe GIPSIs to buy lots of goods from Germany. In some cases, such as Greece, it wasthe government that borrowed lots of money. In other countries such as Ireland andSpain, it was property developers and banks. In Italy and Portugal, it was a mixture ofthe state, the private sector and consumers.Nevertheless, in each country, there was a huge rise in borrowing. In Portugal, forexample, the total of household, corporate and government debt rose from 251% ofGDP in 2000 to 366% of GDP in 2010.This debt-to-GDP ratio was unsustainable. In Greece, the bond markets refused tolend to the government any more. In Ireland, the debts in the banking system becameso overwhelming that the government had no choice but to take them over. Either way,prolonged trade deficits created debt, and the debt created the crisis.The euro won’t be on a path to long-term stability until those trade deficits start toclose. There are some signs of it happening—the Spanish deficit, which at one pointwas more than 10% of GDP—is narrowing. But it is being achieved through massiveausterity programs and recession, which reduce demand. Over the medium term, itneeds to happen through the peripheral countries becoming more competitive.Only then will the euro become a more stable currency.© 2012 The Futures Company. Some rights reserved. 4
  5. 5. Thinking about scenariosSovereign default—when a to invest in property and Dealing with creditors, then,state defaults on all or part land in the Mediterranean becomes the critical issueof its debts—is surprisingly states.) As the asset bubble for economic recovery.common, given how seriousit is supposed to be. Since European current account imbalances1900, according to CarmenReinhart and Kenneth Rogoff 2in This Time is Different, 44 Germany 1.5countries have defaulted 1worldwide, some of them 0.5more than once. Of these, 35 Percentage of EA GDP 0have defaulted since 1975. 1999 2000 2001 2002 2003 2004 2005 2006 2007 2007 2009 2010 2011 -0.5In short, debt defaults by -1states can be thought of as a -1.5normal—if extreme—part of GIPSIs -2the working of international -2.5financial markets. Historically,they note, there have been Source: Paul Krugman, ‘Conscience of a Liberal Blog’, New York Timeslong periods when a highpercentage of countries are expands, so debt grows. But For governments and theirin a state of default and/or inflation in asset values cannot creditors, this can representrestructuring.1 continue forever; there is a a complex situation best moment when the market characterized by game theory.In developing these scenarios, turns, confidence collapses Bond markets can increasethen, we have tried to strike and crash follows. After: asset the interest rates they chargea balance between the costs markets suffer from a deep to governments because theyand the benefits of default. and prolonged collapse in see greater risk, but increasedThere are circumstances when value, the value of government interest rates put greaterdefault is the best of a bad set debt tends to explode, and pressure on public finances,of options for a country. there is a prolonged increase forcing tax increases or further in unemployment and a cuts in public spending,The path of financial crises is sustained fall in output. increasing the levels ofwell charted by Reinhart and Although bailout costs are a austerity and reducing output.Rogoff. Before: you see spikes factor in shaping the post- (To take a simplified example,in commodity prices, and crash economy, it is the if government debt representslarge asset bubbles develop, decline in production which 100% of GDP, and interestinflated by easy credit and does the most damage to rates on government bondsstrong capital inflows. (This economic performance and increase from 4% to 6%, thishappened in the eurozone as therefore to living standards. represents a 2% cut in output,money flowed out of Germany or the equivalent of a year’s 5 The future of the eurozone
  6. 6. economic growth in more From the perspective of a the eurozone, Spanish or Irishnormal times.) government, this amounts savings are as likely to be to a balance of costs; yes, invested in Euro-denominatedContinued cuts increase there are penalties in being bonds invested by otherthe political pressure on partly or fully excluded from governments, which meansgovernments, and so there the international capital taking money out of nationalcomes a point at which it markets, and the period economies.makes both economic and after a default is politicallypolitical sense to seek a debt ugly. But there are also In the context of the Europeansettlement. It also makes heavy domestic political and Union and the eurozone, theresense for bond holders to economic costs from paying is a second layer of the gamelisten to such proposals; at high interest rates on debt being played out: the point atsome point it becomes a from an economy which is in a which the cost of sustainingchoice between getting some cycle of decline. Beyond this, the eurozone starts to threatenmoney back and getting less. for countries such as Ireland the political integrity of theAs Keynes once said, if you and Spain, which like the US European Union.owe your bank a hundred and the United Kingdom arepounds, you have a problem; suffering from a ‘balance These are high-stakes games.but if you owe a million, it sheet recession’ as described As David Harvey has noted,has. The numbers are larger in a recent paper by Richard “One of the basic pragmaticnow, but the sentiment is the Koo2, eurozone membership principles that emerged insame. In the first instance, presents a particular problem. the 1980s, for example, wassuch negotiations are about In a balance sheet recession, that state power shoulda partial structured default similar to the one in Japan in protect financial institutionswhich doesn’t exclude the the 1990s, debt deleveraging at all costs.” (In particular, hegovernment completely from by the household and suggests, the IMF became the enforcer of this principle.)3 At the same time, the aftermath There are penalties to being excluded of default is politically from capital markets - but there explosive. In 2001, Argentina was marked by political are also heavy domestic costs from instability, factory occupations paying high interest rates on debt and takeovers, highway blockades, and the formation of neighborhood collectives. Paul Mason’s characterizationinternational capital markets; corporate sector creates a of a Greek default is alsoif that fails, or if there is a vicious cycle of recession as chastening:sudden failure in confidence, money is withdrawn from the “Greek politics is polarisingthen there may be a full default economy to pay down debt. To at the same time as itsinstead, perhaps leading to break this cycle, governments professional politicians areyears of negotiations between need to be able to borrow running out of answers.bondholders and government. their citizens’ savings and It is hard not to predict a then spend them. But within social explosion in Greece.© 2012 The Futures Company. Some rights reserved. 6
  7. 7. Should it be forced to exit already has almost a quarter to reduce its debts to US banks the eurozone, then the exit of the workforce (and almost by more than two-thirds.7 plans I’ve seen do not look half of all young people) out of pretty. The one outlined work, and whose indignados So, there are a number of by SOAS professor Costas movement was a forerunner tensions which play out in the Lapavitsas involves bank of Occupy, it is hard to believe development of our scenarios closures, current account that things will turn out for the future of the eurozone, freezes, import and capital well, either economically or which are set out in the controls and probably food politically. diagram below. rationing.” 4 The Default LandscapeBut the other half of theequation is also important. FINANCE Ability to raise EXTERNAL fit st t Ex in nce itu ni co ou funds on bond te sti o tioGreece is already suffering be c ab s s in nt tu n n flu in market d mi ts of tio po s e stfrom many of the an o n on e fin na liti ec gum an l caldisadvantages associated ce r Awith default: it has sufferedeconomic collapse, its debthas increased, and it has High levels of debt Influence of and de-leveraging international andbeen shut out of international financial institutions drive downcapital markets since income levels on governments2010. And as a result of theeurozone-imposed cuts and A in l tr ith ca rt dom eco ure un w lititax increases, as Stergios ic so p ul es no s co icts po ci re at ti mSkaperdas observes, there o- ss l l io c ic nf na y n co ter of“has been a fast downward Emergence of In political oppositionspiral of the economy... The INTERNAL to austerity POLITICSdebt-to-GDP ratio went from measures115% to 160% in less than Source: The Futures Company/Strategy Economicstwo years.” The economicdesperation that has seen Governments which seek to There are economic tensions,increasing numbers of Greeks reduce their debts have more on the one hand, between theput their children into care leverage if there is perceived to desire to be able to borrowcreates political volatility, be a risk of contagion, suggest on the international markets,heightened by the emergence Reinhart and Rogoff.6 It should and the domestic pressuresof parties (either new or also be noted that there are caused by continuing austeritypreviously marginalized) which strategies which governments and declining living standards.have not been associated with can use to build agreement to On the other hand there areausterity measures. reduce their debts; this does political conflicts between not have to be a unilateral the influence of financial andEqually, when the Spanish process. Ecuador, for example, international institutions ongovernment announces new audited its debt and identified governments, and pressuresausterity measures and tax irregularities and illegalities in from citizens for a moreincreases,5 in a country which some loans; the audit helped equitable political settlement 7 The future of the eurozone
  8. 8. (expressed in American Scenario 1: Scenario 3:politics as “Wall Street versusMain Street”). Within these, The eurozone survives in A smaller eurozone with somedifferences over economics its present form. This is the peripheral countries returningmay also emerge between the scenario that the European to national currencies. Oneinterests of industry and of Union and the European of the driving forces offinance, for industrialists need Central Bank (ECB), backed the eurozone—as with thestable markets, or expanding by Germany and France, would formation of the EEC—hasones, to prosper. There are most like to see. But in the been the alliance betweenalso conflicts—which overlap face of shrinking economies Germany and France whichwith these—between external in the peripheral states, and sits at its heart. One of thediplomatic demands and cycles of austerity measures ways of defending the eurointernal electoral demands. in response, it seems unlikely is, in effect, to manage theAnd it is worth repeating to be realized unless the departure of the weakerthat sitting beneath this countries with high levels of peripheral economies whilecombustible mix are levels of public debt are able to write maintaining a core eurozone.public debt which are almost off much larger proportions of This has strategic advantages:certainly unsustainable. these than has been permitted a benefit of the euro is that by the eurozone so far. To be it gives Europe clout as aThe scenarios in this report, realized, this scenario would regional player on the worldtherefore, have looked at the require a fundamental shift in stage. In this scenario, we seepossible pathways from the German attitudes to debt and a two-tier Europe, with thosepresent unstable situation, economic management. inside having more clout thanbased on how these economic those out of it. But it alsoand political tensions requires that Germany andmight play out. These are Scenario 2: France maintain some kindrepresented by the decision of parity, which may becometree in the diagram on the A ‘dual Euro’ is created, with harder as France’s economyfacing page. weaker economies shifting deteriorates. to a ‘southern Euro’: the logic of this scenario is that the countries with weaker Scenario 4: economies are able to devalue their currencies, which All countries revert to national provides a far more rapid currencies, but the euro economic boost than the long- remains as a trade currency. term structural adjustment Even if the eurozone comes that is otherwise required. So, unstuck, it seems unlikely this scenario enables countries that the euro will disappear. that wish to devalue to stay in The strategic advantages of the eurozone. This scenario is a shared currency remain unlikely even if a blueprint has valuable, and the EU and ECB been drafted in Brussels or by continue to make and receive the ECB itself. payments in euros, while© 2012 The Futures Company. Some rights reserved. 8
  9. 9. European companies can Scenarios for the future of the eurozoneissue euro-dominated bonds.National governments don’t Scenario Is a Eurozone may survive if it can 1particularly like this, since it significant address structural issuescreates a second fiat currency, proportion of debt YESbut it is required as a condition cancelled?of EU membership. This isincreasingly straightforwardto manage in a digital world. NOIt provides some economic Weaker economies moved to ‘sudo’ todiscipline within the EU, and permit devaluationthe continuing benefits of EU Dual Euro survives Scenario 2membership outweigh the until attacked by Do countries financial marketsdisadvantages. sign up for the non-core YES Euro?Scenario 5: NOAll countries revert to national Weaker economiescurrencies. This is the end default, leave theof the euro experiment, and Euro Twin-track’ Europe’ Scenario 3something of a nightmare Does core and non-corescenario. This scenario members the corerepresents an economic Euro area maintain YESfailure as well as the collapse cohesion?of much of the idea of thepolitical union of Europe. Such NOa currency disintegration Core economies startwould be messy and to fragment because ofprolonged, and would certainly differential recoveriesextend the European recession Parallel Scenario 4for several years. On the face currency Does the EU systemof it, it is a return to the EU of maintain the Euro asthe 1970s and 1980s, but it YES a tradecould be worse. It could be a currency?return to the fractious hostileEurope of the 1880s instead. NOIn the next section, we willfocus on the scenarios which Return to Scenario 5involve defaults, and their national currencieseconomic implications. Source: The Futures Company/Strategy Economics 9 The future of the eurozone
  10. 10. Exploring the implications forEurope and the eurozoneWhat are the economic implications of the different scenarios, and how will theyshape the commercial environment in which companies doing business in theeurozone will have to operate? Scenario 1: do, the fiscal union will be far more politically centralized. The eurozone The eurozone survives in Most major economic its present form cannot decisions will be made in This is by far the most Brussels. But there will also be continue to preferable solution for far more persuasive nationalist stumble from policymakers, and the one movements within each that involves the least change country, since not everyone crisis to crisis to the economic makeup of will be happy with the loss of Europe. It is a mistake to think national sovereignty involved. that it involves no change, however. The eurozone cannot Two: Peripheral Europe will continue as it is, stumbling need to have restructured from crisis to crisis, and with its economy, and will have major countries such as Italy become far more competitive. increasingly locked out of the Labor markets will be financial markets. If it is still have been liberalized, and a working currency area of 17 youth unemployment will countries in 2020, it will need have been cut. Retirement to be very different from today. ages will have been raised. Female participation in the There will be three main labor market will have been changes. dramatically increased. Protected monopolies in areas One: A fiscal union—or Die such as retailing and transport Fiskalunion as it is known will have been broken up. in Germany—will have been State assets will have been created, involving major privatized. Wages will have transfers of funds from the been held down for years, core to the periphery. That will and productivity raised. All be accompanied by far greater those measures would allow control of national budgets by peripheral Europe to compete a central authority. Since tax with the core—but will imply and spending decisions are at huge changes in the structure the core of what governments of each economy.© 2012 The Futures Company. Some rights reserved. 10
  11. 11. Three: Core Europe— a growing band of supporters, It is unlikely that a singlemainly Germany—will have particularly in Germany, market would survive in theserestructured its economy to which has the dominant voice circumstances. Rather like thebecome far less reliant on in this debate. In many ways, splitting of the Roman Empiremanufacturing and exports, it is a neat solution. Many of in 395 AD, the two zones wouldand far more dependent on the advantages of a single gradually drift apart. In reality,retailing, leisure and financial currency are preserved, but companies should prepare forservices, thereby allowing it to divided into more natural two European economies: aimport far more manufactured currency areas. The trouble north and south. They wouldgoods from Southern Europe. is with the sudo. The largest both be single markets.The eurozone will survive economy within it by some But over time they wouldonly if it becomes far more way would be Italy. And the acquire different rules andbalanced economically—and Italians have suggested characteristics.this means there will be that they would not wishchange in the core as well as to take on the economicthe periphery. responsibility involved. Scenario 3: Smaller eurozone But if it did happen, it with some peripheralScenario 2: would create a line down countries reverting toA dual euro is created, with the European economy. In national currenciesweaker economies shifting effect, there would be twoto a southern euro economic zones, with the A smaller eurozone with some sudo constantly depreciating nations splitting away is aThe Southern euro—the ‘medi’ against the ‘neuro’ (as the high-probability outcome.or ‘sudo’ as it has been dubbed northern euro might be known). It is politically easier simply toin the financial markets—has remove some small countries than to restructure the entire bloc. The most likely route is that membership is temporarily suspended, with no one in a great rush to re-impose it, rather as Sweden appears to have conveniently forgotten about its legal requirement to join the euro. Greece might leave first, followed by Portugal, and perhaps Slovakia. If it was just those three countries, the impact would be fairly minimal. 11 The future of the eurozone
  12. 12. The big issue would be Scenario 4: Second: the euro wouldwhether the core remaining expand over time. Small Countries revert toeurozone could move forward countries might not find national currencies, butto stability or not. The trade it worth the expense of the euro remains as adata would suggest not. Spain, maintaining national trade currencyItaly and now France all run currencies. The three Beneluxmassive trade deficits with It is quite possible that the countries might switch to theGermany, suggesting that all euro will survive as a parallel euro as the only currency usedthree of them are still steadily currency alongside national in those countries. So mightlosing competitiveness within currencies. This would have the Baltic States—Estoniathe eurozone. two major consequences. (already a member), Latvia and Lithuania. Austria mightThe overall outcome would First: the euro would be decide to join. Meanwhile,be similar to Scenario One— the financial/multinational the ‘euro’ economy mightsouthern and northern Europe currency. We would expect gradually expand over time,will still both need to be that equity and bond markets as larger percentages of eachtransformed to achieve long- would use the euro. Corporate national economy switchedterm stability. But the removal debt would be accounted for to it. The euro would expandof the most highly indebtedcountries would make thatprocess easier, buying some The future of the euro could be as atime to create a more unifiedcurrency area. parallel currency alongside national currencies in euros. Equity prices would organically, adopted from the be denominated in euros, and bottom up rather than the top cross-border transactions down. By 2040, a large part would be accounted for in the of Europe might effectively single currency. A two-tier be using the euro as its main economy could open up, with currency, and some of the the financial markets and national currencies might start multinationals using euros, to fade away again. and small and domestic businesses using national currency. However, and this is important, it should not be assumed that the ‘euro’ economy would do better. Medium-sized companies are often more dynamic than big ones and can grow faster.© 2012 The Futures Company. Some rights reserved. 12
  13. 13. Scenario 5: up in a very different place. This scenario implies bothCountries revert to that the countries with weakernational currencies economies have left the EuroA total reversion to national relatively quickly, and thatcurrencies is the most the core economies havedramatic outcome for the been unable to maintain theireurozone. It is not the most cohesion. In turn this meanslikely outcome at this point, that a number of the EU’sbut it can no longer be ruled institutions would have failed.out. The circumstances of It suggests a prolonged periodthe euro’s collapse cannot be of crisis, and the erosion ofpredicted at this stage; it might trust between countries withinhappen chaotically or it might Europe. In other words, ithappen by agreement. involves an extended period of economic, political, andOn the face of it, this scenario diplomatic pressure - andis no more than a return to possibly even the unravellingthe Europe of the 1980s. But of the European Union.the process of getting therewould mean that we ended 13 The future of the eurozone
  14. 14. Europe’s economies afterthe eurozone crisis We see three big trends: economy; it would be similar to the peace dividend seen A country like One: after the end of the Cold War Germany that The periphery recovers when countries were able quickly to significantly reduce their builds up a spending on defense. big surplus Greece, Portugal, Spain and Italy would recover fast. There Finally, we assume that all the impoverishes its would be a very traumatic peripheral countries will have trading partners transition period (although made significant structural because of its geopolitical reforms. It may not be enough importance, Greece in to stay in the euro. But when particular would be likely to combined with devaluation receive US aid, just as it did in and debt relief, it will provide aAs we outlined at the beginning the years after World War Two). platform for dramatic growth.of this report, international Within five years of the endeconomics is a large and of this difficult period, their Remember that Italy was onecomplex system. Unlike a economies would begin to of the fastest-growing post-household, a country such as grow significantly. war economies. From 1951 toGermany that builds up a big 1973, its growth rate averagedsurplus merely impoverishes Here’s why: 5% a year, only slightly lessits trading partners, requiring than Germany and Japanthem to run big deficits. We also assume there would over the same period. In ItalyIt’s this imbalance which is be a substantial devaluation it was known as ‘il miracoloat the heart of the current of their currencies, which economico’ This can certainly .eurozone crisis, and the only would immediately boost their happen again.way to resolve the crisis is to competitiveness.change the economic balance Two:between Germany and the We assume as well that, as Core Europe will slumpMediterranean nations. So it is part of the break-up of euro,possible to sketch out how the the peripheral countries would Germany and the rest of theEuropean economy will be re- negotiate a partial default on core eurozone have done wellshaped as this is corrected. their debts. This can be highly out of the single currency. significant. Italy, for example, But if it broke up, they would spends about 6% of GDP on go into a prolonged slump. debt repayment. Freeing itself of that burden would be a huge boost to the rest of the© 2012 The Futures Company. Some rights reserved. 14
  15. 15. Here’s why:We assume they would seea major upwards revaluation The economies of core Europe haveof their currencies. Although been distorted by an undervaluedGermany exports as much onquality as on price, price is not currency. They will need to build upirrelevant. The export sector domestic demand - in sectors suchwould be hit hard. as retail and leisureWorse, the losses from debtrenegotiation by the peripheralcountries would be borneby the core eurozone banks,mainly in France and Germany. Three: Here’s why:The banking system would The single market willhave to be bailed out by the go into retreat We would expect to see a risegovernment, hugely increasing of economic nationalism.debt-to-GDP ratios. In effect, The euro was created, in EU law will provide somethe core would pay for the part, to complete the single protection against this, buteuro’s collapse. This would market. It is hard for goods companies should expect andbe a drain on the economy and services to move freely plan for an increase in informalin much the same way as across borders when prices protectionism.reparations were after World are fluctuating against eachWar One. other. Through the 1970s In addition, we expect to see and 1980s—first with the a move back towards localFinally, since before the ‘snake’ and then with the production. In a Europe ofcrisis, the economies of core exchange rate mechanism— different national currencies,Europe have been distorted governments tried to control the only real way to protectby having an undervalued currency movements. yourself from currencycurrency. They have become movements is to have factoriesexcessively reliant on exports. With the return of national in each country. The euro sawSo they would need to currencies, we would expect a centralizing of productionrestructure towards domestic to see the single market move to the benefit of the coredemand, building up sectors backwards, not completely, euro economies, Germany insuch as retail, leisure and but partially. particular. The post-euro erafinancial services that have will see a decentralization ofbeen lagging in the past production.decade. This will be a painfulperiod of adjustment, andit will have to be achievedagainst a backdrop of acontracting economy. 15 The future of the eurozone
  16. 16. The break-up of the ruble-zone You don’t have to dig So rather than have 15 new wasn’t permitted to print notes, very deep into the history currencies, it made a lot but could create credits for books to find an example more sense to have a single the government, essentially of a currency union falling currency. Just like the euro monetizing their debt. apart. There is one from area, floating currencies the very recent European appeared inefficient in such Again, that is remarkably past—the creation and a tightly integrated economic similar to the eurozone. While dismemberment of the ruble- area. Also, it was argued that it is only the ECB that can zone that was created so that the smaller counties might issue banknotes, the national the states that emerged from find themselves buffeted central banks remain in the break-up of the Soviet by the foreign exchange existence. They cannot create Union in 1990 and 1991 could markets, whereas membership credits for their governments, share a single currency. It is of the ruble-zone would but in effect the debts of the a story that has very clear ensure stability—again, an peripheral nations are now lessons for the likely fate of argument often heard for being monetized because the the euro as well. the euro. Indeed, the IMF in ECB is buying their bonds in 1992 was urging the former the markets. The comparison The arguments for Soviet republics to stay in the isn’t perfect, but it also isn’t creating the ruble-zone ruble-zone, much as today that different. were remarkably similar it is advising the peripheral to those for creating the euro-area counties to stay in So what happened? euro. The former Soviet the euro. Union covered what later The ruble-zone was a turned into 15 different When it was created, the catastrophe for everyone countries. The legacy of ruble-zone had 15 members involved. The scheme central planning meant that ranged from the Baltic states incentivized each country they were highly integrated; of Lithuania and Latvia in the to run up vast government centralizing production and west to Tajikistan in the east. It deficits, and then transfer creating national/regional was the largest single currency most of the costs to their specialization had been bloc in the world (the CFA franc neighbors. Georgia was the one of the main aims of the created by France to circulate worst offender. It went from Soviet planners. It was also a in Africa never got above 14 a budget deficit of 3.5% of very closed system, because states). The Russian Central GDP in 1991 to 34% in 1993. In the Soviet Union traded Bank maintained a monopoly the same period, Uzbekistan relatively little with the rest of on issuing banknotes, rather went from a deficit of 3.5% of the world. like the European Central Bank. GDP to 15.8%. There was an Each member state, however, explosion of debt right across had its own central bank, which the region. The pressures© 2012 The Futures Company. Some rights reserved. 16
  17. 17. on the system were intense. Although all eyes have been Finally, an analysis of theIn the summer of 1992, the on the possibility of Greece ruble-zone shows that thethree Baltic states, Latvia, being the first country to leave countries with the lowestLithuania and Estonia, all the eurozone, it could also be fiscal deficits made theof which had been fairly a country such as Finland, swiftest recovery. The samefiscally responsible, quit perhaps to preserve its may be true if the eurozonethe system and established triple-A rating. does break-up; the lower thetheir own currencies. Soon debt burden on leaving theafterwards, the remaining Two: when the ruble-zone currency union, the easier itmembers introduced their broke up, it was a small will be to recover—althoughown currencies one after country that left first. It is the lower debt burden mayanother: the Armenian easier for a small country to come in the form of defaults.dram in November 1993, the leave than a big one becauseUzbekistan som in January it is doesn’t have to take The ruble-zone was an1994, and so on. Russia itself responsibility for destroying interesting experiment ineffectively pulled out of the the monetary system. If monetary union. In the end, itsystem with the introduction of Finland decided to suspend swiftly fell apart and was justa new ruble in 1993. Tajikistan membership—perhaps as quickly forgotten.staggered on with the ruble to preserve its triple-Auntil 1995, long after everyone rating—it could be presentedelse had given up on it.So what can the eurozonelearn from the ruble-zone?One: the strong countries leavefirst. It was the Baltic Statesthat were the first to exit thesystem. Why? Because theycould afford to. They were therelatively strong economies,with manageable fiscal deficits.By leaving the ruble-zonethey were swapping a chaotic as a minor adjustment. Ifcurrency for a relatively stable Germany leaves, it wouldand strong one (their own). be the end of the euro inIt is not hard to see the same its present form. Althoughincentives coming into play all eyes have been on thewithin the euro area. As the possibility of Greece beingcurrency staggers through the first country to leaveperpetual crisis, there is less the eurozone, it could alsoand less incentive for the be a small country such asFinns or the Dutch to stay in. Finland or Slovakia. 17 The future of the eurozone
  18. 18. What does the futureof the eurozone mean for mystrategic planning?The reason we use scenarios There are seven big trends that In Italy, for example, femaleis to help plan for uncertainty. we believe companies should participation in the workforceThis helps to ensure that we start planning for. is only 45%, compared withare less likely to be blindsided almost 70% in the UK, andby changes in the external more than 70% in Sweden. Itenvironment or even the New consumers is one of the lowest rates in theoperating environment, OECD.are more likely to identify One: Italian women go outrisks to target operating to work Female labor participation ismodels, and are better one of the major determinantstuned to opportunities for If the euro is to survive, the of economic growth forimprovements in service and peripheral countries will need advanced industrial societies.operational effectiveness. to undergo massive socio- Since GDP is simply averageWhichever of the scenarios economic change to close output multiplied by thesketched out above turns the gap in competitiveness numbers of workers, andout to be the most accurate, with the core euro members. since both productivity andthe eurozone economy will The huge imbalances in the overall populations are notlook very different in 2020 system are caused by the gap changing significantly, one offrom the way it looks today. in competitiveness, so it is only the few ways to increase GDPThe striking thing about the by closing this gap that the substantially is to increase thefuture of the eurozone is that currency union can become numbers of women working.the only uncertainty about more stable.the consequences described If Italy is to close itsbelow is their timing. This has huge implications competitiveness gap with the for many sectors of society. rest of the eurozone, it has to Italian women are amongst the least likely in the OECD to be in paid work 80 70 60 50 40 30 20 10 0 SE DK UK US AU DE JP FR OECD KR IT Source: OECD© 2012 The Futures Company. Some rights reserved. 18
  19. 19. 90 2000=10085 13080 Ireland 125 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 120 Greece 115 EU unemployment rates by gender to become stable again, the 22 competitivenessSpain gap between 110 thePortugal periphery will core and the 21 Italy have to be closed, as we have 20 105 argued above. One of the key France 19 100 ways of doing this will be to % 18 deregulate labor markets so 17 95 that more jobs are created. 16 If the euro is to survive, 90 Germany restructuring of labor markets 15 is an essential condition. If the 14 85 periphery economies leave the I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV euro, their new currencies will 80 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 EA17 EU27 have to be massively devalued, 2000 2000-December 2011, seasonally adjusted. 2006 2007 2008 2009 boom. Source: European Commission. January 2001 2002 2003 2004 2005 creating new jobs as exports 2010 120 enable more women to work, with all the peripheral Either way the present 110 to be hitting UK levels by 2020. eurozone countries, youth unsustainable rates of youth This has100 major implications unemployment rates are very unemployment will start to fall. for the consumer market. 22 90 high, and continue to grow. Working women consume very 21 This is partly because of This has major implications for 80 differently from non-working 2008 2006 2007 20 the severe recessions 2011 2009 2010 in the consumer markets. At the risk women, and family structures peripheral countries, but also of stating the obvious, young and spending are very different19 because of restricted labor people with jobs spend very in societies where it is the % 18 markets which offer very high differently from young people norm for women to be in work. levels of social protection to without jobs. Apart from 17 the employed, at the expense anything else, they have more This will present huge 16 of the unemployed. money. Property will boom as opportunities for companies they move out of their parents’ 15 that make products and This will have to change. If houses, and so will retail and provide services for working 14 the European economy is leisure spending. women. Again, there is I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 much potential in Italy for Where’s that boom? – EU27 EA17 foreign companies who have German retail sales 2006-2011 experience in addressing this market. 120 110 Two: The young Europeans get jobs 100 90 Spain now has a youth unemployment rate of 50%, 80 compared with just over 2006 2007 2008 2009 2010 2011 20% in 2005. In common Source: Bundesbank. 19 The future of the eurozone
  20. 20. Changing leisure; those sectors, along goods targeted at working with financial services, will see women as female participationnational potentially strong growth. in the economy rises.economies Four: The periphery Five: Poland will be Europe’sThree: Germany becomes a will grow faster financial powerhouseconsumer economy The eurozone has been getting Imagine in 2020 you areIn all scenarios, Germany steadily more and more looking for Europe’s financialneeds to boost consumption. unbalanced. The core grows powerhouse. A country withDespite a booming economy, faster, while the periphery low debt, a growing economy, aGerman retail sales have been declines. As we have argued thriving private banking system,flat (see graph on previous above, this is unsustainable. and a large population. Therepage). It can happen because One way or another it will have will only be one country thatthe euro collapses, and the to change. Whether this is meets all those criteria: deutsche mark soars in via the break up of the singlevalue, making imports very currency and revaluations of Poland’s government deficitcheap and exports expensive. the new national currencies, was 5.9% of GDP in 2011Or it can happen because or by the periphery and will drop below 2.9% inSpain and Italy and the other making massive strides in 2012. Government debt as aperipheral countries become competitiveness remains to be percentage of GDP will fall tofar more competitive, and seen. But the gap will get closer. 52% next year. GDP is forecastexport more to Germany, to grow by 2.5% in 2012 evenwhile reducing their imports The consequence will be that as the eurozone slips intofrom that country. Either way, 2010-2020 will be a mirror recession. And with 38 millionGermans will have to image of 2000-2010. It will people, it has a substantial andconsume more. be Spain, Italy, Portugal and skilled population. As countries Greece that are among the such as France lose theirThat means Germany will fastest growing eurozone triple-A rating, and nationsneed to grow its leisure, retail, economies. The core— such as Britain drift away fromproperty and financial services Germany, the Netherlands, the core of the EU, there will besectors hugely. Paradoxically, Finland, and Austria—will grow space for Poland to develop anits economy will have to more slowly. increasingly assertive voice.become a lot more like theUK’s (while the UK is trying The boom in the peripheral By 2020, Germany will beto become a bit more like countries will be concentrated struggling with restructuringGermany). in manufacturing and exports its economy, and coping with because it is the export sector a bankrupt banking systemThis will present huge that has to grow to claw back (see point six, below). Polandopportunities for companies lost competitiveness. This will be the EU’s powerhousein those sectors, both means there will also be strong economy—and the one marketdomestic and foreign. German growth in property and leisure no major company can affordcompanies are not traditionally as youth unemployment to ignore.strong in retail, property and declines, and in consumer© 2012 The Futures Company. Some rights reserved. 20
  21. 21. Sectoral They will operate far more like highly-regulated utilities. If the euro area fragments, or some countries peel away,impacts companies will feel compelled Seven: National production to start producing more locallySix: Banking systems will makes a comeback again. It will be the only waybecome publicly controlled to insure themselves against The euro has become an currency movements.The French and German banks engine of de-industrializationhave massive exposure to across many of the peripheral Indeed, even the risk of aperipheral country debts. For nations. When Europe had return to national currenciesexample, France has $548 national currencies, the will encourage companies tobillion of exposure to Italian only way to protect your re-think production strategies.debt, according to data from business in the long-term A company selling to thethe Bank for International from currency fluctuations Greek market, for example,Settlements. Germany has was to build factories in all the can no longer count on Greecean exposure of $212 billion. main nations—in Spain for the being in the euro in 2020.French banks have $140 billion Spanish market, in Germany Moreover, if, as we predict, aand $160 billion of exposure for the German market, total or partial break-up of theto Spanish and German banks and so on. Once currency eurozone is accompanied byrespectively.Our view is that some form Debt defaults within Europe areof default on peripheral inevitable - and when it happenscountry debt is inevitable.It may happen within the there will be huge losses in Europe’seuro, through negotiatedhaircuts. Or it might happen banking systemby countries leaving thesingle currency. But one wayor another it will happen. fluctuations were abolished a retreat of the single market,Unsustainable debt is precisely forever with the introduction of then companies will also needthat—unsustainable. Therefore the euro, no one had to worry to build local production hubsit will be reduced. about currency movements to insure themselves against a anymore. It made more sense rise in protectionism.When it happens, there to build one huge factory towill be huge losses in the serve the whole of Europe. For all those reasons, thebanking system. The scale industrial map of Europeof the bail-outs required will will gradually become morelead to nationalization – decentralized, and productionjust as it did with the Royal will move back to being closerBank of Scotland in the UK. to the point of consumption.Nationalized banks will beconservative, risk-averse andreluctant to pay bonuses. 21 The future of the eurozone
  22. 22. Conclusion unravels (as in Scenario 5) Seven trends the outcomes described in which will Sometimes, when you use futures methods to look this report are likely rather than unlikely. They present shape Europe further ahead, the work turns significant opportunities for around and surprises you. So it businesses, as well as some after the euro- is in the research and analysis risks. Corporate strategists zone crisis – done for this report. would be foolish not to start planning for them. at a glance There is so much focus by politicians and public officials 1. Italian women go out in managing the crisis, with These changes to work - making the media coverage of the day Italian economy more to day drama of the politics will take time, productive and much emphasis in the commentary on the dangers and when they 2. Young Europeans get jobs - and start of default, that there has been do occur, they spending money little consideration of what might lie on the other side of will unfold 3. Germany becomes a consumer economy - the crisis. unpredictably more spent on leisure and retail It is worth underlining, then, that the sometimes startling 4. The European findings in this research start periphery states from only two uncontentious will grow faster assumptions. Both are than the middle - uncontentious. The first is either because of restructuring or that economic crises do not devaluation go on forever. The second is that because of the systemic 5. Poland will become nature of macroeconomics, Europe’s financial crises are resolved only by powerhouse - gaining the rewards of rebalancing the system: prudence nations with large surpluses need to reduce them to enable 6. Banking systems those with large deficits to will end up in public bring them down. ownership - overloaded with debt Of course, such changes 7. National production take time, and they unfold makes a comeback unpredictably. Although - to help manage scenarios are usually about currency risks helping to plan for uncertainty, unless the European Union© 2012 The Futures Company. Some rights reserved. 22
  23. 23. Endnotes 1. Carmen M. Reinhart and Ken Rogoff, 2009. This Time Is Different: Eight Centuries of Financial Folly. Princeton University Press. 2. Richard Koo, 2011. ‘The world in balance sheet recession: causes, cure, and politics’, Real World Economics Review, Issue no. 58 3. David Harvey, 2010. Enigma of Capital. Profile Books 4. BBC News 2012 - ‘Three big questions for the eurozone’. [ONLINE] Available at: news/business-16367653 [Accessed 31 December 2011]. 5., Spain Misses Deficit Target, Sets Cuts’, 2012. Spain Misses Deficit Target, Sets Cuts - [ONLINE] Available at:http://online. 0204720204577130382564753536. html. [Accessed 12 January 2012]. 6. Carmen M. Reinhart and Ken Rogoff, 2009. Ibid 7. Blackburn, R, 2011. ‘CRISIS 2.0’. New Left Review, 72 (November/ December)The future of the eurozone by Andrew Curryand Matthew Lynn is licensed under a CreativeCommons Attribution-NonCommercial-NoDerivs3.0 Unported License. 23 The future of the eurozone
  24. 24. The Future of the Eurozone was written byAndrew Curry of The Futures Company andMatthew Lynn of Strategy Economics. S t r a t e g y E c o n o m i c sAbout The Futures Company S t r a t e g y E c o n o m i c sThe Futures Company is the leading global foresightand futures consultancy. We are a team of consultants,researchers and futures experts who apply a foresighta andi gc y S t r t e E c o n o m sfutures approach to unlock new sources of growth for ourclients. We offer a range of subscription services and researchand consulting solutions. We have teams in the UK, US,Mexico, Brazil and Argentina and partnerships in China, Indiaand Poland. We are a Kantar company within WPP.The Future of the Eurozone© The Futures Company, 2012.Published under a CreativeCommons licence, with somerights reserved.Designed by Augustus Newsam.Will Galgey, Global CEOT: +44 (0)20 7955 1818will.galgey@thefuturescompany.comwww.thefuturescompany.comwww.© 2012 The Futures Company. Some rights reserved. 24