Whither the Euro?

Thomas F. Stephenson (Ambassador to Portugal, 2007-2009)


As the debt and growth crisis has worsened in Europe in recent months, many have wondered and asked if the Euro currency is a flawed concept.  Is it possible to have a functional joint currency for a collection of countries with widely divergent cultures and economies while there exists only very limited ability on the part of the Euro governing bodies to enforce any fiscal discipline on the part of its member countries?  As ambassador to Portugal in the latter part of the Bush Administration and during the first six months of the Obama Administration, I gained some modest appreciation for some of the relevant issues on this subject.  As one of the so called PIIGS (Portugal, Ireland, Italy, Spain, and Greece), Portugal has been in the middle of the sovereign debt crisis in Europe, and is, in some ways, an interesting proxy for what ails the Euro.


Portugal, as a relatively backward Mediterranean country and economy in the 1980’s, was a huge beneficiary of the formation of the EU and the common currency.  Access to low cost Euro debt enabled Portugal to make very dramatic and much needed additions to the country’s basic infrastructure.  But large amounts of debt were also incurred to fund lots of public works projects that had little positive impact on economic growth and long term job creation in the private sector.  While Portugal is hardly alone among EU members in having too much dependency on the State for employment and job growth, the country lacks the entrepreneurial and risk taking culture and proclivities of some of its EU neighbors, and thus struggles mightily to create jobs in the private sector and generate significant growth in GDP.  When I left Lisbon in the summer of 2009, Portugal was certainly suffering from some of the effects of the expanding financial crisis that emanated from the bursting of the US housing bubble.  Unlike its neighbor Spain, however, Portugal had no housing bubble of its own, and on the surface its banking system did not appear to be in bad shape.  The crisis of confidence in European sovereign debt, however, precipitated by Greece, initiated much closer scrutiny of Portuguese sovereign debt and its holdings by the country’s commercial banking system.  The combination of the huge amounts of sovereign debt accumulated during the period of availability of low cost Euro bond financings, a general lack of public sector spending discipline, and the inability to grow the economy at an adequate pace, have caused a  crisis of confidence in Portugal’s ability to fulfill its debt obligations at the same time as  the other PIIGS countries are experiencing their own crisis for many similar reasons.


On the surface, there might appear to be some attraction for Portugal and the other PIIGS countries to leave the Euro currency union and be able to adjust their exchange rates in a way that will deflate the value of their sovereign debt obligations.  One can also make a case that Germany and the other northern European EU members, who are having to fund the bail out of the PIIGS countries, might welcome the departure of the PIIGS and thus avoid the economic and domestic political costs of bailing them out.  As we’ve seen in recent months, it has been somewhere between difficult and impossible for the Euro currency members to reach a common understanding as to how a longer term restructuring will work.  Everyone understands that the various stopgap measures adopted to date won’t really solve the underlying structural problems presented by the PIIGS economies today and possibly other Euro countries tomorrow.  The long term solutions to the union’s structural issues require a degree of fiscal discipline and a ceding of sovereignty that few, if any, of the members seem willing to accept.  Germany is the key to what happens.  As by far the largest and strongest economy in the union, Germany will bear the brunt of the burden in bailing out the underperformers, and will do what it perceives to be in its best interest.  Given the critical role that the Euro currency countries play as customers and trading partners for Germany’s export economy, it is very difficult to see how Germany can afford to let the Euro union disintegrate and dissolve.  It won’t be pretty, but Germany will do whatever is required to ensure that the Euro survives.