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April 2011

PARADISE LOST? THE EURO AFTER THE CRISIS

Benjamin J. Cohen

Department of Political Science University of California, Santa Barbara Santa Barbara, CA 93106-9420 tel: 805-893-8763 email: [email protected] home page: www.polsci.ucsb.edu/faculty/cohen

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ABSTRACT

The aim of this essay is to assess the implications of the global crisis for the euro’s prospects as an international currency. I begin with a brief look at the euro’s record to date, which shows clearly how much the money’s achievements in cross-border use have fallen short of aspirations, followed by a summary of the structural deficiencies that have been responsible for this disappointing outcome. I then focus on EMU’s agonizing experience since the start of the global crisis, which has left the euro battered and bruised. The euro has failed to mount a successful challenge to the global dominance of the U.S. dollar and is fated to remain a distant second to the greenback far into the foreseeable future.

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Can the euro make the grade as an international currency? Until recently, the global future of Europe’s joint money seemed secure. According to the euro’s many enthusiasts, it was only a matter of time before it would overtake the U.S. dollar as the world’s pre-eminent international currency (Chinn and Frankel 2008; Papaioannou and Portes 2008; Dehesa 2009). Polls taken in late 2008, just ahead of the euro’s tenth birthday, indicated that a majority of Europeans expected their money to surpass the dollar within as little as five years. The paradise of shared currency leadership with America’s greenback – perhaps even global dominance – seemed imminent, shimmering brightly on the horizon. But that was before the great crisis that struck the world economy in 2008, just as Europeans were preparing to celebrate completion of the euro’s first decade. Since then, a rash of sovereign debt problems around the periphery of Europe’s Economic and Monetary Union (EMU) has severely shaken confidence in the currency. The question of EMU’s survival is now on the table (Krugman 2011; Rodrik 2011). No less an authority than Paul Volcker has dramatically warned of the “potential disintegration of the euro.” Suddenly the prospect of a successful challenge to the greenback seems far less certain – perhaps even doomed. Has paradise now been lost? For some of us, the seductive vision of a globally dominant euro was always something of a mirage. I, for one, have long argued that Europe’s money suffers from a number of structural deficiencies that were bound to limit its appeal as an international currency (Cohen 2003, 2009, 2011). Recent experience has simply served to confirm that such skepticism was warranted. Paradise, I would argue, has not been lost: one cannot lose something that was never likely to be gained in the first place. The reality is that the euro has failed to mount a successful challenge to the greenback and is fated to remain a distant second to the dollar far into the foreseeable future, however much its enthusiasts might hope otherwise. The aim of this essay is to assess the implications of the global crisis for the euro’s prospects as an international currency. I begin with a brief look at the euro’s record to date, which shows clearly how much the money’s achievements in cross-border use have fallen short of aspirations, followed by a summary of the structural deficiencies that have been responsible for this disappointing outcome. I then focus on EMU’s agonizing experience since the start of the global crisis, which has left the euro battered and bruised. If anything, Europe’s money now seems further from paradise than ever. THE RECORD TO DATE The paradise envisioned by euro enthusiasts was always a bit vague. What does it mean to “overtake” the dollar? At issue is the degree or extent of use of a money for various international purposes—what is commonly referred to as currency “internationalization.” Crossborder usage of Europe’s currency was expected to grow. Without further explication, however, the notion of currency internationalization is ambiguous at best. In practical terms, at least three separate dimensions are involved: trajectory, scope and domain. To assess the euro’s achievements and prospects on the world stage, all three dimensions must be considered. By trajectory, I mean the path traced by the euro as its international use increases. Could the growth of usage be expected to continue ever upwards until parity with the dollar (or more) was attained, or was some ceiling likely to be hit short of that goal? By scope I mean the range of functional categories of use. Could euro usage be expected to grow for all international

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purposes, or just a select few? By domain I mean the geographic scale of use. Could euro usage be expected to expand across most parts of the globe, or in just a more limited number of countries or regions? Euro enthusiasts confidently expected that Europe’s currency would do well in all three dimensions. Cross-border usage would not bump up against a low ceiling and would be extensive in terms of both function and geography. In short the euro’s reach would in time span the globe, fully matching if not surpassing the dollar in both scope and domain. Reality, however, has turned out to be much duller. The vision of the currency’s fans proved unattainable. For a broad picture of what has really happened, there is no more authoritative source than the review of the international role of the euro published annually by the European Central Bank (2010). Data are provided on all three dimensions involved. With respect to all three, the ECB’s conclusions are unambiguous—and damning. The euro’s reach, it turns out, greatly exceeded its grasp. Concerning trajectory, the ECB observes that international use of the euro has decelerated noticeably and appears to have stabilized for more than half a decade. A fast early start was certainly to be expected, once market actors were persuaded that the euro was here to stay. From the moment of its birth, Europe’s new money clearly enjoyed many of the attributes necessary for competitive success. These included a large economic base in the membership of the euro zone, initially numbering some 11 countries—including some of the richest economies in the-world—and now up to 17 partners. They also included unquestioned political stability and an enviably low rate of inflation, all backed by a joint monetary authority, the ECB, that was fully committed to preserving confidence in the currency’s future value. Moreover, there was every reason to believe that sooner or later the global position of the dollar would weaken, owing to America’s persistent payments deficits and looming foreign debt. Hence it was no surprise that in the euro’s early days, use seemed to be expanding exponentially. “Momentum has led to an increase in the international role of the euro,” proclaimed the ECB in 2002 (European Central Bank 2002: 11). But subsequently, it is plain, that momentum slowed considerably. After its fast start, which appears to have peaked sometime around 2003-2004, “international use of the euro,” the ECB now ruefully concedes, “has remained relatively stable relative to that of other international currencies” (European Central Bank 2010: 13). In effect, the euro has done little more than hold its own as compared with the past aggregate market shares of EMU’s “legacy” currencies. Given the fact that Germany’s old Deutsche Mark had already attained a number two ranking in global monetary relations, second to the greenback, anything less would have been a real shock. But beyond that, a ceiling does indeed appear to exist. Straight-line extrapolation of the euro’s early acceleration far into the future does not seem to have been warranted. Likewise, with respect to scope, it is evident that growth of euro usage has been uneven across functional categories. The expansion of international use has been especially dramatic in the issuance of debt securities, reflecting the growing integration of EMU financial markets. There has also been some modest increase in the euro’s share of trade invoicing and central-bank reserves. But in other categories, such as foreign-exchange trading or banking, the dominance of the dollar remains as great as ever. The ECB’s (2008 : 7) polite way of putting this is that use of the euro has been “heterogeneous across market segments.” The picture is also clear with respect to domain, which is sharply bifurcated. For the most part, internationalization of the euro has been confined to countries with close geographical

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and/or institutional links to the euro zone—what might be considered EMU’s natural hinterland. “The euro’s turf,” economist Charles Wyplosz (1999: 89) calls it. These countries include the newest members of the EU, all destined eventually to join the monetary union, as well other candidate states (for example, Croatia or Montenegro) and non-member neighbors like Norway and Switzerland. They also include many of the nations around the Mediterranean littoral as well as a good portion of sub-Saharan Africa. In these countries, where trade and financial ties are deep, the euro obviously enjoys a special advantage. Elsewhere, in stark contrast, scale of use drops off abruptly, and Europe’s currency remains very much in the greenback’s shadow. The evidence, concludes the ECB (2010: 7), clearly confirms “the strong regional character of the euro’s international role.” STRUCTURAL DEFICIENCIES The reasons for the euro’s disappointing record as an international currency are by now familiar (Cohen 2003, 2009, 2011). Europe’s money is handicapped by several critical shortcomings, all structural in character, that severely limit its appeal as a rival to the greenback. These include relatively high transactions costs; a serious anti-growth bias; and, most important, ambiguities at the heart of the monetary union’s governance structure. Transactions costs First is the cost of doing business in euros. Transactions costs directly affect a currency’s attractiveness as a vehicle for exchange transactions or international investment. From the start, it was clear that the dollar would be favored by the natural advantage of incumbency unless euro transactions costs, which began high relative to the widely traded greenback, could be lowered to a more competitive level. That, in turn, would depend directly on what could be done to improve the structural efficiency of Europe’s financial markets. In practical terms, much has been accomplished to knit together previously segmented national markets, particularly at the wholesale level. Efficiency gains have been substantial. Yet for all that effort the dollar’s cost advantage has persisted, discouraging wider use of the euro. The core problem has long been evident. As many informed observers have emphasized (e.g., Cooper 1999), the euro was condemned to remain at a disadvantage vis-à-vis the dollar so long as EMU was unable to offer a universal financial instrument that could match the U.S. Treasury bill for liquidity and convenience. This was a deficiency that would remain impossible to rectify so long as the euro zone, with its diverse national governments, lacked a counterpart to the federal government in Washington. The public debt market was fragmented – not one but more than a dozen separate markets, with nothing in common other than the currency of denomination. The best the Europeans could hope to do was encourage establishment of selected benchmark securities to help guide trading. Gradually three euro benchmarks emerged, including the Italian bond at two years, the French bond at five years, and, most importantly, the German bond at ten years. But such a piecemeal approach fell far short of creating a single market as large and liquid as that for U.S. government securities. The greater depth and convenience of the U.S. Treasury market was bound to give a sustained advantage to the greenback.

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Anti-growth bias Second is a serious anti-growth bias that appears to be built in to the institutional structure of EMU. By impacting negatively on yields on euro-denominated assets, that bias could be expected to directly affect the currency’s appeal as a long-term investment medium. When the euro first came into existence, eliminating exchange risk within the European region, a massive shift was predicted in the allocation of global savings as compared with holdings of European assets in the past. But as the ECB has repeatedly noted in its annual reviews, international portfolio managers have in fact been quite slow to commit to Europe’s joint money. Liquid funds have been attracted when there was a prospect of short-term exchange-rate appreciation. But underlying investor preferences have barely budged, in good part because doubts persist about longer term growth prospects in EMU countries, which have been trending downward for decades. Many factors, as we know, contribute to the slowing of Europe’s trend rate of expansion—aging populations, which limit manpower increases and overload old-age pension systems; rigid labor markets, which hinder economic adaptability; and extensive government regulation, which can constrain innovation and entrepreneurship. EMU, regrettably, added yet one more brake on growth. The core problem here, as is well known, lies in EMU’s institutional provisions governing monetary and fiscal policy, two key determinants of macroeconomic performance. In neither policy domain is priority attached to promoting output. Rather, in each, the main emphasis is on other considerations that tend to tilt policy toward restraint, producing a distinct anti-growth bias for the euro zone as a whole. On the monetary policy side, the European Central Bank was mandated to focus exclusively on fighting inflation, even if over time this might be at the cost of stunting growth. Similarly, on the fiscal policy side, members sought to institute formal rules to prevent excessive sovereign borrowing from the euro zone’s common savings pool, even if this might be at the cost of inhibiting contra-cyclical stimulation when needed. Though the monetary union’s first attempt in this regard – the controversial Stability and Growth Pact, setting a strict cap on public deficits at 3 percent of gross domestic product (GDP) – turned out to be something of a failure, the search for effective budget constraints has lived on and remains a high priority. Is it any wonder, then, that the anticipated shift of global savings has turned out to be illusory? Governance Finally, there is the governance structure of EMU, which for the euro’s prospects as an international currency may be considered the biggest handicap of all. The basic question is: Who is in charge? The answer, regrettably, has never been obvious. Effectively, the euro is a currency without a country, the product of an inter-state treaty rather than the expression of one sovereign power. For outsiders, therefore, Europe’s money could be considered only as good as the political agreement underlying it. From the start, uncertainty reigned concerning the delegation of authority within EMU among national governments and EU institutions. Consider, for example, the question of financial stability. Who, ultimately, was to be responsible for crisis prevention or the management of financial shocks? Under the Maastricht Treaty, the EMU’s founding document, no specific tasks were assigned to the ECB to help forestall crises. Though linkages among financial markets were expected to grow, increasing the

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risk of contagion should troubles hit, the ruling principle remained decentralization, otherwise known as subsidiarity—the notion that the lowest level of government that could efficiently carry out a function should do so. Formal authority for prudential supervision and regulation continued to reside at the national level, as it did before EMU. Each member was charged with responsibility for the financial institutions based within its own national borders. Watchful observers repeatedly warned about the risks of such a fragmented governance structure, which left EMU remarkably unprepared to cope with any major disruption. In the words of the International Monetary Fund (IMF 2007: para. 12): “The core problem is the tension between the impulse toward integration, on the one hand, and the preference for a decentralized approach, on the other…. This setting rules out efficient and effective crisis management and resolution.” No one, it seemed, was directly accountable for the stability of the euro zone as a whole. The risk that regulatory authorities might work at cross-purposes, provoking or aggravating a crisis, was effectively discounted. Or consider the issue of fiscal policy. Though responsibility for monetary policy was now consolidated in a single institution -- the ECB -- fiscal policy remained decisively in the hands of individual governments, subject only to the week reed offered by the Stability and Growth Pact or other attempts at rule-making. De facto, some degree of fiscal coordination was sought through the Eurogroup, the euro zone’s informal committee of finance ministers, which soon began meeting on a regular basis. But since the ruling principle within the Eurogroup is consensus, effectively giving each participant a potential veto, it was clear from the start that the committee could hardly be expected to be in a position to impose its will on individual members. The Eurogroup was obviously no substitute for a genuine economic government for EMU. Finally, there was the issue of external representation. Who was to speak for the euro zone on broader macroeconomic issues such as policy coordination, crisis management, or reform of the international financial architecture? Here the Maastricht Treaty had no answer at all, leaving a vacuum at the heart of EMU. No single body was formally designated to represent the bloc in international discussions. As a result, Europe was at a permanent disadvantage in any effort to exert influence. EMU, lamented euro enthusiast Fred Bergsten (2005: 33), “speaks with a multiplicity, even a cacophony of voices…. Hence it dissipates much of the potential for realizing a key international role.” At a minimum, the treaty’s silence compounded confusion about who was in charge. At worst, it condemned the euro zone to lasting second-class status, since it limited the group’s ability to project power on monetary matters. CRISIS And then came the global crisis, which was bound to put EMU’s governance structure to the test. To the chagrin of euro enthusiasts, the test appears to have been failed badly. While the U.S. Treasury and Federal Reserve were able to react to developments decisively and with some degree of alacrity (if not always with great efficacy), European governments remained divided and uncertain. The ECB did what it could to inject liquidity into the system—but under the Maastricht Treaty that was all it could do. National authorities, in the meantime, clung to a piecemeal, patchwork approach that certainly has done little to bolster confidence in Europe’s joint money. The political agreement underlying EMU, said a prominent German journalist (New York Times, 2 March 2009), has proved to be no more than a “fair-weather system,” incapable of handling the rougher foul weather that descended on Europe from 2008 onward.

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All EMU’s structural deficiencies came to the fore, like chickens coming home to roost. At first, Europeans were inclined to breathe a sigh of relief. Monetary union, they felt, had actually reduced their vulnerability to the kind of financial tsunami that was engulfing nations elsewhere. In the past, a crisis like this one might have triggered waves of speculation against the EU’s weaker currencies, creating a maelstrom of monetary instability. But now, with a single joint money replacing a gaggle of national currencies, participants no longer had to fear the risk of exchange-rate disturbances inside their bloc and, in combination, were now better insulated against turmoil elsewhere. As The Economist (3 January 2009) commented at the time: “Being part of a big club has made a currency run far less likely.” For a continent long plagued by monetary instability, that seemed no small accomplishment. Moreover, with the growing acceptability of the euro outside EMU, members now enjoyed a much improved international liquidity position. Deficits that previously would have required foreign currency could now be financed, at least in part, with Europe’s own money. Europeans could be forgiven for thinking that, for them at least, the worst had been averted. It soon became apparent, however, that they were wrong. Speculative tensions had not been eliminated. They were simply diverted -- from currency markets to the market for government bonds. Prior to the crisis, investors had barely distinguished among the securities of different governments in the euro zone; spreads over the key ten-year German bond remained remarkably narrow, rarely going even as high as one-half of one percent (50 basis points). But by 2009 the climate had shifted. Instead of betting on exchange rates, investors began to bet on sovereign debt, with the greatest attention focused on weaker bloc members like Portugal, Ireland, Greece, and Spain – the so-called “PIGS,” with their massive liabilities and gaping budget deficits. For all four PIGS, credit ratings soon were being downgraded and spreads started to widen dramatically – at times, to as much as 300-400 basis points or more. After “a brief moment in the sun,”as The Economist put it (7 February 2009), EMU found itself increasingly threatened by looming storm clouds of potential default. By 2010, emergency bailouts had to be arranged for both Greece and Ireland, followed in early 2011 by Portugal. Many feared that the monetary union might well be torn apart by mounting financial-market pressures. At time of writing (mid-2011), the storm clouds had still not safely passed. Could EMU’s sovereign debt problems have been avoided? At least two possibilities come to mind. On the one hand, governments might have agreed to do all their borrowing through some kind of common “Eurobond,” backed by the “full faith and credit” of the collective partnership. Had public debt markets been unified from the start, weaker members would never have been exposed to the same risk of investor attack. Debt crises at the state level would have become as unthinkable as exchange-rate disturbances. In addition, there would also have been the ancillary benefit of offering a more effective rival to the U.S. Treasury market. On the other hand, in the absence of a common Eurobond, governments might have put more effort into devising truly binding rules for fiscal policies, going well beyond the unenforceable provisions of the Stability and Growth Pact. The firmer the budget constraints in place, the lower would have been the chance of excessive borrowing by any one of the partners. Default risk might not have been eliminated entirely, but it could have been reduced substantially. Neither possibility, however, had even the remotest chance of being politically acceptable. Ever conscious of their privileges as sovereign states – and ever sensitive to the demands of their domestic voters – members were simply not ready to surrender control over budget policy to their peers. A genuine economic government for EMU was never seriously

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considered. As a result, when the crisis struck, Europeans were utterly unprepared to cope, just as the IMF and others had warned. All the ambiguities of the monetary union’s governance structure were laid bare for the world to see. Europe, summarized economist Paul Krugman (New York Times, 16 March 2009), “is turning out to be structurally weak in a time of crisis.” After a gradual build-up of tensions throughout 2009, attention began to focus on Greece, where a newly elected government in October 2009 revealed that the government’s budget deficit, at some 13.6 percent of GDP (later revised upward to 15.4 percent), was far worse than anyone had previously realized. By early 2010 Athens seemed on the verge of default. The first reaction of Greece’s EMU partners was denial. “There is absolutely nothing to these rumors,” said a German finance ministry spokesperson (New York Times, 29 January 2010). “They are without foundation.” And then came carefully worded assurances of “determined and coordinated action” (to quote from the communique of a February summit of EU leaders), conveniently silent on what form that action might take. But these rhetorical devices merely served to delay the inevitable. After months of rising market pressures – and much agitated debate and negotiation among European governments – a rescue package for Greece was finally announced in late March, combining a promise of loans from EMU partners together with help from the International Monetary Fund (IMF). Once details were thrashed out over the next month, the total amount of aid came to some €110 billion (nearly $150 billion) in all. Though many breathed a sigh of relief, the general reception among informed observers was tepid at best. The Greek bailout, commented columnist Martin Wolf (Financial Times, 30 March 2010), “was not a solution but a fudge.” With “underlying tension unresolved,” added the Washington Post (26 March 2010), the package actually “could erode perceptions of the euro as a global currency.” The Financial Times (26 April) described the whole protracted process as “an exercise in cat-herding.” Few were surprised, therefore, when tensions emerged anew after the hiatus of Europe’s long summer holiday. Attention now focused on Ireland, whose government found itself overwhelmed by the expense of backstopping the country’s banks following collapse of the local housing market. In September, an already high budget deficit of 12 percent of GDP soared to 32 percent, nearly a third of GDP, as a result of fresh capital infusions into the banking system. Yet again, as with Greece, it took months of rising market pressures and much frenzied negotiation before agreement could be reached in November on the terms of a rescue – a loan package totaling some €85 billion (including €17.5 billion from domestic Irish sources). And again the reception was tepid at best. For the New York Times (28 November 2010), “it remained unclear whether enough had been done.” For The Economist (20 November 2010), Ireland’s bailout failed to resolve the “real problem,” which was “the absence of a credible plan to deal with errant countries.” For Martin Wolf (Financial Times, 30 November 2010), “the fault lines in the currency union stand revealed.... The question is whether the union will survive.” And just four months later came Portugal, following what by now was becoming a depressingly familiar script. Denials went on for months, despite intensifying market pressures and repeated downgrades by credit-rating agencies. Then finally, in April 2011, the Portuguese government caved in, suddenly applying for help following parliamentary defeat of a package of domestic austerity measures. The bailout was expected to amount to some €80 billion. Reactions, predictably, were once more unenthusiastic. EMU’s latest rescue could be seen as one more example of what economists Jean Pisani-Ferry and Adam Posen (2009: 2) describe as “the defensive crouch in which European policymakers continue to treat shocks to the euro

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area.” Commented Irwin Stelzer of the Hudson Institute (Wall Street Journal, 28 March 2011): “The euro-zone summiteers seem to have concluded that if at first you don’t succeed, continue making the same mistake.” Martin Wolf (Financial Times, 29 March 2011) called it “the perils of Pauline route to integration.” A defensive crouch, lurching from crisis to crisis, hardly seemed likely to bolster confidence in the euro’s prospects as a global currency. RESPONSE Europeans, of course, are not unaware of the inadequacies of their “fair-weather system” and understand the need to resolve the “real problem.” Along with their serial bailouts, therefore, they have also undertaken a number of initiatives intended to make EMU better able to handle foul weather in the future. In principle, the aim has been to bring the euro zone closer to something approximating a genuine economic government. In practice, however, members have remained as protective of their sovereign privileges as ever, leaving most of the ambiguities of the monetary union’s governance structure essentially untouched. Underlying structural deficiencies have still not been forcefully addressed. Stung by Greece’s near-default – what many referred to as EMU’s own Greek tragedy – the EU moved in May 2010 to create a more formal safety net for troubled debtors. Two new lending windows were opened: a European Financial Stabilization Mechanism (EFSM), endowed with €60 billion available to all EU countries; and a much larger European Financial Stability Facility (EFSF) for euro-zone members only. The EFSF was established for a period of three years with total resources advertised at €440 billion. Together with a parallel pledge from the IMF of an additional €250 billion if needed, this meant a total of €750 billion (close to one trillion dollars) might now be available to sustain investor confidence. The hope was to calm the financial waters with what amounted to an overwhelming show of force – a strategy of “shock and awe,” as it were, to forestall any further spread of default concerns across Europe.. The impact, however, was short-lived. Observers were quick to note critical weaknesses – most importantly, the fact that no money was actually being provided up front. The EFSF, designed specifically as a backstop for the euro, was not actually a fund. Rather, EMU governments merely committed to backing a borrowing mechanism, a so-called “special purpose vehicle,” that would be authorised to raise money by issuing debt should a member country find itself in trouble. Moreover, not all of the €440 billion would actually be available for lending, since some of the cash raised would have to be held in reserve to protect the EFSF’s triple-A credit rating, and all euro-zone governments would have to agree to the loan. In practice, not more than €250 billion might truly be usable in the event of an emergency. Nor did the strategy do anything to ensure a greater degree of fiscal discipline to reduce the risk of future crises. The general sense was that the Europeans were still far from a real solution to their problems. In the words of The Economist (15 May 2010), “the rescue plan has a patched-together feel.... The package, impressive though its scale and speed may be, only buys time for troubled governments.” Within months, therefore, Europe’s leaders were forced back to the drawing board, to try again to calm the waters. In November, simultaneous with the Irish rescue, agreement was announced on the creation of a permanent new lending arrangement – the European Stability Mechanism (ESM) – to succeed the EFSF (in combination with the smaller EFSM) at the end of

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its three-year life in 2013. Loans from the ESM would be available to deal with any future debt crises, and new policy rules would be implemented to curb the risk of renewed fiscal excesses. An early warning system, with closer monitoring of national budgets, would be put in place, and enforceable penalties would be imposed in the event of errant behavior. At last, it appeared, the euro zone would get its house in order, deepening the degree of integration among its members. Governments would now be much more intimately involved in one another’s tax and spending policies. Gloated Olli Rehn, the EU’s economic commissioner (The Economist, 4 December 2010), “if the 1990s was the decade of constructing the EMU and the 2000s the decade of turning it into a reality, we are now at the beginning of the decade of fundamental reform.” Most details, however, were left for subsequent negotiation, which only served to perpetuate market uncertainties. The ESM would require ratification as a limited change to the European treaties. Governments commenced to argue about everything from the size of the ESM to the indicators that would be used to evaluate fiscal policy. Many looked to Germany, the EU’s wealthiest member, for leadership. But Berlin – caught between the needs of its EMU partners and the resentments of its domestic taxpayers – repeatedly vacillated, while potential debtors took every opportunity to water down proposed disciplines. Within months it was clear that the idea of truly enforceable penalties had fallen by the wayside – and for all the usual reasons. Commented columnist Wolfgang Münchau (Financial Times, 20 March 2011): “We know from experience that the heads of state and government are too interdependent. They need each other. They do not slap sanctions on one another. Can you imagine the Council imposing a fine on France?” One might add: Can you imagine a fine on France, if imposed, ever being paid? In March 2011, a euro-zone summit took what German chancellor Angela Merkel called a “big step forward” by agreeing on a capital structure for the proposed ESM: a total capital of €700 billion, of which €80 billion would actually be paid in over three years, sufficient for a lending capacity of €500 billion. However, the effect was vitiated when Mrs. Merkel, under pressure from voters at home, almost immediately changed her mind, demanding that there should be no up-front payment and that funding should take place over five years rather than three. The summiteers also signed a fresh new “Pact for the Euro,” once again pledging to achieve closer economic coordination. But since the pact was no more than a reiteration of principle, lacking any effective powers of enforcement, it was not clear how much progress this actually represented. Many observers concurred with the judgment of The Economist (2 April 2011) that the result was “something between a fudge and a failure... Leaders fell short on almost every task they set themselves.” At time of writing most features of the new crisis regime remained undecided, leaving EMU as structurally weak as ever. CONCLUSION So has paradise been lost? Certainly recent experience has given little reason to anticipate any major improvement in the euro’s disappointing record as an international currency. The chance was there. Indeed, if there was ever to be an opportunity to tip global preferences away from the dollar, it should have been during the last three years, following the sub-prime mortgage collapse in the United States, when the soundness of America’s entire financial structure was thrown into question. Yet even when the greenback seemed most vulnerable, Europe’s money failed to mount a successful challenge. Instead, all the structural

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deficiencies of EMU were vividly reaffirmed as members muddled their way through a succession of crises of their own. Not that this means that the euro’s days are numbered. Alarmists like Paul Volcker almost certainly go too far in suggesting that the monetary union may be facing disintegration. But neither would EMU’s performance since the start of the global crisis seem to give much encouragement to euro enthusiasts. My own view, which I have often expressed to my students and others, is that over the long term the euro will not succeed – but neither will it fail. It will not fail because the political commitment to its survival, in some form, simply runs too deep across the EU. But neither will it truly succeed because its inherent weaknesses are also too deep, as recent experience has sadly reaffirmed. The paradise of shared leadership with the greenback is simply out of reach.

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REFERENCES Bergsten, C. Fred (2005), “The Euro and the Dollar: Toward a ‘Finance G-2'?,” in Adam S. Posen, ed., The Euro at Five: Ready for a Global Role? (Washington: Institute for International Economics), 27-39. Chinn, Menzie and Jeffrey A. Frankel (2008), “Why the Euro Will Rival the Dollar,” International Finance 11:1, 49-73. Cohen, Benjamin J. (2003), “Global Currency Rivalry: Can the Euro Ever Challenge the Dollar?,” Journal of Common Market Studies 41:4 (September), 575-595. __________ (2009), “Dollar Dominance, Euro Aspirations: Recipe for Discord?,” Journal f Common Market Studies 47:4 (September), 741-766. __________ (2011), The Future of Global Currency: The Euro Versus the Dollar (London: Routledge). Cooper, Richard N. (2000), “Key Currencies after the Euro,” The World Economy 22:1 (January), 1-23. Dehesa, Guillermo de la (2009), “Will the Euro Ever Replace the US Dollar as the Dominant Global Currency?,” Working Paper 54/2009 (Madrid: Real Instituto Elcano). European Central Bank (2002), Review of the International Role of the Euro (Frankfurt: European Central Bank). __________ (2008), Review of the International Role of the Euro (Frankfurt: European Central Bank). __________ (2010), The International Role of the Euro (Frankfurt: European Central Bank). International Monetary Fund (2007), “Concluding Statement of the IMF Mission on Euro-Area Policies” (Washington: International Monetary Fund). Krugman, Paul (2011), “Can Europe Be Saved?,” New York Times Magazine, 12 January. Papaioannou, Elias and Richard Portes (2008), The International Role of the Euro: A Status Report, Economic Paper 317 (Brussels: European Commission). Pisani-Ferry, Jean and Adam S. Posen (2009), “The Euro at Ten – Successful, but Regional,” in Jean Pisani-Ferry and Adam S. Posen, eds., The Euro at Ten: The Next Global Currency? (Washington: Peterson Institute for International Economics), 1-15. Rodrik, Dani (2011), “Thinking the Unthinkable,” The International Economy (Winter), 44-45.

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Wyplosz, Charles (1999), “An International Role for the Euro?,” in Jean Dermine and Pierre Hilton, eds., European Capital Markets with a Single Currency (New York: Oxford University Press), 76-104.