November 26, 2018 / 3:02 PM / 14 days ago

Commentary: Euro at 20 - success amid all the flaws

LONDON (Reuters) - The euro turns 20 in January but came of age as the world’s number two currency some time ago.

File photo: A man receives several 50 euro bank notes from an ATM in this illustration picture taken in Zurich REUTERS/Arnd Wiegmann

After two decades of relentless critique and predictions of doom, the single currency has already outlived many of its harshest critics’ predictions when it was born in 1999.

But for all its well-documented flaws and all the blistering criticism of European monetary union, the euro has emerged after two decades with three notable achievements.

First, opinion polls show it garnering higher public support than at any point in those two decades.

Second, governments in the bloc’s most indebted countries have saved trillions of euros due to the lowering borrowing costs it offered.

And third, the European Central Bank has proven far more flexible and innovative in the face of periodic crises than even its strongest advocates thought possible when it was designed in the late 1990s.

While those conclusions mask the highs and lows of the intervening period, they are testament to the durability and adaptability of a system many - including Nobel laureate and U.S. monetarist Milton Friedman - felt was too rigid to get past its first full-blown recession.

In 2010, the year Greece received its first international multi-billion euro rescue package and Ireland was also bailed out, only 51 percent of respondents in an annual European Commission poll thought the euro was a good thing for their country.

The 2018 survey published last week showed that 64 percent of respondents across the euro zone said the euro was a good thing for their country, and almost three quarters said that they thought it was a good thing for Europe.

These are the highest levels of support since surveys began in 2002. In only two countries - Lithuania and Cyprus - do a majority of people think the euro is a bad thing.

Remarkably, despite the deep economic and social pain inflicted on them by the harsh terms of the rescue loans, 60 percent of Greeks say the euro is good for Greece, and 71 percent say it is good for Europe.

Attitudes in Italy are also revealing. Italian growth has been anaemic for years, Italy boasts the world’s third-largest debt burden, and the current populist government has in the past threatened to leave the euro.

Yet 57 percent of Italians think the euro is a good thing for Italy and 68 percent think it is a good thing for Europe, according to the European Commission poll.

Some 69 percent of the 17,589 respondents surveyed across all 19 euro zone countries said they favoured deeper economic coordination across the bloc, including budgetary policies. Only 7 percent said there should be less economic coordination.

Closer fiscal cooperation between the 19 nations will take years and maybe even decades for meaningful progress to become evident. Not so monetary policy under the auspices of the ECB, although the Frankfurt-based bank’s evolution over the last 20 years would also have seemed fanciful.

In the first few years of its existence the ECB was often shot at by both sides - criticised simultaneously for being too rigid in its obsession with keeping inflation capped at 2 percent as well as being responsible for “stealth inflation” surrounding the introduction of notes and coins in 2002.

Measured against other central banks governing single economies with decades - or even centuries - of history, the ECB’s policy-making process was often slated for being slow, cumbersome, and inadequate.

Teething problems, perhaps. But less than two years after the euro was launched at $1.1747 it had lost 30 percent of its value and was worth just $0.8240. The ECB, along with the other G7 central banks, successfully carried out several rounds of FX market intervention to prevent it from plunging any further.

“EURO PREMIUM”

But the euro survived that pummelling, demonstrating a resilience that would be critical in the crises of 2007-08 and 2010-12. It quickly began to establish itself as the world’s second most important currency.

Legacy euro currencies made up 17 percent of global FX reserves when the euro was launched, and a decade later the euro accounted for 27.6 percent of global reserves. It has ebbed and flowed since but never fallen below 20 percent, and foreign central banks now hold some 2.4 trillion euros as part of their hard currency reserves.

Then there’s the so-called “euro premium”, the money governments have saved due to euro membership bringing down borrowing costs.

Analysts at Unicredit estimate that Italy’s interest payments on its debt - the third largest in the world behind the United States and Japan - were around 900 billion euros lower than they would have been if Italy had not been in the euro.

During the 1990s the Italian/German yield spread widened to as much as 750 basis points, and for most of the decade it was over 300 bps. From the euro’s launch to the summer of 2008 just before Lehman collapsed, the spread hardly ever exceeded 50 bps, averaging around 25 bps.

It was a similar story in other “peripheral” euro zone countries, such as Spain, Greece and Portugal, saving these governments hundreds of billions of euros in debt-servicing repayments. Companies, households and individuals benefited too, resulting in an even bigger “saving”.

While the euro undoubtedly insulated more vulnerable economies in the bloc from global financial storm of 2007 and 2008, its own home-grown aftershocks a few years later posed a far greater test of the then teenage currency.

Yet over successive crises in its second decade, a combination of negative interest rates, trillions of euros in cheap loans to banks and a 2.6 trillion euro asset purchase programme dramatically and successfully reined in troubled countries’ borrowing costs.

These are extraordinary policy steps from any central bank. They are even more extraordinary coming from one serving 19 sovereign countries, based in Frankfurt, and constructed in the inflation-busting and fiscally conservative mould of Germany.

A Bundesbank study last year found that euro zone countries saved almost 1 trillion euros between 2008 and 2016 in interest rate payments because borrowing costs were so much lower than pre-crisis averages. That is a saving of some 9 percent of GDP.

The framework for previously unthinkable flexibility and crisis management is in place, despite the ECB’s restrictive “one size fits all” monetary policy. It ultimately saved the euro, and will ensure it survives and thrives. Warts and all.

The opinions expressed here are those of the author, a columnist for Reuters.

Writing by Jamie McGeever; Editing by Alison Williams

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