The single currency was supposed to have led to greater political union, but the policies taken to ensure its survival are having the opposite effect. An orderly retreat from the euro might be the EU’s least-bad option.

As the euro area enters its seventh year of economic stagnation, the future of the European integration process remains in suspense.1 In the medium-to-long term, highly divergent scenarios remain possible, with variable degrees of likelihood, from full-blown federalisation at one extreme to the catastrophic collapse of the euro and of the European Union at the other. Somewhere in between comes the actual set of policies currently followed, sometimes described as ‘muddling through’, more aptly called ‘muddling down’ in terms of its effects on growth and mass unemployment. Since the middle of 2012, the mix of recessive policies of ‘internal devaluation’, limited pooling of eurozone liabilities and decisive intervention by the European Central Bank (ECB) have deferred for an undetermined period of time the risk of a disorderly break-up of the euro.2 The strategic consequences of this range of potential and actual policy paths have been discussed in previous issues of Survival.3

It is time to at least consider another option: that of a deliberate and orderly unravelling of the euro in the framework of a preserved European Union. After having explained the reasons for this approach, described its aims, and assessed its technical and political feasibility, this article will examine some of the strategic issues it raises.

The unavailable, the unachievable and the undesirable

There would be no need to contemplate an economically risky, technically tricky and politically backward-looking option such as the orderly dismantling of the euro if more promising policies were at hand. For one, federalism, in the true sense of the word, is not available politically. Under current conditions, calling for the creation of a democratically accountable federal government for Europe and a 10%-plus of GDP federal tax, of the sort which underpins the single currencies of continental-scale federal states such as the United States, Brazil and India, would destroy the electoral prospects of any political leader. Yet such measures would make the euro sustainable in the long run, as is the case for other continental-scale currencies in economically diverse, non-centralised political entities.

Nor does muddling down inspire much confidence in the long term. In a low-growth context, replacing external devaluation with the internal sort leads not to growth but to lasting stagnation as swathes of the working-age population are withdrawn from the labour market. Progress of the eurozone towards becoming an optimum currency area is patchy at best.4 Although labour mobility was put in place in the Common Market from 1968 onwards, movement towards a US-style labour market in a multilingual EU remains limited: in 2010 only 0.35% of EU workers were moving to EU countries other than their own, versus an inter-state mobility rate of 2.4% in the US and 1.5% in Australia. Notwithstanding crisis-driven flows from the periphery to the core of the eurozone, labour mobility appears to have returned to its pre-crisis average, after a spike in 2008.5 Although the EU figure is probably an underestimate due to incomplete reporting, it is not clear that the US or Australian statistics are different in this regard. The countries of the eurozone have been witnessing a twin renationalisation of their banking systems and of their sovereign debts since the beginning of the economic crisis, along with a domestic credit crunch in the southern countries – developments of potentially great importance to the future of the euro.6

Nonetheless, the EU, and within it the eurozone, is witnessing movement towards greater integration. The ECB, a truly federal institution, albeit a politically unaccountable one, has been developing a role well beyond the traditional interpretation of its formal mandate, leading, inter alia, to ongoing lawsuits brought before the German constitutional court. The creation first of the European Financial Stability Facility, and then of the European Stability Mechanism, mutualised at the EU level virtually (if not, or not yet, actually) liabilities incurred at the national level, to the tune of some €500 billion, and to the great displeasure of public opinion in the creditor states.7 The EU institutions have acquired the power to exercise upstream scrutiny of member states’ public-spending plans before they are submitted to national parliaments.

In parallel, the intergovernmental 2012 Treaty on Stability, Coordination and Governance ratified by 26 out of 28 EU members sets a binding schedule for deficit-cutting. This is underpinned by the mandatory inclusion of the golden rule (forbidding government borrowing for current expenditure over the duration of a business cycle) in national constitutions or constitutional practice. With the exception of the development of the ECB’s powers, these measures represent top-down, ‘Jacobin’ integration, sometimes overt, sometimes de facto, rather than federalism, with its emphasis on the principle of subsidiarity. In the US, for instance, liabilities incurred at the state or municipal levels (think California or Detroit) are not handed over to the federal government.

Beyond their Jacobin character, there are two problems with these changes. On the one hand, they are not, or not yet, delivering the goods in terms of what the creation of the euro was supposed to provide: more growth, more stability, more convergence of national economies. On the other, they are undermining the political support provided to the EU: since the beginning of the crisis, trust in the EU has dropped by some 20 percentage points on average, with limited deviations from that trend.8 The euro was supposed to have led to a greater degree of political union; the policies taken to ensure its survival are having the opposite effect. As growth fails to pick up to levels leading to net job creation, six years after the beginning of the crisis electorates are increasingly tempted to opt for other ways – at worst, by providing direct support to know-nothing extremist parties; at best, by putting pressure on mainstream parties to discard what had hitherto been part of the EU’s genetic code, most notably on the free movement of people and labour within the Union. The 9 February 2014 Swiss referendum opting for a return to pre-1999 restrictions on labour movement set a precedent, even if Switzerland is not an EU member (but, unlike the United Kingdom, belongs to the Schengen borderless area). The Jacobin nature of the current integration process is also prone to anti-EU rejection by the electorate. As time passes, with no end in sight to mass unemployment in much of Europe, the likelihood increases that a political or social upset will occur in one or several of the member states of the EU and eurozone, leading in turn to renewed existential crises for the euro. Another chain of causality, in which repeated sovereign-debt crises lead to existential risk to the euro and the EU itself, as occurred in 2010–12, is less likely today but remains a possibility.9

In the meantime, there are now two eurozones. One, composed of Germany, Finland and Austria, enjoys limited unemployment (with Germany’s rate having dropped from 10.7% in 2007 to 5.6% in 2013), an early return to pre-crisis levels of GDP (albeit barely, with Germany ticking up by just 3% in six years) and great impatience with efforts by less fortunate states to transfer their liabilities to the EU level. The other eurozone has yet to recover to pre-crisis levels, with mass unemployment and long-term joblessness creating a ‘lost generation’, and unbelievably patient electorates who have not, at the time of writing, voted in latter-day fascists or Bolsheviks. France falls squarely in between these two blocs. In short, muddling down does not look good.

If federalism is unavailable, and the hope of a return to stability and growth by muddling down is unachievable, the disorderly break-up of the euro is utterly undesirable. This may seem to be a truism, given the economic devastation it would cause, along with the probable shattering of the EU itself, imperilling the freedoms that the Union bears (the free movement of people, capital, goods and services, along with freedom from despotism and from war). But the warning is worth repeating, not only because the fund of political bad will following the catastrophic collapse of the euro would mean the end of the EU, but also because this is a scenario that could well occur as a result of muddling down. Although it may be tempting to defend muddling down as a lower-risk option than the orderly unravelling of the euro, the opposite is arguably true: the low growth, deep social distress and corrosive centrifugal forces generated within Europe by an extension of current policies could well lead to a brutal break-up. This is a hope-based, high-risk option, not a pragmatic, minimum-risk choice.

Back to the future

The goal of the option presented here is to ensure the long-term survival of the European Union as a democratic project of politically and economically open societies through a successful return to growth. The device to achieve this aim is an approximate return to the monetary conditions prevailing in the European Community during the last decade of the Cold War, while preserving the step changes that have occurred in the interval, notably (but not only) the creation of the single market and the enlargement of the EU’s membership, and with one signal exception: the euro as a single currency would be dismantled by common consent.10 In short, the erstwhile European Monetary System would be recreated, with national currencies floating in a limited band, allowing for controlled fluctuation of parities. The euro would cease to be a single currency used by 18 EU member states, and would be recycled as a common accounting unit, along the lines of the pre-euro European Currency Unit.

This would in itself be a far from ideal outcome. In political terms, the return to national currencies would be universally considered a humbling setback for a Union that has always assumed that the European project knew only one direction: forward, with the occasional doldrums only marking a halt before the next onward push. The fact is, however, that this narrative is both dangerous (moving a bridge too far lands you in deep trouble) and wrong: in 2005 the scrapping of the EU’s constitutional treaty after an unambiguous ‘no’ vote in two of the six founding states was a major reversal, which the EU eventually coped with. Economically, the growth potential resulting from flexible parities would remain limited if the weaker countries did not proceed with otherwise desirable structural adjustment: to judge from pre-euro experience, the higher interest rates the markets would exact from weak-currency countries may be an insufficient incentive for reform. Other incentives, discussed below, would be required. Nevertheless, the improvement in terms of growth would be substantial, in view of the last six years of recession brought about by policies intended to rescue the euro.

Even limited devaluations come at a price, as they diminish the general wealth somewhat, but the suffering is thinly, if widely, spread and is not recessive in nature. In contrast, the eurozone’s internal devaluations, as put in place from 2010 onwards, are not only immediately and strongly recessive – worse, their long-term impact on growth is negative as mass unemployment is transformed into long-term joblessness, permanently destroying productive potential as people become unemployable and eventually drop out of the labour market. After six years of mass joblessness, and notably of youth unemployment (currently at around 60% in Spain and Greece) in most eurozone countries, the lost-generation stage has been reached, which makes the situation unlike that of countries such as Sweden during the 1990s or Germany during the Hartz reforms, when they underwent their national internal devaluations.

The European Monetary System, warts and all, also has the advantage of having operated in practice and not only in principle. Even in the worst moments (notably, when the pound left the European Exchange Rate Mechanism in 1992), its shortcomings did not lead to the sort of deep and protracted systemic crisis that Europeans have been experiencing under the euro. A ramshackle, ‘half-baked’ system, as Alan Walters put it, is more forgiving than what William Hague called the euro’s ‘burning building with no exits’.11

This option could entail a latter-day revival of currency areas such as the Deutschmark zone, which in its heyday included the Benelux countries, Denmark, Sweden, Finland and, for a time, even the UK, with the pound informally tracking the Deutschmark (one of the reasons for the UK’s monetary crisis of 1992). A new version of such an area would include the Central European members of the EU. Some have gone further by suggesting, facetiously or in earnest, the creation of a northern euro – a ‘neuro’ or, worse, ‘Bis-mark’ – eventually balanced by a southern euro, or ‘sudo’ (as in ‘pseudo’).12 It is not clear why countries that would have dismantled the euro to recover a degree of monetary autonomy would want to jump into another straitjacket.

A remake of the European Monetary System, with or without the re-establishment of a de facto monetary area built around a recreated German national currency, would be entirely compatible with post-Cold War developments within the EU. The single market, which was up and running from early 1993 onwards, would not be hurt by the absence of the euro; after all, the UK, Poland and Sweden, among others, appear to be enjoying the full benefits of the EU’s internal market, despite having their own currencies. Indeed, these currencies have fluctuated vis-à-vis the euro since the latter came into effect without these changes in parity having hampered the smooth operation of the single market for all and sundry.13 The same would apply to EU enlargement, arguably the EU’s most impressive accomplishment since the end of the Cold War: instead of some EU members being outside the eurozone, none of them, old or new, would be using the euro as an effective currency. There would be no adverse strategic or political consequences for those countries that have wanted to join the euro for geopolitical reasons. Similarly, the Schengen area would have no reason to suffer from the absence of the euro: not all countries within it belong to the eurozone (Sweden, Poland, Denmark and the Czech Republic); indeed, some of its members do not belong to the EU (Norway and Iceland).14

In political terms, the return to national currencies would restore a sense of control to citizens who currently feel dispossessed, which in turn leads to the rejection of EU policies on hot-button issues, such as the free movement of workers.

In other words, an EU without the euro would not simply be a remake of end-of-the-Cold War Western Europe. It would be fully compatible with the consequences of post-1990 policies of trade integration, territorial enlargement and the broadening of competences (such as in justice and home affairs), and would help defuse popular feeling against the transfer of hitherto core national competences to a European level perceived as being less legitimate in political terms.

Technically feasible, politically difficult

Setting the destination is easier than ensuring that the EU gets there safe and whole. Indeed, it would not be worth raising the unravelling-the-euro option in the absence of relative calm and control: attempting such a policy in an atmosphere of crisis akin to that of the 2010–12 years would have led to a disorderly break-up of the sort that would have killed the EU rather than saved it. The assumption made here is that, barring a meltdown of the emerging economies or the scrapping of the ECB’s post-June 2012 market-calming policies, the EU and its members have a number of years during which to consider future options, such as the one laid out here. As a consequence, upstream debate could in its academic stages be broad-ranging and systematic, with a view to assessing the most promising avenues; political decision-making could be careful and deliberate, albeit under the conditions of secrecy called for in monetary affairs; and implementation would have to be sudden and comprehensive.

There have been several cases of the unmaking of single currencies in the last century. Most occurred as a consequence of the prior or concomitant break-up of an underlying political union, often as a result of war-induced collapse. These include the Austro-Hungarian krone, replaced by the national currencies of half a dozen successor states; the tsarist rouble (from which the Soviet rouble emerged after years of civil war); the Ottoman lira; the Yugoslav dinar, which succumbed to the break-up of the corresponding federation in 1992; and the Soviet rouble, whose disorderly disappearance also occurred in that year. The processes of unmaking for these currencies were economically and socially extreme, usually accompanied by inflationary or hyper-inflationary surges. They are clearly models to be avoided.

However, less dramatic cases of monetary divorce have also occurred. The unmaking of the Scandinavian Monetary Union in 1914 and the gradual renationalisation of the Latin Monetary Union between 1893 and 1914 (including the Greek exit in 1908) may not be readily transposable to our monetary age.15 Closer to us, the ‘velvet divorce’ (between the Czech lands and Slovakia in 1992) led to the establishment of separate currencies with little fuss or hardship. Furthermore, although the collapses of the Soviet rouble and the Yugoslav dinar were chaotic overall, some of the peripheral republics, such as the Baltic states, Slovenia and Croatia, made the transition from a federal to a national currency with relative ease (and sometimes back to a federal currency, as occurred in Estonia, Latvia and Slovenia when these countries eventually joined the euro). However, these successful transitions from multinational to national currencies were small-scale affairs, limiting the lessons they may provide to a continent-wide dismantlement of the euro.

Although not involving a switch from federal to national currencies, there are some examples of rapid and orderly transformation of one monetary order into another. Here, the precedent to avoid is the helter-skelter, albeit eventually successful, set of competitive devaluations-cum-dismantlement of the Gold Exchange Standard during the Great Depression; this was neither rapid nor orderly. Conversely, Brazil’s switch from the cruzeiro to the real in July 1994 provides useful pointers. Brazil is a federal country, as large in area as the whole of Europe, formed of 26 states and with a population of close to 200 million people. Its political and business culture is more Latin than Nordic Protestant. Yet within a few days, the pre-existing currency was demonetised as all bank accounts were switched to the new currency and pre-existing coins and bills were physically replaced. This massive operation took place without major economic disruption or substantial insider abuse; it put an end to more than a century of monetary disorder in Brazil and opened the way to economic and social modernisation.

In sum, if Brazil could pull off something of the sort 20 years ago, so could, in theory, the eurozone, albeit with a substantial add-on. Exchange-rate controls of the sort authorised by EU treaties under certain conditions, and put in place to handle the Cypriot crisis in 2013, would be necessary at least during the normally brief period during which the currency switch would take place and new parities would be set.

During the centenary of the First World War, it is worth recalling that the first weeks of the conflict also witnessed the first global financial crisis. As Europe suddenly divided into two warring camps in the last days of July 1914, the flow of goods and finance in a highly integrated global economy came to a juddering halt, as practically all of the world’s stock and commodity exchanges shut their doors.16 In London, the financial hub of the global economy, catastrophe loomed as the British government and the Bank of England attempted to cope with both massive insolvency and the drying up of liquidity at all levels. The latter was immediate at street level in an age in which legal tender came either in the form of gold coins (sovereigns and half sovereigns), instantaneously hoarded by high-street banks, or banknotes in high denominations (the lowest being £5, the equivalent of £400 today). Yet within six days of crisis management and a five-and-a-half-day bank holiday, low-denomination notes were printed, flooding Britain in a prequel to Milton Friedman’s tongue-in-cheek monetarist answer to the risk of deflation (dropping dollar bills from a helicopter).17 Shored up by other emergency measures, Britain experienced no systemic bankruptcy, and within weeks the economy was thrown into full throttle on the basis of a currency that was de facto unhooked from the Gold Standard. Humankind would possibly have been better off if financial collapse had prevented the bloodily efficient conduct of the First World War, but as an exercise in moving from a standing start to the establishment of a new financial order in a week or so, the British case of July–August is convincing.18

The orderly unravelling of the euro would be no less feasible in technical terms than the two transformations cited here. Furthermore, time to reflect and prepare is available. Nor has disagreement with that suggestion in my book La Fin du Rêve Européen been mainly based on technical difficulties.19 What can and does provoke argument are the issues of necessity or desirability on the one hand, and of political feasibility on the other. The latter is indeed questionable. There exists today no government within the EU, not even in euro-averse Britain, which wishes to wind up the euro. Political parties hostile to the euro exist, but most of them are driven by hostility to the EU, with the euro as just one facet of a broader Europhobe agenda: Marine Le Pen’s National Front and Geert Wilders’s Partij voor de Vrijheid (Party of Freedom) are cases in point. Given the EU’s remarkable achievements as an area of shared values and freedoms, both political and economic, its demise would be a calamity; it is in order to avoid such an outcome that the walking back of the euro is suggested here. For its part, Germany’s Alternative für Deutschland (Alternative for Germany) is anti-euro, not anti-EU, but it has the electoral limitations of a single-issue group, with its appeal further diminished by its adherence to a narrative of economics as a morality play. In short, the orderly retreat from the euro is for the time being a political orphan, much like federalism. This could change rapidly, however, as other options prove incapable of delivering the goods; in particular, muddling down will lose a lot of its current political appeal if it causes elections to be lost, with the EU parliamentary elections in May 2014 a possible bellwether.

Creating a political constituency for unravelling is a necessary but not sufficient condition. In order to be successful, the demonetisation of the euro and the recreation of national currencies has to occur during the compressed time frame of a longer-than-usual bank holiday, initially with a very small group of institutional actors (no more than the heads of a couple of states and the chairman of the ECB), before the circle is broadened after the basic decision to unravel the euro has been taken. That group must necessarily include Germany, as the euro’s pivotal member. For solid political and historical reasons, Germany will not and should not be alone in taking the decision: although technically possible, George Soros’s suggestion that Germany should take the lead in leaving the euro will not happen politically.20 Therefore, another country, big enough to be seen as operating in the same league as Germany, must be part of the initiating group; this could be either France or Italy, or the two together (as a group, Germany, Italy and France account for more than 60% of the eurozone’s GDP). Italy may find it easier to take the plunge than France, as most of the former’s sovereign debt is domestically held, facilitating its subsequent monetisation, and Italian industry would clearly benefit from a substantial devaluation, thus fuelling growth. Furthermore, Italy would not harbour a latent fear of the recreation of a German-currency area, whereas one of the reasons that France went for a single currency after the fall of the Berlin Wall was the sense that a united Germany should not benefit from the soft-power dominance of the Deutschmark and the Bundesbank in post-Cold War Europe. However, France would be the more credible candidate. Germany would presumably see France, in the framework of the French-German couple, as providing substantially better political balance than ‘Club Med’ Italy.21 And the French may conclude that a German-centred eurozone (or an EU that would have become a continental system after an exit by Britain) is even less appealing than a strong German-currency area in the centre of Europe.

Germany would be in a position to set conditions for agreeing to jointly unravel the euro. The implementation of Hartz-type reforms (such as the overhaul of labour-market mobility, social security and retirement) could be a requirement that the French and the Italians would do well to take on board if they want the return to monetary autonomy as a tool of economic modernisation rather than a temporary fix masking deeper competitiveness issues.

If such a team were to walk back the euro, with the ECB cast as the coordinating agency, the other member states would presumably have no other option than to be part of the broader circle that would cooperate in the practical implementation of such a policy during an extended bank holiday.

The legal aspects would be less than satisfactory, since no such option is provided for in any of the existing EU and intra-EU treaty language. However, there exists a precedent here, with the Franco-German decision in 2003 to break out of the EU’s pre-euro, solemnly ratified Stability and Growth Pact supposed to condition entry into the euro and to serve as a cornerstone of subsequent economic policy. Berlin and Paris were happily followed through the breach by the great majority of eurozone states. Yet this blatant and deliberate violation of the pact was one of the reasons that Germany’s tough reforms at the time produced results, with their recessive impact being largely offset by the German recourse to deficit spending well beyond the limits of the pact.22 In legal terms, the pact continues to be binding, notwithstanding the ongoing massive violation of its debt and deficit criteria by most EU and eurozone countries. Once legal virginity has been lost so spectacularly in the field of economic and monetary union, it may not be too much of a stretch to consider that expediency may be invoked yet again.

Winners and losers

A successful walking back of the euro would have substantial strategic consequences, for the EU in general and for specific member states.

In the short run, the EU would be seen as a loser, by the same logic that holds that ‘wars are not won by evacuations’.23 Furthermore, it is the EU that will be held to account: the euro may be the eurozone’s legal tender, to the exclusion of the non-eurozone area, but it is an EU policy implemented by the EU’s institutions and all of its member states, barring none.24 But the fact of being seen as acting decisively and competently will redound, Dunkirk-style, to the EU’s credit. Definitive judgement will be suspended pending subsequent developments. A return to sustained growth beyond the eurozone’s German core would rapidly be hailed as the positive consequence of what was initially a strategic retreat. Late-1990s talk about the EU developing as a strategic actor could become fashionable again: in the same way that the 1998 ‘Blair initiative’ paved the way for the emergence of the European Security and Defence Policy, the European project could set new, broader aims than the self-punitive rescue of a premature single currency. It is worth remembering that today’s euro area enjoyed robust 3% annual growth during the second half of the 1990s; it is always easier to develop plans when the economy is ticking along.25

This could also be a Union in which traditional British euroscepticism would have fewer reasons to develop into full-blown, exit-prone europhobia. Would British Prime Minister David Cameron have felt compelled to call last year for an in–out referendum on EU membership in the absence of the integrationist moves linked to the rescue of the euro, along with the perceived role of the EU as a contributing factor to prolonged recession? Although there can be no guarantee that an EU without the euro would eliminate the risk, the probability of a British exit is much higher in all other scenarios. Federalism, an extension of current integrationist policies as part of muddling down or an explosive break-up of the euro would all be likely to reinforce EU rejectionism in the UK.

Symmetrically, another sort of British exit could occur not as a result of the UK deciding to leave the Union, but as a consequence of the eurozone attempting to set up its own political institutions, including an executive and a parliament, along lines promoted by the Groupe Eiffel Europe in France and the Glienicker Gruppe in Germany, creating a parallel EU.26

Conversely, an EU of which the UK is a member and whose long-term status is no longer in question would be strategically stabilising, not least as a war-shy, balancing-to-Asia United States adopts a more instrumental, tough-love attitude towards NATO and its European members. Uncertainty about the strategic role and persona of a German-centred EU, with the UK drifting offshore, would not be desirable in such a context. A post-euro EU in which Britain and France reinforce their nuclear and conventional ‘entente frugale’, while France and Germany serve as the pivot of the EU’s collective security and defence policy, would resemble an English rather than a French garden.27 But such a degree of messiness, to which Europe and the US have become accustomed, would be preferable to the apparently neat architecture of a post-British-exit EU as a continental system. This would probably generate new friction between a preponderant but anti-hegemonic Germany at its heart and France, with its assertive strategic culture, while other members, not least the militarily and politically powerful Poland, were caught in the middle.

At the national level, a post-euro EU could see substantial reordering of pre-existing economic and political hierarchies. Here, the UK would benefit, as its financial industry would no longer be threatened with exclusion resulting from deeper integration between eurozone countries.28 It would possibly also suffer, as its current monetary autonomy would cease to be a competitive advantage in Europe. This downside may also affect Poland. Italy, which has been exercising insufficiently noticed budgetary discipline, and Spain, with its vigorous economic reforms, would both see their relative positions improve with the export boost of downward currency realignments, while the largely domestic nature of private and public debt would facilitate the management of the transition from the euro to national currencies.29 Over time, this would allow Italy and Spain to rebuild their gutted defence forces and sustain the extension of their influence in the Mediterranean and Africa. Spain has been making impressive inroads into traditional French markets in North Africa; a competitive devaluation would reinforce the trend.30

Germany’s situation would be less straightforward. A return to a national currency could lead to a major revaluation, hampering German export performance. Even if this were the case – and the limited revaluations that have occurred in neighbouring non-euro countries call for prudence in making such a forecast – Germany would simply return to an era in which the economy was driven by both exports and domestic demand.31 Today, domestic demand, whether in the form of household consumption or private or public investment, is weaker than is good for Germany’s future growth and competitiveness. Insufficient upkeep of public infrastructure is a particular concern in this regard.32 Getting Germany to fire on two cylinders instead of one may be beneficial in an economy that is bound to feel the impact of rapid ageing. A new Deutschmark zone would probably be created; the area would include countries that are closely tied to Germany in terms of trade or investment, such as the Benelux nations, Denmark, Sweden and most of ex-communist Mitteleuropa. This would have substantial soft-power implications, and would cramp the monetary and economic policies of other EU states in ways similar to those that led to the pound’s exit from the European Monetary System in 1992. However, Germany’s pivotal position and policy prescriptions within the single-currency eurozone have been more durably divisive and recessive than the old Deutschmark area ever was. Anti-German sentiment has emerged in the worst-hit eurozone countries, whereas it had not been a feature of the pre-euro monetary system. Here, again, the image of a messy English garden comes to mind, as opposed to the geometric order of the euro as a garden that may have been French in its inspiration but is definitely not managed by a French gardener.

Of the major EU powers, France would possibly have the greatest short-term difficulties in coping with the return to a national currency. Some two-thirds of the country’s sovereign debt is not held domestically, increasing the debt burden if the successor national currency were significantly devalued vis-à-vis the euro. Historically, France has rarely had a positive balance of trade, and for more than a decade deindustrialisation has caused the country’s industrial base to shrink to British proportions. All other factors being equal, a currency realignment would not promote growth in France to as great an extent as it would in Italy (which has one million more industrial jobs than France and a vibrant network of export-oriented small businesses) or in Spain. Without as with the euro, France would remain saddled with its inherent competitive disadvantages; it would therefore be in the country’s interest to use the return to a national currency as an opportunity to engage in Hartz-type reforms. The recessive effects of these reforms could then be partly compensated for by the real, if limited, stimulative consequences of the return to growth in the post-euro EU. Probable German pressure in this direction should be heeded rather than resisted. In the longer run, France has solid foundations for sustained and relatively high growth: healthy demographics akin to those of the US (and therefore, and unlike Germany, the mathematical space for sustainable pension reform); a traditionally deep pool of household savings and a high household-savings rate of close to 16% (although long-standing state incentives misdirecting savings towards real estate would need to be changed); good physical and social infrastructure; and a skilled labour force with a strong work ethic in the private sector.33

Above and beyond the recessive policies followed by the eurozone and its members in their attempt to rescue the euro, there exists a counter-intuitive, rarely stated and powerful reason that the euro has been bad for France’s competitiveness, in the form of apparently ever-decreasing interest rates on the international market for sovereign bonds. Like Germany, and unlike the southern countries and Ireland, France has benefitted from the global and European flight to safety. Historically, the country had never been able to borrow at rates of the sorts that have prevailed in recent years. In May 2013, French ten-year treasuries dropped to less than 1.7%, an unprecedented interest rate. At the time of writing, they are under 2.2%, with a spread of some 50 basis points vis-à-vis comparable German paper.34 Under such conditions, and notwithstanding the threat of deflation, France’s overall debt can (and does) increase, while the servicing of that debt diminishes; whatever the reasons for bond-market forbearance (such as France’s fate being seen as tied to Germany’s, or France’s excellent tax-recovery system and debt-repayment record), the incentive to engage in painful reforms of any kind is in effect non-existent. Ordinary French politicians, like ordinary politicians anywhere, will only be ‘courageous’ if there is political value in being so.35 Removing the euro would presumably have the effect of toughening market discipline in a way that would not apply to those countries that have already been hit by interest spreads. ‘La peur du gendarme est le début de la sagesse’ (‘fear of the gendarme is the beginning of wisdom’), as the French saying goes.

France would have a difficult time, but it has the fundamentals to recreate growth. In the eurozone as a whole and, by connection, within the broader EU, a concerted and careful undoing of the euro would generate more growth than is permitted by the policies currently available for rescuing the currency. In doing so, the great, ongoing economic, social and, eventually, political divergence that is threatening to tear the EU apart would come to an end.

The worst of all systems

Winston Churchill stated that ‘it has been said that democracy is the worst form of government, except all those other forms that have been tried from time to time.’36 It may be presumptuous to invoke the great man in defence of an option that has no constituency, whose implementation would be fraught with risks and uncertainties, and whose effects can, at best, only be the object of educated guesswork. Yet the alternatives are, if anything, no easier to defend. The fact that we know (or think we know) what the certainties of our current predicament are does not grace muddling down with a badge of respectability, even if human beings and markets instinctively fear uncertainty despite knowing that progress and wealth follow from running risks. The author would be delighted if he has convinced the reader of the case he makes. But he would also be happy if a sceptical reader were to accept two recommendations independently of the option discussed here.

One, of an upstream nature, is that more research and more debate should go into the examination of future policy recommendations regarding the future of the euro and its interaction with the EU project in all of its aspects. Too often, discussion is mono-disciplinary rather than multifaceted (even if there inevitably needs to be a heavy emphasis on economics and particularly on political economy). More comparative work is also needed; when the fate of the euro and the EU are at stake, one should be looking harder at precedents of monetary and institutional union in time (some cases have been suggested here) and space (for example, are there lessons to be learned from the CFA franc, a currency created by France in 1945 that covers much of Africa and seems to work better than the euro?).37 Similarly, more retrospective analysis of the monetary facets of the global crises of 1914 and the Great Depression could inform current policy: Ben Bernanke and Paul Krugman, two prominent scholars with strong views on the lessons of the Great Depression, have managed to inform the US debate (and famously, in the case of Bernanke, central-bank decision-making). Is similar work by their European counterparts identified and taken heed of by current or would-be policymakers?

The other, policy-oriented recommendation is that European policymakers examining options for the euro and its future give pride of place to the question of how their choices will affect the EU as a whole. This should go without saying; yet it does not seem to be a general practice, either within or outside of the eurozone. When the euro was in imminent danger of collapse, threatening all of Europe, Sweden and Britain, two non-euro countries, took very different sets of decisions. Sweden opted for contributing financially to the measures taken to prevent the break-up of the euro. The UK, while calling on the eurozone to wheel out a ‘big bazooka’, preferred to avoid putting skin in the game, even if its economy would have been ravaged by a disorderly collapse of the euro and probably of the single market as well.38 Symmetrically, when Germany and France, followed by all other EU members apart from Britain and the Czech Republic, decided in December 2011 to draft a new version of the Stability and Growth Pact, little account appears to have been taken of the impact of such an initiative on the British stance. Indeed, the spin in the following day’s media in Germany suggested that Schadenfreude was the general mood. Yet it is not self-evident that either Germany or France’s broader aim was to facilitate the transition from euroscepticism to europhobia in Britain. Thinking strategically implies not losing sight of the overarching goal; the argument here is that the preservation of the EU must be that primary objective, to which the positive or negative fate of the euro must be subordinated.


1 The eurozone’s GDP only returned to its pre-crisis level (that for the third quarter of 2007) at the end of 2013. Between 2005 and 2013, the eurozone’s GDP grew by an average of around 0.5% per annum. The European Commission’s autumn 2013 forecast for eurozone growth in 2014 stood at 1.1%. European Central Bank, ‘Selected Indicators for the Euro Area’,; European Commission, ‘Autumn Forecast 2013 – EU Economy: Gradual Recovery, External Risks’,

2 ‘Unable to benefit from currency depreciation, [countries on the periphery of Europe] have been urged to seek other ways to improve their balance sheets by means such as “internal devaluation” – regaining competitiveness by lowering costs, particularly wages.’ Kate Mackenzie, ‘We’ll Settle this Internal Devaluation Question Quicker than We Thought’, Financial Times, 18 September 2012, Efforts to prevent the disorderly break-up of the euro have included the EU’s introduction of a longer-term financing operation in December 2011 and the announcement by the ECB’s governing council of the possibility of outright monetary transactions in secondary sovereign-bond markets on 2 August 2012. This followed ECB president Mario Draghi’s statement that the ECB would ‘do whatever it takes to preserve the euro’ on 26 July 2012. European Central Bank, ‘Verbatim of the Remarks Made by Mario Draghi’, 26 July 2012,

3 See the articles on the strategic consequences of Europe’s lost decade in the December 2013–January 2014 issue of Survival, particularly Thomas Wright, ‘Europe’s Lost Decade’. Survival, vol. 55, no. 6, December 2013–January 2014. See also François Heisbourg, ‘In the Shadow of the Euro Crisis’, Survival, vol. 54, no. 4, August–September 2012.

4 An optimum currency area is a zone in which the costs of joining a monetary union are lower than the benefits. ‘Definition of Optimum Currency Area’, Financial Times,

5 Dawn Holland and Pawel Paluchowski, ‘Geographical Labour Mobility in the Context of the Crisis’, European Employment Observatory, June 2013,

6 Daniel Gros, ‘The European Banking Disunion’, Centre for European Policy Studies, 14 November 2013,

7 The European Financial Stability Facility was authorised to borrow up to €440bn; since July 2013, the European Stability Mechanism has been the sole mechanism for new financial-assistance programmes to euro-area states. It is authorised to approve bailout deals of up to €500bn and has a €200bn capital reserve. European Stability Mechanism, ‘Key ESM Facts and Figures’,

8 Pew Research Center, ‘The New Sick Man of Europe: The European Union’, 13 May 2013, p. 23, The UK is the main exception to this trend, as the EU’s popularity rating was already very low in that country before the crisis began.

9 At various stages of the sovereign-debt crises of 2010–11, German Chancellor Angela Merkel, then French President Nicolas Sarkozy and President of the European Council Herman Van Rompuy said that a break-up of the euro would lead to the end of the EU.

10 Specifically, the European Monetary System as established in 1979, retaining the wider fluctuation bands that were put in place (too late) in 1993 and the erstwhile European Currency Unit, while keeping the ECB as the currency’s watchdog and banking-union supervisor.

11 Eamonn Butler, ‘Sir Alan Walters Was an Academic, Not a Politician’, Telegraph, 6 January 2009,; ‘William Hague: Euro is a Burning Building’, BBC, 28 September 2011,

12 Facetiously: Martin Taylor, ‘A Pseudo Solution to the Euro’s Failings’, Financial Times, 21 March 2010, In earnest: Hans-Werner Sinn, ‘Rescuing Europe from the Ground Up’, Project Syndicate, 21 December 2013,

13 Between February 2004 and February 2014, the value of the Polish zloty in relation to the euro has fluctuated between a peak of +19% and a trough of -21%, with similar changes being experienced by the Swedish crown. European Central Bank, ‘Statistics’,

14 Switzerland is also a member of the Schengen area, but it is unclear whether this will continue to be the case after the country’s referendum on ending the free movement of labour.

15 Set up in 1873, the Scandinavian Monetary Union between Denmark, Sweden and Norway was linked to gold. The Latin Monetary Union, based on gold and silver, was established in 1865 by France, Belgium, Italy and Switzerland. In both cases, currencies remained national but were fully interchangeable, as the coins and bills of the pre-euro monetary union were between Belgium and Luxembourg (1944–2001).

16 On the 1914 global financial crisis, see Richard Roberts, Saving the City: The Great Financial Crisis of 1914 (Oxford: Oxford University Press, 2013).

17 ‘Deflation, Ben Bernanke and the Famous Helicopter’, Wall Street Journal, 18 October 2008,

18 Unlike Britain, Germany and France had prepared stocks of paper money to be released in case of a war-induced financial crisis. Roberts, Saving the City.

19 See Wolfgang Münchau, ‘Worry about the Euro, Not the European Union’, Financial Times, 3 November 2013,

20 George Soros, ‘The Crisis & the Euro’, New York Review of Books, 19 August 2010,

21 This derogatory expression was used in 1997 by Hans Tietmeyer, then president of the Bundesbank, to describe Southern European countries eligible for the euro. Alan Friedman, ‘EU’s “Club Med” States Get Serious about Financial Rectitude’, New York Times, 5 March 1997,

22 German sovereign debt rose from 58.8% of GDP (just short of the Stability and Growth Pact’s 60% limit) in 2002 to 68% of GDP in 2006. Trading Economics, ‘Germany Government Debt to GDP’,

23 See Winston Churchill’s reference to the evacuation of Dunkirk in a speech before the House of Commons on 4 June 1940. Hansard, vol. 361, col. 791, 4 June 1940,

24 The Bank of England sits on the ECB’s governing council and holds a substantial, 13.6743% share in the ECB. European Central Bank, ‘Capital Subscription’,

25 Trading Economics, ‘Euro Area GDP Annual Growth Rate’,

26 Groupe Eiffel Europe, ‘Pour une Communauté Politique de l’Euro’, Le Monde, 13 February 2014; Glienicker Gruppe, ‘Aufbruch in die Euro-Union’, Die Zeit, 17 October 2013.

27 Tim Shipman and Ian Drury, ‘The Entente Frugale: Cost-cutting 50-year Deal that will See French Take Command of the SAS and Britain Share Nuclear Secrets’, Daily Mail, 2 November 2010,

28 Iwona Tokc-Wilde, ‘Right on the Money’, Economia, 12 July 2013,

29 Since the introduction of the euro, Italy has had a primary budget surplus every year, save one, thus keeping control of the massive debt burden with which the country entered the eurozone. European Central Bank, ‘Statistics’.

30 Adam Sfali, ‘Ministère Espagnol de l’Économie: Exportations Espagnoles Records vers le Maroc en 2012’, Le Quotidien Maghrebin, 15 March 2013,

31 Since the euro’s introduction, the Czech crown has risen by 8% and the Polish zloty by 3%, while the Swedish crown has dropped by 6%, with substantial fluctuations in between. Between 1991 and 2000, German consumer spending increased by 18% (in current euros), versus a rise of 4% during the following ten years. Trading Economics,

32 Overall, investment in Germany slid from 23% of GDP in the 1990s to less than 17% of GDP in 2013. Marcel Fratzscher, ‘Investment, Not the Surplus, is Germany’s Big Problem’, Financial Times, 18 November 2013, On disinvestment in Germany’s public infrastructure, see Nina Koeppen, ‘German Policy Takes Toll on Public Works’, Wall Street Journal, 14 March 2013,

33 The household-savings rate stood at 15.6% in 2012. L’Institut National de la Statistique et des Études Économiques,

34 See table and graph for French ten-year treasuries (OAT) at, For German ten-year bonds, see ‘Germany Generic Govt 10Y Yield’, Bloomberg,

35 As in Sir Humphrey’s ‘how very courageous, minister’ in Yes Minster, BBC,

36 Hansard, vol. 444, col. 207, 11 November 1947,

37 The CFA franc is used in 15 African countries, which have a combined population of 150m.

38 George Parker and Lionel Barber, ‘Cameron Voices Eurozone Frustration’, Financial Times, 9 October 2011,

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Francois Heisbourg is Special Adviser to the Fondation pour la Recherche Stratégique and Chairman of the IISS. This article builds on La Fin du Rêve Européen (Editions Stock, 2013).

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Survival: Global Politics and Strategy

April–May 2014

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