A euro at two speeds?

Economist, Broadcaster and Author

How can the euro crisis unfold? For David McWilliams, Irish economist and best-selling author, the answer is probably a two-speed arrangement between core and periphery. 

One of the great American popular economists of the last century was Herbert Stein who combined journalism with policy work. He also held the prestigious position of chairman of the Council of Economic Advisors in the US during the 1970s. His greatest contribution to economics was a simple rule: “If something can’t go on forever, it will stop.”

Thinking of the endless crises within the euro zone, whether it is in Belgium, Greece, Ireland, Italy or Spain, whether it is bank debt, household debt or sovereign debt, whether it is Germany’s taxpayers or France’s banking system, Stein’s law comes to mind. This can’t go on forever, so it will stop one way or another.

The dirty little secret, which our politicians don’t want to spell out, is that every country “rescue” thus far has been nothing more than a bailout of private professional investors at the expense of the ordinary taxpayer. The bill for more and more private debt is being transferred to more and more people who had nothing to do with the debt in the first place. Therefore every rescue erodes public confidence in politics and chips away at the legitimacy of the entire EU project.

Increasingly, as events overtake all previous bailout/rescues, it is becoming evident that the option of the two-speed euro is now on the cards. No one has fleshed this out yet, but it is likely to happen because Europe has always had a core/periphery dimension. Faced now with a meltdown of their system, Europe’s elites need a solution that snatches a political victory from the teeth of financial defeat.

Apocalypse, in the guise of a country being ejected from the euro, is not a political option because the risks of everything falling apart are simply too high. In contrast, a two-speed euro, with a hard euro for the core and a soft euro for the countries in trouble, relieves the pressure on the whole European financial system.

A two-speed euro, involving two distinct but related currencies, keeps the entire euro project together and gives the EU donkey the carrot of moving forward while at the same time deploying the stick of promised economic reform. It is important to understand that the perpetual forward motion idea lies at the heart of the EU. As long as the project seems to be moving forward slowly towards the nirvana of more integration when the time is right, Europe is progressing.

A break-up of the euro means the project has stalled, and this is unacceptable to the people who make the rules in the EU. They are believers; and like any ideologues, these true believers are driven by then utopian notion that the future is always brighter than the present.

We are at a tipping point and it has been a long time coming. For many years now, I have pointed out that the euro could break up. At the time it was unfashionable to suggest that the currency might be dogged with internal inconsistencies centred on inter-country trade and capital imbalances, national idiosyncrasies and profound economic differences. More radical still was to follow this logic by predicting that the system would implode.

But the euro in its present form is doomed. So let’s look at what is likely to replace it.

The first thing we know is that the peripheral countries can’t keep up with Germany. Take Ireland as an example. When the punt was linked to the Deutschmark, we devalued six times in 13 years just to try to keep up competitively with the Germans. Conversely, when we joined the euro and could not devalue, we lost 30% competitiveness against Germany. It could not be clearer.

So peripheral countries need a change in the value of the currencies we trade in to make our companies more competitive and thus more likely to export. In tandem, we need to make imports more expensive so we don’t buy too many of them. The weaker exchange rate achieves this. Devaluations work. And to anyone who doubts that devaluations work in small European countries, just examine the lasting competitive gains garnered by Finland and Sweden after their 1992 devaluations.

Without currency change, we can’t keep up with the Germans. Up till now, we borrowed to achieve a lifestyle and a level of economic activity. Now none of us can pay this money back.

So we need debt forgiveness or some debt deal. Accompanying the new euro would be mass debt write-downs because if you don’t reduce the value of their outstanding debts, people will simply not be able to pay and their countries will default after the devaluation. Everything must be done together.

So let’s think about the new euro. First, the currency would be distinct but closely related to the hard euro. The European Central Bank (ECB) would split in two to manage both currencies. This idea is not new. In fact, several central banks have done this in the past, Germany in the 1950s being a prime example.

The new soft euro would trade at, say, 70% of the old one (a figure plucked out of the air). This would mean that relative to Germans, standards of living in the soft euro zone would fall by one third overnight. We would achieve in one night what the present policy seeks to do in five years.

Ireland, for instance, would be an extremely attractive place to invest in because its labour would be much cheaper. But don’t forget that this reduces Irish incomes by the same amount.

All periphery debts would be reduced by 30% because they would be in a new currency. Obviously, the banks that lent in hard Euros and would now get paid in soft euros would carry a huge exchange rate loss. This would need to be dealt with. Possibly, the banks in each country could issue bonds backed by the EU and redeemable for new euros at the ECB. These bonds could be considered capital, preventing the banks from going bust.

The savers who lost out on their stock of old euro savings could be given new inflation-linked euro bonds issued by the state and redeemable from the ECB, but not straight away. There would be an incentive to keep them in the banks as savings. This is normal because if you think about it, most people don’t touch their savings.

A two-speed euro would at least prevent the chaos of a messy implosion and a rushed reintroduction of many currencies. It achieves the competitive devaluation, while giving the heavily indebted commuter generation a break.

There is never a best way out of a crisis, just a least bad way. Maybe this is it.



McWilliams, David (2010), Follow the Money, Gill & Macmillan Ltd., Dublin.

McWilliams, David (2007), The Generation Game, Gill & Macmillan Ltd., Dublin.

©OECD Yearbook 2012

Economic data

GDP growth: -9.8% Q2/Q1 2020 2020
Consumer price inflation: 1.3% Sep 2020 annual
Trade (G20): -17.7% exp, -16.7% imp, Q2/Q1 2020
Unemployment: 7.3% Sep 2020
Last update: 10 Nov 2020

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