Resident Fellow Desmond Lachman

One has to wonder whether Martin Wolf is not being too charitable in his assessment of EMU's prospects over the next ten years, even after taking into account that the Euro is after all celebrating its tenth birthday. For, rather than questioning the Euro's longer-run sustainability, he frames the question about the Euro's future by asking whether the Euro will become an ever important global currency and whether it is still too early to declare the Euro's triumph.

Mr. Wolf places a relatively positive spin on the Euro's future despite noting the very marked divergences in the balance of payments and competitiveness performance among the Euro member countries. One would have thought that those deep divergences would have prompted him to raise the more existential question about the Euro's longer run prospects, especially given the very fundamental imbalances in the Euro's Mediterranean member countries.

In today's very difficult global economic and financial setting, it would seem that one can only arrive at a benign long-run assessment of the Euro's future by glossing over the fundamental point that the Euro does not remotely satisfy the conditions for an optimum currency area. In particular, the Euro area's product and labor markets are hardly characterized by price and wage flexibility, there is only limited labor market mobility between Euro member countries, and Europe does not enjoy a system of federal fiscal transfers that might soften the impact of adverse inter-country economic shocks.

Failing to meet the requirements of an optimum currency area exposes Europe to considerable tensions, especially at a time when the European economy is being buffeted by a series of adverse economic shocks that do not impact the Euro's individual member countries in a uniform manner. And if ever there was a time when the Euro area was being subjected to adverse economic shocks coming in the form of battalions rather than of single spies, it has to be now. The Euro has now risen to all time record high levels, the US economy is veering toward recession, international oil prices have now increased in a manner reminiscent of the 1979 oil price shock, and global credit markets are in the grip of the most wrenching crisis in the post-war period.

Subjecting the Euro area to these types of shocks would be bad enough in normal times. However, for at least Spain and Italy, among the Euro area's major member countries, these are hardly normal times. Spain is presently at the start of the bursting of a major housing market bubble that makes that of the United States pale by comparison. For its part, Italy's public finances remain in as desperate a shape as they have been at the very time when the Italian economy appears to be on the cusp of recession.

The key question that must cast doubt on the Euro's longer-run sustainability is whether it is politically feasible for Spain and Italy to endure prolonged recessions as they attempt to deal with their respective problems within the straitjacket of Euro membership at a time of a highly unfavorable external environment. Without an independent monetary and exchange rate policy, Spain would appear to be doomed to many years of subnormal economic growth as its housing market bubble continues to burst and as it is forced to regain around 30 percent in lost international competitiveness through relative price deflation. Similarly, it would seem that Italy is condemned to a prolonged period of very low growth as it struggles to get its fiscal house in order without the benefit of its own interest rate or exchange rate policies.

One cannot of course rule out that in ten years time we will find that the Euro will have survived in its present form despite all of its serious shortcomings. However, as storm clouds gather over the European economy, it would seem that all the clues are pointing in the opposite direction.

Desmond Lachman is a resident fellow at AEI.