Europe and the euro

Past, present and future

31 October 2019

4 minute read

We explore what the past and present of Europe and the euro might tell us about its future.

The subject of Europe and the euro is marmite in the UK at the moment. Few seem not to have a view. Many of those who voted ‘Remain’ back in 2016 seem to have acquired a deep and seemingly unconditional love of the project. While, on the other side, a fervent loathing for all that the euro stands for has taken hold amongst some of the more passionate believers in Brexit. We explore below what the past and present might tell us about the future of this most ambitious of projects.

The (distant) past

It would be a mistake to assume that the European project was dreamt up a couple of decades ago by some grey-faced bureaucrats. It can be plausibly argued that the unfinished union you see today can date its origins easily back to the 18th century.

Then, as now, there were myriad motivations behind the uniting of a diverse group of cultures and languages. Some of these early integrationist instincts can be seen as a response to a then revitalised Russia, unleashed by the reforms of Peter the Great. However, much can also be chalked up to attempts to build ‘perpetual peace’ on a continent that was then ravaged by seemingly perpetual war1. Interestingly, many contemporary texts and sources talk of the commercial benefits of such a union. But efforts to forge one struggled to gain traction.

As the 19th century aged, fresh impetus for union came from a somewhat surprising source – North America. By the end of the century, the rise of America was becoming increasingly impossible for Europeans to ignore. Its rise provided two kinds of stimulus for the Europeans: first, its booming economic clout and geopolitical swagger were seen as a threat, to which the logical response would be to pool European resources.

However, America also provided a successful template for the benefits of the clubbing together of a diverse group of states. It was George Washington, in a letter to the (French) American revolutionary war hero Lafayette, who is thought to have first coined the phrase ‘United States of Europe’. That language did not become prominent in Europe until the middle of the 19th century, but it still illustrates that the idea is far from a new one.

Nonetheless, plans for union again stumbled. This time it was the mutual antipathy between the French and Germans that proved the major stumbling block, particularly over the contested region of Alsace Lorraine.

It took the horrors of two world wars to apply the final push for Europe to start the process of integration in a more meaningful fashion. The treaties of Paris and Rome in the 1950s were the first real building blocks towards the incomplete union we see today2.

The present

The problems that Europe and the euro face are many (Figure 1). To do them justice would require a far longer essay. However, when trying to cut through it all and identify the most important deficiency, one former Irish central banker coined the phrase ‘transferphobia’3. This describes the stark differences in economic character (and others) between Northern and Southern Europe: different languages, cultures, and most importantly, attitudes to thrift.

FIGURE 1: The eurozone debt crisis hasn't been kind to the euro

The eurozone debt crisis hasn't been kind to the euro

Source: FactSet, Barclays, as at 31 July 2019.

The concern from the likes of Germany, the Netherlands and others classed within the thrifty bunch is of subsidising the profligacy of the south. The inability to build the vital missing architecture in the euro – from the ability to consolidate government debt across the region (Eurobonds) to the ability to have a centralised budget – can be chalked up to this continuing perception (Figure 2).

FIGURE 2: Large regional inequalities still exist within the eurozone

Large regional inequalities still exist within the eurozone

Source: FactSet, Barclays, as at 28 June 2019.

In this integrationist no man’s land, the continental European economy continues to list a little. Or at least, certain parts of it do. Central bankers continue to battle to generate any inflation, and populist, separatist forces continue to have the scope to undermine the project’s integrity.

The future

As with all crystal ball gazing, apply plenty of salt. However, there are a number of points that we can plausibly make.

First, a study of the periods in history when international trade has flourished and when it has not points to some interesting concepts. The periods characterised by lower barriers to international trade have often coincided with the presence of a dominant global superpower: the US in the post-war period, the UK for a large chunk of the 18th and 19th centuries, and the Dutch before that.

In the periods when the pack seems to be catching up with the hegemon, we’ve found the opposite – persistently higher barriers to international trade. The point is that we could be entering a prolonged period where the dominant global superpower feels the competition’s breath on its neck, and responds as its predecessors have.

If such a period is in the offing, then trade within regional blocks such as the US, Asia and Europe could become more important and relatively less expensive than trade between them. In some senses, this could actually be helpful to the European project.

Second, one of the more interesting recent political trends on continental Europe has been the surge in support for Green parties. This change in European political hue has been accompanied by increasingly concrete talk of a ‘Green New Deal’ – a massive spending project to rival President Roosevelt’s post-war fiscal splurge, aimed at updating all aspects of the energy infrastructure in Europe. Such a package could even conceivably be a Trojan horse for some sort of pooling of fiscal sovereignty. Could it be that the hard deadlines resulting from soon-to-be irreversible damage to our environment are actually helpful for the euro?

There is, of course, an alternate scenario, or several, where the union does not survive in its current form. Its half-finished fiscal and political architecture means that it is much easier to imagine a break-up of the euro project, than it is to, say, the United States of America.

This doesn’t mean that it’s easy to conceive. There were no trap doors built in deliberately. It would be hard to exaggerate what an economically disruptive event a break-up would be, and not just for Europe. Depositors would naturally seek ways to protect the value of their deposits. Bank runs and liquidity droughts would surely follow.

The long history of attempted unions cited above suggests that this may not be the last attempt by Europeans to pool their resources. However, no matter what side of the Brexit debate you sit on, it would be a somewhat bizarre act of economic self-harm to actually court the break-up of the euro.

Investment conclusion

Our main tactical position in Europe at the moment is an underweight to the region’s high quality bonds. This is not a bet that all is rosy on the continent. It’s a more an assertion that the gloom baked into the world’s bond market, including those traded in Europe, is excessive.

We don’t currently have much of a tactical axe to grind in the region’s stock markets. However, European equities still play an important role in the bigger strategic picture for our investments.

The point for us is that despite its many problems and contradictions, the euro is likely here to stay. We need to position our investments accordingly.

Things to consider

The value of investments can fall as well as rise. You may get back less than what you originally invested.

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