The Cyprus Crisis: Was It Inevitable?

For a while, it appeared that the political leaders of the European Union were beginning to solve their monetary problems. Despite fiscal crises and social unrest in Greece, Spain, Italy, and other member nations, the union of sovereign states had survived one crisis after another without splitting apart at the seams.

But who could have anticipated that tiny Cyprus would have precipitated the most significant monetary crisis yet? As the island nation teeters through a banking crisis that may plunge it into bankruptcy, many have concluded that the Euro zone itself is heading towards a breakup.

Some economists are now concluding that the fundamental design of the European Union is flawed, and is thus exacerbating these economic challenges. Is it possible that such flaws actually made a crisis inevitable?

Remember The ECU!

The European Union, of course, wasn’t created in its current form. Although visionary founder Jean Monnet spoke wistfully of a United States of Europe, the entity was originally founded as a trade bloc for the coal and steel industries in France, Germany, Italy, and the Benelux nations of Belgium, Luxembourg, and the Netherlands.

It later evolved into the European Economic Community (EEC), a free trade association of the same six sovereign nations, with each maintaining its own currency and monetary policy. And later, a basket currency known as the European Currency Unit (or ECU) emerged in virtual form.

A virtual basket currency? How did that work? Well, let’s assume that a firm was owed a certain amount of French francs. Instead of receiving its entire payment in francs, it could choose to receive an equivalent collection of French francs, German marks, Dutch gilders, etc.

It was a useful policy that permitted firms to diversify their currency holdings while operating throughout the EEC. In essence, it created a pan-European common currency, without forcing nations to incur the risk of merging their incompatible monetary systems and currencies.

Truly Necessary?

In retrospect, the incompatibilities between national economies and systems appear to be strikingly obvious. After all, why would any one have expected the German and Cypriot economic systems to have blended into a single unified entity? Or the Spanish and Estonian systems, for that matter? Or the Irish and Greek systems? Yet all of these states committed to utilizing a common European currency.

Let’s take a moment to think about this commitment. Germany, after all, is an immensely wealthy industrial powerhouse that exports advanced technological products around the world. Cyprus, on the other hand, is a Mediterranean island that is primarily known as an offshore banking haven for Russian business people and other global residents.

Was it truly necessary for all of these nations to adopt the same currency? What long term benefits could such a union have possibly conferred on these parties? Although the decision may have generated a fair amount of short term pan-European pride and international goodwill, such feelings might have continued to develop under the structure of the EEC and the ECU any way.

NAFTA: A Case In Contrast

For a comparable case of a trade bloc of members that never chose (and, in fact, never even discussed) the possibility of evolving into a monetary union, consider the North American Free Trade Association (NAFTA). From the time of its initial formation in 1994, NAFTA’s trio of member nations (Canada, Mexico, and the United States) have been content to eliminate trade barriers and coordinate economic policies without blending their independent monetary systems.

Can you imagine the chaos, disorder, and controversy that would ensue if Mexico were to abandon the peso and adopt the United States dollar? Or if Canada were to consider “bailing out” the American government’s $16.7 trillion accumulated deficit? It’s difficult to even visualize a scenario where any of these nations might wish to do so.

Furthermore, although all three NAFTA members have also signed free trade agreements with other nations, NAFTA itself has remained a bloc of only three sovereign states. Representatives of the three countries agree that the bloc would become unwieldy if it were to expand and encompass other nations.

The End Game

Although encountering noteworthy political opposition, European leaders are continuing to insist that the European Union and the common currency zone will survive this latest crisis. It remains to be seen whether they can manage to achieve this goal; furthermore, it is even appropriate to wonder whether it would be beneficial for any one to do so.

It is, in fact, quite possible that an inevitable fracturing of the European Union has already begun. Reportedly, the level of uneasiness about the very existence of the Union itself continues to rise among the citizens of the member nations.

In other words, an “end game” may have already begun to play out throughout the capital cities of Europe. And with it may emerge the unwinding of the Euro zone, accompanied by the re-emergence of the Cypriot pound, followed by the Greek drachma, the Spanish peso, and the Italian lira.