May 25 ,2012
The Demise of the Euro
Over a decade ago the core nations of the European Union forged a common currency, and got rid of their liras and deutschmarks and francs and schillings. From then on, there was no need to exchange money when traveling from Paris to Madrid or Berlin or Rome. It seemed like the ultimate culmination of the European dream, and it was thought the currency union would lead to dramatic economic efficiencies that would propel growth throughout the continent.
While Britain and Sweden stayed out, almost all the major nations of Western Europe joined together. And those countries that did not make the original cut, such as Greece, Hungary, Poland, and the Baltic states, looked forward to the day they could join. Greece was admitted in 2002, but only after it had cooked its books to make itself look fiscally sounder than reality.
In 2012, it has now become clear that the Euro was not a common path to prosperity, but a monetary straitjacket that is strangling everyone but the Germans. How did we get here?
It is useful to think about another currency union that involves an economy even bigger than the Eurozone, that being the dollar zone. California shares a common currency with Florida and Texas. This dollar union works and will continue to work, because it has four critical elements that the Eurozone lacked. These elements were disregarded during prosperous times, but exposed the flaws in the Euro when the financial crisis hit.
The US has a very flexible labor market and a single language. If times get bad in Nevada, but are booming in Illinois, workers can move from one state to the next. Secondly, there is a single national government that transfers tax money from prosperous regions to struggling regions, through programs like food stamps and unemployment insurance and Medicaid spending. Thirdly, each state does not run up its own sovereign debt. The debt of the United States government is collectively guaranteed by the entire nation, which means that depressed areas don’t get hit with very high interest rates out of fear that they are insolvent and can’t pay back their debt. Finally, in the US, the Federal Reserve sets interest rates based on what is best for the country as a whole, not just for one portion. If the country overall is depressed, but a region is doing well, the Federal Reserve will pursue policies to end the depression, as it should.
The Eurozone lacked all these elements. During a downturn in one country, it was not easy to transfer workers from a soft region to a better performing region, because Greeks and Spaniards can’t just move to Germany and work as easily as people move from Nevada to Illinois. Language and cultural barriers loom large, and personal identities are bound up in one’s own country. Secondly, there is no single Eurozone budget or debt, each country has its own budget and is responsible for its own debts. The Germans are in no mood to subsidize and support Eurozone countries that are experiencing a downturn, so there is no higher fiscal authority that the Greeks or Italians can get help from. Finally, the European Central Bank has behaved as an extension of the German Bundesbank, setting monetary policy in a manner that suits Germany while strangling the southern European nations.
The Greeks have given up on the conditions of staying in the Euro. The recent Greek election failed to create a government so they will vote again next month, but parties that oppose the Euro austerity package are poised to win. The Greeks will then finally do what should have been done two years ago: leave the Euro and return to their own currency. This will be a painful and shocking event, and will likely be done without advance warning. But if it allows Greece to experience a real economic recovery over the next 18 months, it will cause the other Eurozone countries mired in double dip recession and harsh austerity, places like Spain and Ireland and Italy and Portugal, to think seriously about leaving the Euro. If the Southern Europeans leave, it is hard to see how the Euro survives.
There is one way the Euro could be saved. It would require a major rethink by the Germans. There would have to be a fiscal union of the Eurozone, where a supranational budget is decided that is binding on all the Eurozone nations. In addition, there would have to be an end to national debts, and the bonds of the individual Eurozone nations would have to be changed to being a universal bond backed by all the nations of the Eurozone, essentially making Germany a co-signer on the loans of all Eurozone nations. But will the Germans do that without complete control of everyone’s national budgets?
Finally, the ECB would have to realize that it must act in the best interest of the Eurozone as a whole, and not the interests of the Germans only.
Comments can reach me at nali@socal.rr.com.
