The Euro Currency: An Incompetent Disaster Creating Penury for Europeans
Posted at BNP Ideas on Nov 2011
By Andrew Moffat.
“Euro-realists” have long warned of the dangers that would arise from the single currency. Simply put, different countries have evolved dissimilar economies. Those economies reflect varying economic models, trading patterns and infrastructures. They also function at diverse degrees of efficiency and are, to a significant extent, a product of their peoples.
The advent of the European currency has stripped the governments of the 17 member nations of their rights to determine their monetary affairs. By ‘monetary’ affairs, we mean the ability to set interest rates – usually via their Central Banks – and to determine the value of their currencies, usually via the markets.
The prevailing interest rate and the value of a currency, in general terms, reflect the health of a nation’s economy.
In recent years, the Bank of England has cut interest rates to record lows, currently at 0.5%. Sterling, the UK’s currency, has lost approximately 20% of its value, reflecting the condition of the UK economy and its yawning trade deficits. Had the UK joined the single currency in 2005, say, the UK’s interest rates would have been set by the European Central Bank (ECB) and would now stand at 1.25% – following the ECB’s recent cut. There would, moreover, have been no depreciation to Sterling; the UK economy would be locked into the value of the Euro currency, against which Sterling has devalued in recent years.
One of the principal difficulties afflicting the single currency, amongst the 17 nations who comprise the Eurozone, is differing rate at which the individual economies grow.
In general terms, the northern economies, particularly Germany, are dynamic and efficient. In the south, the reverse is generally the case: these economies are less dynamic and inefficient. As this gulf widens, so do the economic strains between the two blocs.
Up until the advent of the Euro currency and since the 1950s, the German economy has only ever revalued upwards its currency. By contrast, the southern member nations always devalued their currencies.
Such revaluations are no longer options. This means that as the German economy, for example, becomes more efficient, its exports grow more competitive on world markets. Unlike in the past, there is no mechanism by which an equilibrium can be reached, simply because there is no longer any Deutschmark which can be revalued.
In the south, the opposite is true. The Italians and Greeks, for example, whose economies are becoming more inefficient against their northern competitors, cannot devalue their currencies. Nor can they reduce their interest rates, now determined by the ECB.
What can be done? The answer is that to become more efficient are regain their competitive edge under the current system, the southern economies must reduce their costs. This means they must also reduce their wages.
This is easier said than done. If wages are to be decreased instead of increased each year, how do families pay their mortgages, debts or rents?
If wages are reduced, where does the money come to pay the taxes the government requires to maintain its spending? Indeed, where does the money arise to keep the economy in shape and industry healthy?
The answer might be found in this interesting statistic. In all of the past 10 years, the Italian economy has grown by less than 1%.
Wage levels are still enormously out of line and there is a wide divergence in costs with the more dynamic northern economies. A cut of some 25% in Italian wages would be necessary to restore competitiveness, given there is no Italian Lira to devalue and restore competitiveness.
The backdrop is even more ominous because the Italians possess a vast national debt of some Euros 1.9 trillion. Simply put, there is no growth in the economy to pay off this debt and the Italians are instead running structural deficits where the national debt keeps rising.
The Italian dilemma, rather like the bigger Euro-currency dilemma, has not been lost on the markets. The perceived inability of the Italian government to address its deficit has resulted in its government’s bond yields rising from less than 4% in recent months to more than 7% last Thursday.
Some readers may recall that these were levels that precipitated crises in Ireland, Portugal and Greece, causing their bail outs by a combination of the EU, the ECB and the IMF and, in the case of Ireland, by the British taxpayer. The UK, of course, also contributes to the IMF.
The difficulty last Thursday involved merely Euros 4bn of Italian debt. Next year, the Italian Government must refinance Euros 300bn of debt, which it needs to roll over to later maturities. How will this be possible? Certainly, at a coupon of 7%, it will be unaffordable to finance this level of debt.
Who owns the Italian national debt? For the most part, other banks own this debt, especially Italian banks. Should these banks fall into difficulties, the Italian Government will have to bail them out and raise further funds on the bond markets to do so – creating a further downward spiral in the value of its existing bonds, held by the same banks!
Greece is a forerunner of the type of predicament in prospect. Its economy is a fraction of the size of Italy’s and the country has become entirely dependent upon bailouts from the ECB, the EU and the IMF, with its bond market no longer operable and its existing bonds trading at high double digit yields. Greece has therefore had to re-schedule its debts – a form of default.
In order to balance its budget, to pay for its bailouts and its rescheduled debts – largely owed to the banking system – Greece will be placed even more firmly through the EU’s wringer. As one commentator stated recently: “Greece has been subjected to the greatest fiscal squeeze ever attempted in a modern industrial state, without any offsetting monetary stimulus or devaluation.”
The EU is, in effect, repeating the mistakes of the Federal Reserve between 1929 and 1932, during the great depression. Unlike the USA, however, the EU is not a nation.
Monetary stimulus is impossible so long as Greece remains within the Euro currency. In other words, Greece has lost its monetary sovereignty and, as a result, its fiscal sovereignty.
The constraints it has had to endure are prescribed because it is a member of an internationalist political scheme, overseen by unelected EU Kommissioners, which has resulted in its economy contracting by some 15% since its problems began. Its debts ill magnify to over 180% of GDP next year and even after re-scheduling, will stand at 120% of GDP by 2020.
In other words, future generations of Greeks will become wage slaves to serve the ideal of ever ‘closer political union’.
There are several measures the EU may take to facilitate the continuation of monetary union. It could, for example, create a system whereby the wealthier northern nations guarantee or purchase the debts of the poorer nations. It could also encourage a new competence, whereby the EU gains the right to tax the citizens of the ‘Union’ and it could require that the tax revenues of the wealthier countries be used to finance the borrowing or some of the expenditure of the poorer countries. By means of compensation, the EU would tightly regulate the budgetary policies of the poorer nations and oversee the regulation of their economies.
Another possibility is to provide the ECB with more flexibility.
Currently, the ECB has been purchasing the bonds of the afflicted member nations in an attempt to support their prices and maintain or reduce their yields. Invariably, it has suffered colossal losses. The ECB is backed by the subscription capital of the EU member states, including the UK. Ultimately, if the ECB experiences financial difficulties, it will be backed by the taxpayers of the member states.
The ECB could be provided with the right to create new money to buy the bonds of the afflicted member nations. This would be the equivalent of the Bank of England’s programme, known as ‘quantitative easing’ (QE). Like the other possibilities, this proposal is opposed by Germany. The German Government sees no reason why its taxpayers should rescue the economies of the afflicted member states. It also considers ‘QE’ to be akin to a sticking plaster, that fails to address the underlying causes, whilst risking the spectre of inflation – which it experienced in extreme circumstances in the 1920s.
There are, of course, some alternative solutions which will not be countenanced by the EU.
Germany could leave the Euro currency. It would regain its Deutschmark, which would soar on the currency markets. The Euro would fall in value without the German anchor and the southern nations would then become more competitive.
The southern nations could also form a separate currency bloc, which would align their interests more closely. This possibility has already been discussed by Germany but it would create a two-tier system, which is unattractive to the Kommissars of the EU.
Better, Greece could leave the currency union and recreate the Drachma. The Drachma would plunge on the currency markets but the Greeks would again become competitive and would, after a year or two of upheaval, enjoy economic growth. Clearly, Greece would have to re-price Euro debt into Drachma debt, to avoid paying devalued Drachma’s to redeem more expensive Euro debts. Such a scenario would entail a further default on its Euro debts. On the other hand, the Greek Central Bank could again issue its own currency, a right it lost when it joined the Euro – which partly explains why it is now dependent upon EU bailouts to keep its economy afloat.
Whilst the UK remains outside the Eurozone, the UK Government is obliged to produce annual budgets that meet the convergence criteria of the EU, with a view ultimately to joining the single currency bloc. Andrew Brons, MEP, obtained this information in a Question he put to the Commission recently, which can be found here and here.
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