Even before the euro was adopted, in 1999, it was clear that neither the EU nor the 12-member subset that has joined the monetary union was an optimal currency area. Ideally, currency zones should be compact and homogenous enough to show little regional variation in business cycles--otherwise a one-size-fits-all monetary policy will leave some regions lingering in recession, while others grow so fast they overheat. Many argue that this is what is happening in Europe, where a few countries, like Ireland, are experiencing rapid growth while big economies, like Germany and Italy, stagnate.
There are ways to mitigate imbalances within big currency areas. Even America is not an optimal currency zone; its regions sometimes boom or shrink out of sync with the rest of the economy. But America has important features that temper the problems of unified monetary policy. Federal programmes act as automatic fiscal stabilisers, siphoning off tax revenues from booming areas and transferring them to ailing regions as unemployment insurance or health benefits for the poor. America's labour market is also highly flexible. This allows wages and prices to adjust downward, giving depressed regions a competitive advantage that can attract new companies and thus smooth out regional disparities. And workers in declining industrial towns frequently pack up and move across the country to find work; capital flows freely as well. Without these mitigating factors, people in depressed areas could easily be trapped in a cycle of stagnation.
In Europe, by contrast, few mechanisms exist to bring the euro area's widely divergent business cycles into sync. The ECB has been trying to chart a middle course between slow- and fast-growing countries while establishing its credibility as an inflation-fighter. The result has been a monetary policy that is too "hot" for some, too "cold" for others, and "just right" for almost no one.
The lack of adjustment mechanisms means that "ever closer union" is not just a glowing ideal; it is a matter of survival. Language and cultural barriers--not to mention wide differences in social insurance and retirement programmes--encourage workers to stay in their own country, no matter how bad the economy, closing off one of the easiest avenues of convergence. If Europe's economies do not drive forward towards a single market, with labour markets that are more flexible (and international), there is a growing risk that some of its members will eventually find the gulf between their economies and their monetary policies too wide to endure.
Unfortunately for euro-boosters, recent policy moves have all been in the wrong direction. Not only has the stability and growth pact, which was supposed to help force fiscal policies into rough alignment, been weakened. Progress has also stalled on measures to widen market access, such as the EU's services directive. And fierce public resistance to eroding generous worker and consumer protections has made governments unwilling, or unable, to implement the kinds of deep structural reforms that could help.
Those fissures have been deepened by the current fiscal crisis. Countries like Italy, Spain, and Greece benefited from their membership in the euro because they didn't have to pay a premium for currency risk. Italy, for example, used to use serial devaluations as an export stimulus, shoring up manufacturing industries like furniture and clothes. Unfortunately, while euro membership has lowered Italy's borrowing costs, and made some business transactions easier, its manufacturers have struggled to make themselves competitive with an appreciating currency.
Those sorts of difficulties are multiplying rapidly now:
Now, in the middle of the worst economic downturn since the euro's birth, a new view is emerging -- especially as the creditworthiness of Greece, Spain and Portugal, one after the other, has been downgraded. The view is that the balm of euro membership allowed these countries to gloss over serious economic problems that have now roared to the fore.
"Membership is not a panacea for a country's social and economic problems," said Simon Tilford, the chief economist at the Center for European Reform in London.
"In fact, there has been a huge divergence in competitiveness that shows up in massive trade imbalances," he said, comparing Greece with the wealthier euro countries. "While Greece may have been insulated from the risk of a currency crisis, there is also the risk of a credit crisis and a collapse of confidence in its solvency."
While sharing a currency with some of the mightiest economies in the world helped Europe's poorer nations share in the wealth, a boon during boom times, in hard times the rules of membership are keeping them from doing what countries normally do to ride out economic storms, including enormous spending.
So Germany, France and the Scandinavian countries are mounting billion-dollar stimulus plans and erecting fences to protect their banks. But the peripheral economies are being left to twist in the market winds.
If the global recession deepens, and both fiscal and monetary stimulus remain closed to the eurozone's problem children, eventually their governments are going to have to make a stark and ugly choice between leaving the euro zone, or standing idly by while their economies crater and the rioting spreads.
It will probably take only one exit to start a sizeable exodus. Much of the benefit of eurozone membership for those countries comes from the perceived integrity of the zone. Once one member has exited, creditors are going to take a long, hard look at the remaining members.
It would help the euro zone a lot if the commission acted more like a central government--stepping in to help floundering members before they're forced towards default or defection. But the systems aren't there for that kind of action--and the EU's ponderous structure is deliberately designed to prevent rapid central action.
I still wouldn't put anything like a 50% probability on a defection. But I'd say it's a lot more probable today than it was three years ago.
Breaking up the Eurozone? Don't count on it. Hell, the Eurozone may grow by adding Iceland.
I don't see how you get around the problem that a country in trouble that wants to leave the Eurozone, screws itself: nobody will have faith in the new (old) currency and the banks will collapse as people flee to Euro-country banks. And that problem is worse than it was three years ago!
" nobody will have faith in the new (old) currency"
That's a feature not a bug. A weak and debased currency will make exports more competative and debt easier to service.
faster please!
I've always wondered if sovereignty issues would be trouble for the Euro. Even if it makes sense in aggregate, countries like Spain and Italy have to be wondering if Germany and France aren't making decisions primarily with the interests of Germany and France in mind.
The point of the EU is that it should make decisions primarily with the interests of France in mind. Bien sur.
Sanjay has the right of it -- leaving the 'Zone is only telegraphing your intent to devalue your currency. Desperation is always unattractive.
Also, even the German banks are starting to break down now -- the EU may start handing out goodies soon now, and it would be foolish to leave the party before they've cut the cake.
countries like Spain and Italy have to be wondering if Germany and France aren't making decisions primarily with the interests of Germany and France in mind.
I would think Spanish and Italian politicians are smart enough and experienced enough to know that of COURSE France and Germany are doing that. Spain's making decisions based on Spanish interests, and Italy on Italian ones.
The United States is over two hundreds years ahead of the EU in terms of political integration of its constituent parts, and New York's representatives will still cheerfully screw over Texas (and vice-versa) if it is in their home state's best interests to do so. Why would the EU, whose member states don't even share a common language or culture, be any different?
The United States is over two hundreds years ahead of the EU in terms of political integration of its constituent parts, and New York's representatives will still cheerfully screw over Texas (and vice-versa) if it is in their home state's best interests to do so. Why would the EU, whose member states don't even share a common language or culture, be any different?
I guess my answer would be in the US laws and bureaucrats have to make it past a Senate which gives every state the the same number of votes. Of course I'm 10,000 miles away, but from what I can tell Germany and France pretty much set monetary policy in the EU with little input from the smaller countries.
The Economic Downturn:
My fellow Humanbeings it's only temporary. Don't be scared. Scared is what the evil doers want you to be. This severe economic downturn was not unforeseen. Many of us tried to warn everyone that we could years ago. And we did our humble best to head it off, and limit it's destruction. But their were some very powerful, and Evil forces at play that limited our ability to completely stop this economic downturn before it happened.
Fear not my fellow humanbeings. Your future, and the future of the World is very BRIGHT! now. :-)
The World has continued to be blest with excellent leaders who have brilliantly handled the dangers, and complexity's of our geopolitical challenges. And with the help of the world, America has now elected a new President (President Barack Obama), and a government who stands ready to lock arms with the rest of the World's leadership in solidarity towards a better World for all.
President Obama's choice of Cabinet, and advisers has been nothing short of brilliant. And his performance has been excellent. I believe President Obama stands ready to do whatever he has to do to see the American people, and the World through this crisis.
So spend, but spend wisely. Trade with each other, but trade wisely. Live, work and enjoy the majesty, and miracle of your existence in the community of humankind. This is a great time to be alive. :-)
It is not an accident that humanity exist on a small blue planet tucked in the safest corner of the universe. A planet with a constant source of warmth and energy from the sun. A planet surrounded buy a forcefield we call an atmosphere. And an atmosphere that keeps in the things we need to survive, and keeps out most of the things that could harm us. :-)
It is not an accident that the mass and orbits of the planets, moons, asteroids, and other heavenly body's are perfectly aligned to harmlessly deflect the larger objects that could hurt us away by gravity. Deflecting danger into outer space. Or into the sun.
The sun still shines on us. And our future is GOOD! This economic downturn is just a little darkness before the dawn.
Things are going to be GREAT! That is what you have chosen. The new Renaissance has begun.
God bless all of us
Jacksmith --- Working Class :-)
The only way many of these countries will survive a protracted downturn is via a weak currency (cf. what Russia has been doing).
I'd put a breakup of the euro above 50% if this downturn lasts through the end of the year.
As an Irish person living in the UK I've been hearing all about the Euro's 'inevitable collapse' since its inception. And yet it's still here. There's some discussion in Ireland at the moment about whether the Euro exacerbated the worst excesses of the Celtic Tiger boom (yes) but also an acknowledgment that if we still had our old currency we'd be Iceland right now.
And contrary to the hopes of Eurosceptics, there's no backing out now. If we go down, we go down together (and I'm aware that the latter is not entirely unlikely). Ireland may still end up in Iceland's position but it's funny that they want in whereas there are no credible voices calling for Ireland to leave.
Just to bring people up to date:
- The crisis has re-awakened British interest in joining the euro.
- The ECB has been doing a wonderful job maintaining liquidity; no banking system wants to leave its unbrella.
- Th Hungarians have been giving the example of how unhappy a country can be outside the euro. No country that tries to exit the euro (so throwing itself to the wolves as Sanjay has pointed out) could expect help from its ex-partners.
More fundamentally:
One reason why countries joined the euro was to put the temptation of serial devaluation behind them. Serial devaluation implies constant and expected inflation; the costs are high.
In this world, attempts to specify an 'ideal currency zone' have never achieved a lasting match with the real world. Economies change. The only closed economy is the planet. Maybe Keynes yen for a world currency was less unrealistic than the alternatives.
Lack of political unity is the big problem, I think. It's a lot easier for France to leave the euro than for Alabama to depart the dollar.
Sooner or later, a country will come upon a situation where its advantageous for the politicians to leave the euro.