The Beginning Of The End Of The Euro?
With the political situation in Greece becoming more unstable by the day and the Franco-German alliance on monetary issues likely at an end, it’s beginning to be hard to see how the Euro survives:
Is there any hope for the euro dream?
One potential way forward would be to create a European- level fiscal union that assumes all national debt, much like what Alexander Hamilton did as first U.S. secretary of the Treasury. That isn’t going to happen in modern Europe. Why would German taxpayers and savers agree to pay for the good times previously enjoyed in Greece, Italy or Spain? Who could even ask them to do so?
As a result, all eyes are turning to the European Central Bank, because some in the euro policy elite still hope loose monetary policy and higher inflation rates will provide an escape hatch. But addressing fiscal issues through monetary means generally doesn’t work, and it does nothing to improve the competitiveness of the struggling euro-area periphery.
It appears that the euro-area politicians and the ECB agreed to a pact last year whereby banks bought government debt, and the central bank provided the financing. In return, the ECB got national governments to sign on to fiscal austerity. So far, the results are disturbing.
Employment levels and leading indicators in Spain and Italy imply the economic decline has accelerated. Greece continues to fall. Ireland is held up as a success story, but its debt levels are enormous, a great deal of fiscal adjustment remains to be done, and the domestic economy declined over the past six months.
Voters are already tired of what they perceive as austerity — see Greece, Spain and now France — and the policy debate has begun to shift. The changed tone of the discussion is gradual but it would be a mistake to overlook this development: Austerity programs have been huge social and political failures, removing one more hope for saving the euro area.
Here’s what happens next: The euro becomes cheaper, prodded by the ECB taking extreme credit risk and the popular revolt against austerity.
A cheap currency won’t solve Europe’s deeper problems. Depreciation amounts to a nontransparent way for the Germans to bear more of the costs of the failed euro experiment as their purchasing power falls, but investors will still prefer Germany to Greece. It also increases the risk that European and international investors may simply lose confidence in the euro, leading to mayhem in the area’s leveraged financial markets.
For European politicians, the most important task now is to cover their tracks and blame others. Inflation is confusing. It also is an unfair tax on savers and a transfer of wealth to borrowers (assuming that interest rates can be held down or otherwise controlled, probably through nonmarket means). The ECB will now be under great pressure to take actions that create inflation. This may bring the end of the euro.
Paul Krugman suggests that the collapse could come so fast that it would be beyond the power of policy makers or Central Bankers to do anything to stop it:
1. Greek euro exit, very possibly next month.
2. Huge withdrawals from Spanish and Italian banks, as depositors try to move their money to Germany.
3a. Maybe, just possibly, de facto controls, with banks forbidden to transfer deposits out of country and limits on cash withdrawals.
3b. Alternatively, or maybe in tandem, huge draws on ECB credit to keep the banks from collapsing.
4a. Germany has a choice. Accept huge indirect public claims on Italy and Spain, plus a drastic revision of strategy — basically, to give Spain in particular any hope you need both guarantees on its debt to hold borrowing costs down and a higher eurozone inflation target to make relative price adjustment possible; or:
4b. End of the euro.
Each of these events is entirely plausible, of course.
The exit question is this —- if the Euro collapses, what does that mean for the political future of Europe itself? I’ll leave it to people far better versed in these things than I to answer that question.