EU’s stance on the Euro now seems schizophrenic at best and insolent at worst; there will have to be decision made on the viability of a common currency – either a blanket dissolution into an exchange rate mechanism (similar to what the UK maintained, and consequently exited in 1990s), or a selective dissolution into a more forgiving exchange rate mechanism. Inflation needs to be allowed for weaker members.
Three factors are at play here, differential growth rates, debt payments, and votes.
Germany and Greece seem at extreme ends today in terms of growth rate, and understandably so. Germany with its export growth model, and a recently cheapened euro saw their industrial production at 8% in this quarter. The Greeks on the opposite end have relied more heavily on subsidized production and even heavier subsidies on domestic consumption, result -3.7%. Every other European country sits somewhere in the middle. Herein lies the differential growth problem; the simple rule is that the interest on sovereign debt mustn’t exceed GDP growth. If Germany can pay up on theirs but Greece can’t, and neither can inflate their common currency, there is no way out except for Germany to pay on Greece’s behalf. Or drop Greece from the currency.
Payment to service debt are intertwined with the how secure those debts really are; the more skeptical investors get, the higher the interest (yields) they demand, higher the yields the more jittery they get. The feedback loop in the recent past is exaggerated with a parallel CDS market (though, I’ll be clear, that’s just a by product and not the cause). Greece is stuck in that feedback loop, with Spain, Portugal, Ireland and whoever else is mildly weak to join. Problem is the spread that they’re held against is German. That has to be uncomfortable, when times are good they get to borrow far cheaper that they should and when times a bad they’re forced to cut down on all social expenditure. This is bound to create the worst sort of business cycle, of violently splurging on ‘windfalls’ when they should be investing and retracting murderously when they should be stimulating out of a recession.
And votes…it’s all about being elected in democracies. Pity they haven’t yet started their own tea party politics, but at the end of the day the Germans can’t keep writing checks without losing elections. As long as nationalism precedes Europeanism, the German voters will remain German voters no matter whether the Greeks get their pensions or not; if you think about it, Westphalia decides the fate of Greece.
I can only think of two long terms solutions out of this mess (and that doesn’t set a precedent of bad fiscal behaviour for everyone in the Union – or the Greenspan put, as they call it in America): either dissolve the common currency and move to a European exchange trade mechanism. Essentially, everyone manages their own finances, with a commonly agreed and adjustable peg according to manageable growth rates and debt ratios. Or, the core members with similar fiscal propensities may continue with the common currency and lead the Greeces and Portugals of Europe onto an exchange rate mechanism.
The third way, if Europe had a progressive movement as America, would probably be to ignore the problem at hand and concentrate on establishing a grassroots campaign to change the economics of debt. Thankfully, I haven’t read anything to that effect yet.
