The Euro : Chronicle Of the Currency Crisis
differentials between European government bonds and credit default
new records almost every day. Greece, Ireland, Portugal and Spain
face increasing difficulties in financing their public debt. Financial
markets fear the situation is untenable and are becoming nervous.
Politicians and the ECB all with their own preferences and interests
feverishly search for a solution. The dispute between Sarkozy and
not likely be resolved soon.
Who pays the
Political leaders favor a scenario of debt restructuring with a
rigorous "haircut" for the bondholders, including the already shaky
bank sector. Banking circles and the ECB obviously shun such a
scenario. For Trichet the idea that an EMU member state would fail to
fulfill its obligations is unthinkable. It would undermine the
credibility of the euro project even further. An earlier proposal to
create European bonds as a funding vehicle for individual member states
has already been dismissed. For obvious reasons, banking circles favor
a solution in which the European taxpayer would come to the rescue and
would guarantee faltering government bonds.
Both solutions have serious drawbacks. A debt restructuring would
definitely compromise the financing capacities of defaulting nations
for decades to come. Likely after such a debt restructuring the next in
line after the PIGS (Belgium, Italy, France...) may soon become the
next suspect. A haircut would rise the risk premium and bond yields,
increasing the risk of the euro crisis spreading all over Euroland.
On the other hand, The ECB option of an unlimited
guarantee is contrary to the European
and brings unlimited
exposure to unknown risks. The ECB's proposal also meets
opposition from the German public opinion. Many fear that more
surprises could be hidden behind the empty state coffers. Banks could
need additional state support and unfunded pension debt is becoming an
unbearable burden in several countries. Moreover the European safety
net may cause the moral hazard of proliferation of lax fiscal policy
Euroland’s choice is indeed one between cholera
and the plague. But that's only the most acute problem. In the longer
term, the question arises how to avoid a repetition of future euro
crises and how we can prevent Milton
Friedman's prediction that the euro would fall apart at the first
external shock from becoming true.
De Grauwe’s Keynesian
In a CEPS publication “What
kind of Governance for the Eurozone”, Prof. Paul
De Grauwe analyzes possible scenarios. As appropriate for a
scientist, he starts by analyzing the causes of the euro crisis. On the
basis of obvious data he demonstrates that excessive debt accumulation
- particularly in the private sector - is the key factor leading to the
euro crisis and that the bursting of housing bubbles in Ireland and
Spain was the impetus. De Grauwe concedes partial responsibility of the
monetary policy, but categorically rejects the inflationary low
interest rates as the fundamental cause of the overall credit euphoria.
Italy also enjoyed a sharp fall in interest rates since the euro was
introduced and their credit euphoria was hardly noticeable, the
argument goes. So the low interest cannot be the essential cause, De
Grauwe concludes, without any further investigation
into the cause of the divergent developments in these countries.
The essential difference between Ireland and Spain
on the one hand and Italy on the other was that at the time of the
introduction of the euro, Italy was stagnating at a growth rate of 1.7%
at most. Spain and Ireland on the contrary were booming since years
with GDP growth rates of 4.7 and 11% respectively. Their inflation was
also twice as high as the average EMU rate. For slow-growing
nations such as Italy, the incentive of a low interest rate came as a
welcome stimulus. For the booming Irish economy, the
rate cuts had the same effect as a stimulant drug on a child with an
ADHD condition. Such medicine had to lead to disaster. Every
right-minded housewife knows it, but apparently not so our political an
monetary authorities. They simply disregarded the contra-indicative
growth differentials and Milton Friedman's
explicit warnings. They ignored the world's top financial expert and
proceeded with their political euro project to
dethrone the dollar as a reserve currency anyway.
Spirits or Political Madness ?
Forgetting about the differential growth and inflation rates at the
start of the euro is an intellectual dishonesty aimed at disguising the
role of this monetary blunder as the
fundamental cause of the Irish and Spanish real estate bubbles. Through
exclusion, De Grauwe then comes to the traditional Keynesian
explanation for the credit euphoria: “Animal
Spirits”; the “silly citizens’” irrational spending behavior
funneled by successive waves of irrational optimism and pessimism.
According to the Keynesian-interventionist doctrine, these animal
spirits are the explanation for the boom-bust cycles, and consequently
require tempering by "rational" governments. It is the
fundamental Keynesian justification for massive government intervention
in the economy through monetary and fiscal policy.
Forgetting about the growth differentials at the start of the euro
project has the crucial outcome of condoning the monetary blunder of
the single currency and of justifying even more state intervention on
the same wrong track.
The reality is
that not animal instincts, but the inflationary interest
rates caused the Irish and Spanish spending spree. The introduction of
the common currency provided Spanish and Irish consumers and businesses
with unlimited access to cheap credit on top of their excellent
economic environment and outlook. Their response was as rational as it
was predictable. The Irish and the Spanish factored the artificially
low interest rates into their investment calculations. The opportunity
of unlimited cheap credit lead them into excessive investment in real
estate. Not animal instinct, but inappropriate monetary policy lies at
the basis of their calculations and buying decisions.
In substance, the current eurocrisis can be summarized to the systemic
flaw that a single monetary policy for economies with highly different
growth rates is not sustainable and leads to the leveling down of
growth prospects. On average, the growth deficit due to the single
currency can be estimated
at a yearly 2 to 3%(2) .
For Spain and for
Ireland particularly, the introduction of the euro caused an abrupt end
to a most prosperous period of 20 years of unprecedented growth.
As both a differential interest rate policy and a
change of exchange rates are unfeasible in a monetary union, De Grauwe
now recurs to the third instrument of monetary policy in order to
contain future growth differentials. In order to control
excessive credit expansion and the emergence of new bubbles, De
Grauwe advocates differential reserve requirements. He proposes
to impose higher reserve requirements to banks of fast-growing
economies. This idea would indeed be most appropriate if only the
practical realization would not presuppose restrictions on the free
movement of capital. The promotion of the free movement of capital was
the prime objective and justification politicians used to justify the
euro project. Or how the single currency increasingly gets entangled in
its own contradictions.
The very fact that renowned financial experts now take differential
monetary policies into consideration indicates that even the
euro-believers start to assume the harmful effects of a unitary
monetary policy and that they no longer exclude differentiation.
However, solutions which cause new harmful effects for the prime
objectives or the monetary union are counterproductive. Today millions
of euro-citizens suffer
heavily for the monetary madness of the single currency. Most
deplorably, the architects of the euro project failed to provide an
exit scenario as well as emergency exits for lagging or leading
countries that want to leave. It is high time the responsible
authorities seriously start conceiving the practical modalities of an
orderly exit before markets force the exit in full chaos.
Sooner or later our monetary authorities will have
to recognize that money creation out of thin air cannot promote
sustainable growth. Their manipulation of interest rates far below the
natural equilibrium level only leads to excessive debt accumulation.
Interest rates are the starting point of all economic calculations. The
interest level is not only conclusive in the choice between saving and
consumption, but also in the choice between labor-intensive and capital
intensive investments. Forging this basic measure only leads to wealth
destructing distortions. Too low interest rates lead to
savings deficits, excessive debt accumulation, excessive expulsion of
labor from manufacturing processes, and to inequitable and
counterproductive redistribution from savers to big spenders. The
eternal dream of (nearly) free money is an illusion. The interest rate
level is sustainable only if it leads to the equilibrium
between saving and consumption at which every generation pays for its
own consumption without coercing their heirs or other nations to pay
for the piper.
(1) Art 103 of the Nice Treaty:
" the Community or a member state shall not be liable or
assume the commitments of any EU government body".
Hence, not only can member states not be forced to bail out another
member state, they are not allowed to do so, except when acting jointy
under the exception of Art 100.
FROM 20 YEAR GROWTH DIFFERENTIALS IN EUROPE, De Vlieghere and
In this research
into the causes of growth differentials in the EU the authors found
that all other
things equal, countries having stayed outside the
EMU, had significantly higher growth,estimated
at 2.57% in their multiple regression
( http://workforall.net/WFA_study_English.pdf page 35-36 )
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