Break Up the Eurozone: The Only Workable Option
by Elliott R. Morss
May 12, 2012
For some time, I have argued the Eurozone is not a viable economic entity. In a recent piece, I predicted that until it is broken up:
- The French and German governments, working on behalf of their banks, will squeeze all they can out of the ‘weak sisters’;
- Unemployment rates will continue to increase with accompanying civil disorder/riots becoming more intense;
- The leaders of the “weak sisters” will commit political suicide by continuing to support the ECB/IMF mandates.
Political developments of the last week make it even more certain that a break up is the only viable outcome. And yet, there are some who disagree. Amar Bhidé, in a recent Wall Street Journal piece, argued that:
“Sovereign over-indebtedness and banking solvency are serious problems for Europe, but the common currency is doing its job just fine.”
Bhidé is not alone in feeling this way. In what follows, I will examine the arguments made by those wanting to keep the Eurozone together.
Giving Up National Currencies
Bhidé asserts: “The argument for fleeing the euro to devalue is misguided. Greece and the other peripheral economies lost little in giving up their national currencies.”
Lost little? What? In giving up their national currencies, countries also lost their ability to use monetary and fiscal policies to achieve full employment. Does this matter? Well, maybe not if all Eurozone countries had the same unemployment rates. But they do not. Take a look at the following table. You have some Eurozone countries near full employment. But the countries starting with Belgium have serious unemployment problems. Monetary policies in these countries should be keeping interest rates low while fiscal policies should be creating jobs. Not so for Austria, The Netherlands and Germany: countries at or near full employment. A common monetary and fiscal policy simply cannot address the vast differences in economic conditions in the Eurozone countries.
Table 1. – Unemployment and Government Deficits in Eurozone Countries
Source: IMF WEO Database
There is one other important point to note about Table 1. The two right-hand columns give government deficits as a percent of GDP. Note that under IMF/German austerity pressure, the deficits of all high unemployment countries are supposed to fall in 2013. They will not.
When all countries have to use the same currency, they are held to the competitive standard: they must adjust their internal costs structures to compete on world markets. Take a look at Table 2. Most Eurozone countries with high unemployment have negative current account balances – an indicator of an inability to compete on world markets.
Table 2. Current Account Deficits (as percent of GDP), 2012
Source: IMF WEO Database
If a country has its own currency, its value relative to other currencies will adjust to make the country more competitive on world markets. For example, if a country is running a current account deficit, its currency will weaken, thereby making its exports cheaper for other countries to buy. This valuable adjustment mechanism is not available to countries using a single currency.
What do the “keep-the Eurozone-together” proponents say about devaluations? I again quote from Bhidé: “Devaluation is a blunt, top-down intervention whose benefits and costs diffuse in unpredictable and often unwanted ways.”
I disagree. Take the US as an example. Back in the 1980’s, Japan became extremely competitive as an export nation. Japan was then the “Asian tiger”. In 1985, a US dollar would buy 239 yen. Today, a dollar only buys 83 yen. That devaluation helped US costs adjust so it could remain competitive on world markets. It was not “blunt, top-down intervention”. Instead, it happened gradually through time.
So what do the Eurozone proponents want to do to make its “weaker” countries’ cost structures competitive? A good example is what they tried in Greece under an IMF monitored standby agreement. I quote from an earlier piece I did on the IMF program:
“In all the years I have been covering the IMF, I have never seen such a long list of policy changes being demanded of any country. The general categories include: fiscal reforms, pension reforms, health sector reforms, Social Security reforms, government performance reforms, and economic system reforms. In order to achieve these objectives, the Greek government has agreed to foreign technical assistance in more than 20 different fields. Ok. So maybe if Greece did everything on the IMF list, they could stay in the Eurozone and compete with the Germans. But don’t hold your breath. This will not work.”
There are two primary Eurozone imbalances that need to be addressed:
- Unemployment rates – with some countries at full employment and others with 50% of their younger workers without jobs, how can a “zone” with a single monetary/fiscal policy and little migration get unemployment rates down without causing inflation in countries at full employment?
- The competitiveness gap – without using the devaluation adjustment mechanism, how will Greece ever be made competitive with Germany.
I don’t see how. And of course, a breakup of the Eurozone will have its own risks and consequences. But until then, I see nothing but riots in the streets and government collapses.