The Eurozone is unworkable in its present state
The eurozone treaty genie is out of the bottle and there’s no way to put it back in. In my last piece, I pointed to a WirtchaftsWoche article which quoted German Chancellor Merkel as wanting to "improve" (weiterzuentwickeln) the Eurozone’s basis by revisiting treaty arrangements. Over the short-term, this is not likely to occur because of the sheer complexity of the matter. However, over the longer-term, changes are inevitable because the Eurozone is completely unworkable in its present setup.
Last week I wrote:
Over the long-term, the proposed European Monetary Fund makes sense. However, first and foremost, let’s call it a European Harmonisation Fund because this is the purpose – harmonisation.
For example, within the United States, I imagine there are substantial interstate capital account imbalances between individual states. Florida might have a substantial capital account surplus because of all of the retirees moving there. While New York could have a capital account deficit because of the financial sector wealth. (I don’t know if this is true. The example is just illustrative). But you wouldn’t hear New Yorkers screaming bloody murder about the profligacy of Florida. Nor would you hear the Floridians yelling about New York’s enormous current account surplus.
The point is the United States has more well-harmonised internal market because of the free movement of labour and capital, a common language and federal automatic stabilisers. This is what the Eurozone lacks. And this is why we can change the unbelievable EMF – and its inflammatory expulsion clause into the more believable EHF.
The reason the US internal market is harmonised is not merely about the free movement of labour and capital; Europe has that in spades despite the language barriers. We see Polish workers in Ireland. And German retirees buying houses in Spain. What Europe lacks is a federal treasury.
Below I have translated the cogent argument the Spanish site cotizalia.com put forward earlier today on this point. Note that the article begins with a defence of the euro as a bulwark against crisis, one reason Iceland, Estonia, Lithuania and Latvia are keen to become Euro members.
The role of the euro after ten years and a serious global financial crisis has been challenged by some and highlighted by others. The euro has been an effective umbrella to the adverse economic environment of the past two years, but the crisis has found that macroeconomic coordination mechanisms in the euro area could be improved.
It has also shown that monetary union has no sufficiently effective and centralized decision-making mechanism. These are two of the conclusions of the book "The euro to Europe’s rescue", published by the Elcano Royal Institute and edited by Federico Steinberg, one of the researchers at the institution. Now is the time to overcome the weaknesses of the euro, as highlighted in yesterday’s presentation of the document the European Competition Commissioner, Joaquin Almunia.
Moreover, there are important differences in the confidence that governments have in the effectiveness of discretionary fiscal policy, Steinberg points out in his introduction, stating that "contrary to what the most optimistic Europeans wanted, the crisis has shown that the euro is not yet ready to replace the dollar as reserve currency inside."
The single currency, which has no sovereign support, nor an army like the dollar, will continue behind the greenback, "while it is not issuing its own debt," Steinberg notes. This is one of the theses of American Barry Eichengreen, author of the first of five chapters. Eichengreen, an economics professor at the University of Berkeley (California), believes that "until the euro area makes a homogeneous debt vehicle and creates cohesion in its internal governance, it will have trouble competing with the dollar." It is about building a Unified Treasury in the eurozone to fund economic policies promoted by Brussels, as does the U.S..
For his part, Charles Wyplosz, a professor at the Graduate Institute of Geneva and author of other chapters, thinks it is necessary to advance the creation of a single financial market "with a central controller." Although he does not think this will happen in the short term due to territorial fights and "philosophical and ideological disagreements."
All authors agree that the European response to the crisis was the right one and that without the single currency, it could have had "catastrophic economic and social consequences." But the book underscores that, in addition to more flexible mechanisms for crisis response, it would be nice to have a face to the euro. One idea on which Almunia insisted, is that one of the "clear limits" of the single currency is "weak external representation: there are too many voices, it is poorly organized."
This whole problem points back to my thesis that a Depressionary bust in Ireland is echoed in California, meaning that the individual sovereign states in the Eurozone are akin to U.S. states because the single currency gives them neither monetary control nor wide latitude on the fiscal front. More correctly put, I would now say "a depressionary bust in Spain is echoed in California" because the challenges facing the Eurozone are most evident in Spain. As in Ireland and California, Spain had a massive property bubble that has burst. The result in all three is high unemployment and a severe fiscal crisis.
In my view, the fiscal crisis in California demonstrates that a federal treasury is no panacea. After all, the U.S. has a federal treasury and California contributes more in transfer payments to that treasury than it receives. Yet, it too must cut spending like mad and raise revenue in order to pay its bills. Having a treasury would not have ended the economic pressures for Spain, Greece or Ireland – and I am dubious about a United States of Europe because of the greater fundamental differences within the EU.
Nevertheless, I anticipate some type of change is coming to eurozone treaties. The present setup is unworkable – and if maintained will force a breakup.
I do think a European Harmonisation Fund would be more appropriate than a European Monetary Fund because the point is to create convergence within the Eurozone so as to prevent ECB monetary policy from creating a situation, as we saw in Ireland last decade, where negative real interest rates encouraged housing speculation and leverage.
But, another crucial part of convergence comes on the fiscal side. And that means, yes, there must be penalties for free riders. The last bit of convergence concerns the current account imbalances in the Eurozone. It is completely disingenuous for the Germans to chastise the Spanish for reckless spending when the Spanish were the model of fiscal probity during the last decade. Moreover, their private savings rate is very high right now as Spanish households deleverage.
The fact is interest rates in Europe have always been set for core Europe, a slow domestic growth unit of France, Germany, the Benelux (and Italy to a degree). Everyone knows that. I guarantee you if the ECB had pushed up rates in 2004-5 to choke off property excesses in Spain and Ireland, the Germans would have cried bloody murder as they teetered on the brink of recession. So, when the Germans point the finger at Spain and tell them to get their fiscal house in order, they should remember this fact. Spain’s debt woes and Germany’s intransigence lead to double dip and that is what you are ostensibly looking to avoid.