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January 14, 2011
Paul Krugman has a long and interesting article on the Eurozone in the New York Times magazine that questions the viability of the Euro project. Europe is in deep crisis — because its proudest achievement, the single currency adopted by most European nations, is now in danger.
Krugman's argument is that Europe lacks the institutions needed to make a common currency workable. He says:
when the single European currency was first proposed, an obvious question was whether it would work as well as the dollar does here in America. And the answer, clearly, was no — for exactly the reasons the Ireland-Nevada comparison illustrates. Europe isn’t fiscally integrated: German taxpayers don’t automatically pick up part of the tab for Greek pensions or Irish bank bailouts. And while Europeans have the legal right to move freely in search of jobs, in practice imperfect cultural integration — above all, the lack of a common language — makes workers less geographically mobile than their American counterparts.
As in the US the bubble burst in 2008.The peripheral economies of Europe---Greece, Ireland, Portugal --- had borrowed much more than they could really afford to pay back. First Greece, then Ireland, became caught up in a vicious financial circle: as potential lenders lost confidence, the interest rates that they had to pay on the debt rose, undermining future prospects, leading to a further loss of confidence and even higher interest rates.
Krugman says:
it’s the euro itself that makes Spain and Ireland so vulnerable. For membership in the euro means that these countries have to deflate their way back to competitiveness, with all the pain that implies.The trouble with deflation isn’t just the coordination problem Milton Friedman highlighted, in which it’s hard to get wages and prices down when everyone wants someone else to move first. Even when countries successfully drive down wages, which is now happening in all the euro-crisis countries, they run into another problem: incomes are falling, but debt is not... so debtors have to meet the same obligations with a smaller income; to do this, they have to cut spending even more, further depressing the economy.
The policy solution has not been one of Greece or Ireland leaving the Eurozone and returning to their own currencies. It has been one of harsh fiscal austerity in an effort to regain the market’s confidence, backed in Greece and Ireland by official loans intended to buy time until private lenders regain confidence.
The markets don’t expect Greece and Ireland to pay their debts in full. They are expecting some kind of debt restructuring, that could bring the vicious circle of falling confidence and rising interest costs to an end, potentially making internal devaluation a workable if brutal strategy. The austerity strategy demanded by the Germans is for Greece, Ireland, Portugal and Spain to tough it out:
Governments that can’t borrow on the private market will receive loans from the rest of Europe — but only on stiff terms: people talk about Ireland getting a “bailout,” but it has to pay almost 6 percent interest on that emergency loan. There will be no E-bonds; there will be no transfer union...it will be an ugly process, leaving much of Europe deeply depressed for years to come. There will be political repercussions too, as the European public sees the continent’s institutions as being — depending on where they sit — either in the business of bailing out deadbeats or acting as agents of heartless bill collectors.
Krugman's judgement is that the odds are that the current tough-it-out strategy won’t work even in the narrow sense of avoiding default and devaluation — and the fact that it won’t work will become obvious sooner rather than later.
At that point, Europe’s stronger nations---France and Germany--- will have to make a choice: saving the Euro-project or allowing Greece, Ireland, Portugal and Spain to default on their debts and the French and German banks take a haircut.
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Ha, ha, hoist on their own petards.
Isn't the definition of a camel as an animal designed by a committee so true, when its appled to Europe?
But nice to know Australia is not the only part of the world that operates on the two speed economy priciple?
Camerons are coming, hurrah, hurrah!