The Euro: How a Common Currency Threatens the Future of Europe.
More than a decade after the global financial crisis, the data is in: Europe has lagged behind the rest of the world in its economic recovery. Europe’s weak recovery is the result of a poorly designed monetary system. These problems can be addressed through reform. What follows are some key insights I obtained while reading Joseph Stiglitz’s book on the Euro.
Objectively Worse Than the Great Depression
While counties like Germany and France ‘only’ suffered from low growth since 2009, Greece has been hit so hard that 1/3 of GDP has been wiped out. That makes it a deeper recession in real terms than the Great Depression in the US in the 1930s. Why is this?
During the Great Depression in the 1930s, the US was able to devalue the USD (which like all currencies was pegged to gold) by 40%. More recently, countries like Argentina have defaulted on their debts. But due to the structure of the Euro Zone, the Euro-peripheral countries that were hardest hit by the financial crisis were stuck with a Euro that did not suit their economies. They were not able to devalue their currency and they were not able to properly default on their debts.
Summary of the Problems With the Euro
The European Monetary Union was, according to Stiglitz, designed using neoliberal dogma, rather than evidence-based economics, and continues to be run in accordance with the neoliberal philosophy. This has resulted in a Euro with the following major flaws:
Economic Divergence by Design
It is very easy for individuals and companies to do business across the Euro Zone. Money can easily be transferred from an Italian bank to a German bank, and modern businesses can still sell to customers in Rome if they are based in Munich. Because of a lack of common depositor insurance across the Euro Area, this means that if a country’s banks risk becoming insolvent, money will easily be moved to banks in countries that are faring better. Similarly, if a country raises taxes in order to fund a deficit, corporations can more their tax residency within the EU to a country that has lower taxes because it has less deficit that needs to be funded. The result is that, in times of crisis, countries and banks that are most in need of funding will receive the least funds, while all the capital is moved to the economically stronger countries and banks. This makes the Euro Area fragile.
A more convergent design would see some form of sovereign debt mutualization in the form of Euro-Area bonds and a common depositors insurance for all Euro-Area banks. However, monetary hawks are continuing to prevent this.
Backward ECB Mandate
The ECB has just one mandate, which is price stability with 2% inflation. This means that the ECB cannot pursue other objectives at the same time. When this single-minded mandate was created, the idea was that if there is price stability, then markets would take care of the other aspects that we want from the economy, such as high employment.
The US federal reserve, on the other hand, has a much more broad mandate. Like the ECB, it targets price stability at 2% inflation, but it also targets “the highest level of employment that the economy can sustain”, and it also targets long-term economic stability.
The ECB mandate of just price stability is not enough to optimize employment. The markets’ invisible hand has continued to be invisible in crisis struck Spain with 16% unemployment a decade after the crisis, and similar stories in the other peripheral countries.
Crisis-era Policies Breaking Society Down
Former Greek finance minister Yanis Varoufakis has written and spoken about this issue a lot, and these findings are also explained in detail in Stiglitz’s book on the Euro. The destructive policies that were implemented in response to the crisis cut like a double-edged sword:
On the one hand, austerity was implemented by governments throughout the Euro Area. Especially the hardest hit countries had to make deep cuts to public spending. This is the best policy to respond to an economic crisis, according to the neoliberal dogma that still prevailed in Europe since the creation of the Euro (reports Stiglitz). But evidence-based economics shows that, when an economic crisis strikes a country, it needs stimulus, not austerity. This stimulus was not adequately provided by the ECB because the ECB is not allowed to stimulate the crisis areas more than the economically stable areas. Besides, even if this stimulus was given by the ECB to one country more than another, that capital might have flown to the more economically stable areas of the Euro Zone because of the economic divergence built into the Euro Area which I discussed above. So one problem with the European policies was that economies that needed stimulus did not get it from their governments who were forced to implement austerity, and it also did not come from the central bank, leaving crashing economies without the needed stimulus for recovery.
On the other hand, the austerity measures that were implemented by the government were forced on them by Brussels. Many of these policies were counter effective and micro-managed the way that local economies were run. An example of this is the size of bread in Greece. Before the crisis, the Greek government demanded that bread be sold in standard weights. This makes that bakeries cannot make their bread 3% lighter than their competitors, and encourages bread competition in other areas like quality, availability, and customer service. But after Greece was bailed out by the EU, Brussels demanded that the size of bread be ‘liberalized’. There are lots more such nonsensical measures that were forced on Greece, many of them less benign. This behavior from Brussels has fueled Euro- and EU-skeptical parties, and caused the rise of violent fascism in Greece and vanilla fascism and populism in other European countries.
How to Move Forward From the Current Euro Situation
The problems outlined above have solutions. Probably, the amount of fiscal integration that we now have in the Euro Area is the worst of both options. Stiglitz advocates for either more or less Euro, saying that either would be an improvement. More Euro would take the form of larger EU spending as a percentage of GDP (at the cost of national spending) perhaps by raising EU taxes, sovereign debt mutualization, and Euro Area-wide depositors insurance. It should also include a modern mandate for the central bank that looks beyond price stability. We also need institutions that are democratic enough to prevent populism and fascism taking power. Less Euro – maybe an equally good option – would see an eventual adoption of local currencies. In that case, larger currency blocks may remain, for example a block with Austria, Germany, Luxembourg, and the Netherlands, but for such a block to succeed, the block would need to adopt the ‘More Euro’ measures.
To learn about the macro problems and solutions around the Euro in more detail, I highly recommend Stiglitz’s book, The Euro: How a Common Currency Threatens the Future of Europe.