Wednesday, August 22, 2012

Abandoning the Euro, Saving the Euro

By Professor Jeffery Atik

The Euro crisis tests more than the viability of the current currency arrangements. The sovereign debt crisis affecting Greece and Ireland, Italy and Spain is also testing the limits of wider European democracy. The status quo will likely be abandoned. The open question is whether the Euro crisis will lead to deeper integration among the EU Member States (as an artifact of a Euro rescue) -- or whether a collapse of the Euro will signal a retreat from the past achievements of the European project.

The European Union began as a common market for goods and services. A common European currency space is a more recent development -- the Euro serves as the currency of most (but not all) EU Member States. Adoption of the Euro has reduced trading costs, and has led to more transparent prices.

The Euro crisis is first and foremost a sovereign debt crisis, initially affecting a handful of EU Member States running unsustainable deficits. The sovereign debt crisis is itself an artifact of the establishment of the Euro -- neither Greece nor Spain would have been able to borrow as much in their former currencies (or on such favorable terms) as they were able to using the Euro. Prior to the Euro crisis, the financial markets valued Euro-denominated Member State obligations similarly. As the crisis developed, lenders became far more discriminating, demanding much higher Euro interest rates from weaker Member States (such as Greece and Spain) than from others.

For the grossly indebted Member States, there is no simple escape from these much higher borrowing costs -- absent assistance from more solvent Member States. And -- for the moment -- healthier Member States, such as Germany, have resisted intervention. Austerity has been bandied about (indeed, it has been 'imposed' on Greece), but there is a point of distress beyond which quite painful austerity measures cannot generate the budget surpluses needed by a country to dig its way out of debt. The better answer may be devaluation - but this path is not presently open to a country participating in a currency union like the Euro.

Devaluation could take two forms. One or two countries could exit the Euro and re-adopt a (devalued) national currency. The remaining Euro countries would continue to practice the monetary union. Or the Euro could shatter entirely -- with all countries returning to their historic currencies: a new old world of francs, lire and Deutchmarks.

But rampant revaluations of post-Euro national currencies (upward and downward, in various cases) would dramatically affect intra-European trade -- and would reintroduce risks and costs the Euro had seemingly eliminated.

Of course, the Euro can be saved. All that is needed in the political will to do so. As a technical matter, a Euro rescue would likely involve replacing the arrangements which now permit each Euro-participating country to issue Euro-denominated notes with a collective facility that would enjoy the confidence of the financial markets. Access to the facility would be disciplined in a manner that would prevent 'excessive' borrowing. Put another way, it would remove the ability to run deficits from national political leaders -- deficits that could have allowed the maintenance desired by levels of government services (education, health care, pensions, etc.)

It may be a democratic inevitability that people want high levels of government services, but are unwilling to accept the constraints that accompany fiscal discipline. And -- at times -- austerity is simply the wrong prescription. Be that as it may, these democratic urges are real and (at times) irresistible. If the 'periphery' (in Europe, a term with both financial and geographic significances) is to be included, its European expectations need to be satisfied. And this will cost the center (think Germany).

Germany has a proud history of generosity -- within its own borders (recall the integration of the East), within Europe and without. But there seems to be something that offends a German popular sensibility in bailing out sunnier and more profligate Member States in the current crisis.

Germany and other core Euro states must stand behind the Euro to save the Euro -- and that means, both now and in the future, standing behind the sovereign borrowings of all Euro states. The only way forward to maintain the Euro is to increase the authority of the European institutions -- moving sooner, rather than later, toward a fiscal union.

Doing so has a democratic cost associated with it. National capitals will have far less say in determining national economic conditions in a fiscal union. EU-level politics is already viewed as distant and elitist -- these tendencies would only increase with fiscal union.

The other direction -- abandonment and retreat -- promises more responsive governance, but with a loss of prosperity and a reintroduction of greater economic divergence in Europe with their accompanying tensions.

Follow me on Twitter @jefferyatik

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