The Euro Crisis is Over.

> It was in the late 1970’s that President Giscard d’Estaing and Chancellor
> Helmut Schmidt launched the european monetary system. Already, most pundits
> knew it would never work.
>
> How could a fixed exchange rate (with some flexibility at first) between
> Germany and France ever work? The inflation differential between the two
> countries was just too big and structural. If not cultural.
>
> Without a periodic devaluation of the franc, French companies would
> quickly loose their competitiveness. France would have to make unlikely
> fundamental reforms to bring their long term inflation rate in line with
> Germany for this new currency system to work. That, the overwhelming
> majority of experts believed would never happen.
>
> I clearly remember a German manager of a leading company licking his
> chops. The fixed exchange rate was a wonderful opportunity to run over the
> economic Maginot Line.
>
> Fast forward. From the “currency snake” to the “ECU”, Europe gradually
> built a common currency, the euro. Pundits again told us the latter would
> never work. Even before it got off the ground, financial experts in the
> City condemned it to inevitable failure.
>
> A decade later, these experts thought they were finally being vindicated.
> Club Med countries were coping with growing deficits and the Northern
> European countries were balking at more wealth transfer programs. Whereas
> the euro had brought cheap money to Italy and Spain in the early days, now
> markets were pushing these rates to stratospheric levels. Something was
> about to break.
>
> It didn’t. Instead of whining, member states decided to follow the logic
> of a common currency. If a country cannot devalue its way out of misery,
> structural changes are the only solution. If debasing one’s currency is
> not an option, something else has to give. In an open economy, cost has to
> adjust.
>
> In particular, labor cost has to come down and that includes more labor
> flexibility. Don’t tell anybody: the euro is all about supply-side
> economics. This cannot be mentioned in socialist Europe. But make no
> mistake about it: Europe has put in place a mechanism that gives
> politicians the needed cover to implement obvious structural reforms. The
> socialist Gerhard Schroder understood this ten years ago. Today, his more
> conservative successor is telling the rest of Europe to follow his example.
>
> The euro has now been tested as never before in its short history. Over
> the last three or four years, politicians have been pushed by the financial
> markets. They responded the way one expects them to. They moved only when
> confronted with potential disaster. They took tepid decision after tepid
> decision. But, gradually, the Europeans have moved to solve the euro crisis.
>
> Here is how it works in Euroland. The southern Europeans have been
> dragged, yelling and screaming, to more fiscally responsible policies. The
> northern European countries led by Germany, have been dragged, yelling and
> screaming, to more monetary flexibility. And now, after many tentative half
> measures, we have a credible framework to deal with the euro crisis.
>
> It is quite simple. The European Central Bank, under the strong leadership
> of Mario Draghi, has announced an arbitrage policy between the different
> bond markets of the member states. The ECB will buy bonds in Spain to push
> interest rates down when the spread with German bonds gets too wide. By
> doing so, it makes the Spanish bond market more attractive and will
> encourage the private sector to participate. In return, Draghi conceded to
> the very sceptical Germans to a sterilization program. The way I understand
> this is that the ECB will keep its balance sheet at today’s (high) level.
> Whenever it buys more sovereign debt with one hand, it will sell other
> assets with the other hand. For example, buying Spanish bills while selling
> German bills.
>
> There is another concession made to Germany. Countries will have to ask
> the ECB to intervene in their bond market. The ECB, in return, will be able
> to ask for more structural changes as a condition for help.
>
> Indeed, this is again about supply-side economics. So far, the markets
> are buying it. Spain and Italy have not had to ask for help. The mere
> possibility of such a policy has pushed down their cost of financing.
>
> All this, of course, means that euroland is accepting a tough recession.
> That’s the good news! The reforms are hurting. But so did the German
> reforms ten years ago. Schroder even lost his reelection because of them.
> However, he built the foundation of Germany’s industrial revival and today
> the country is better off for it.
>
> Finally, as often stated by pundits, the euro may very well be a
> fabrication of the elites. However, what one has to understand is that the
> euro is popular. The Dutch elections have once again demonstrated it. The
> pro-euro parties won an overwhelming electoral victory last week. This in
> spite of the fact that they too, like their neighbors, are major financial
> contributors to the many European bailout programs.
>
> But what about the high unemployment rate? Will the Southern European
> countries tolerate it much longer?
>
> It all depends on the definition of unemployment.
>
> Let’s face it. Most people do not want to be unemployed. But with all the
> European social networks in place, this is not what Americans go through
> when they lose their jobs. Just imagine yourself on a piazza sipping an
> espresso after collecting your benefits and waiting for your year end
> bonus. You do not make much money, but life is not too stressful and you
> still have your medical expenditures all paid for by the government. Once
> in a while, you can even make some extra money doing a “unofficial” job.

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