March 21, 2010
Will the Euro Survive its Current Difficulties?
Will the Euro Survive its Current Difficulties? Becker
The short answer is "yes". Yet possibly much more serious challenges to the euro will arise in the future unless some important changes are made in the European Monetary Union (EMU).
When the euro was launched on January 1, 1999, I was skeptical about its long run viability primarily for two reasons. The members of the EMU maintain their ability to follow different government spending and taxing policies, and their economies are subject to specific shocks because they produce different products and services, and have varying levels of per capita incomes and wealth. Since no country has the power to print Euros, no country can offset these country-specific difficulties by devaluating their currencies relative to the currencies of other members of the EMU, or even by devaluing relative to countries outside the monetary union. Devaluation under these circumstances reduces the net import of capital by a devaluing country, and hence eases its foreign debt. In the past, countries like Italy or Greece that had, among other troubles, insufficient taxes relative to government spending, frequently devalued their own currencies (the lira and drachma, respectively). When the debt was issued in local currencies, devaluation also in effect "inflated away" some of the real value of any foreign debt.
A partial alternative to devaluation when a country is in economic trouble is for many of its workers to move to other countries where jobs are more plentiful and wages are higher. Such migration helps soak up the unemployment and reduces the scarcity of jobs caused by the economic difficulties. This is essentially what happens in the US, a common-currency union of 50 states. States that do poorly relative to other states experience outmigration of many of their younger workers. Yet migration is still quite limited within the EU, despite the progress that has been made.
However, the remarkable success of the euro since its launch more than a decade ago had been convincing me that I and other euro-currency skeptics had exaggerated the importance of these missing ingredients in the EMU. The euro has become of the most important international currencies. After falling sharply for a couple of years from its initial launch rate of close to $1.2 per euro to just about $0.80 per euro, it bounced back to reach over $1.5 dollars per euro. The euro is still above its initial exchange rate, with a current exchange value versus the dollar of about $1.35. In the past few years, considerable speculation developed that the euro might well supplant the dollar as the number one currency for international contracts and for assets held internationally.
These rosy euro forecasts have ended, at least for a while. Not only Greece, but also Portugal, Spain, Italy, and Ireland are in financial trouble with their international creditors, although Greece appears to be in the most immediate difficulties. They may all get out of these troubles without defaulting on their debt, but similar challenges are likely to arise in the future unless major changes are made in the architecture of the EMU. Either much more power over taxation and government spending has to be taken away from the individual member countries and given to the central authorities of the European Union in Brussels, or much more effective measures need to be introduced that would prevent government spending of different countries from greatly exceeding their tax receipts.
Since most countries within the monetary union are probably more willing to leave the union than give up sovereignty over their spending and taxation, the centralization of taxation and spending authority seems unlikely. Perhaps a system of fines and other punishments to weak-willed countries will be sufficiently strong to deter future transgressions, but that seems unlikely.
There is no simple way out of this dilemma, which is why Germany, after much initial reluctance, is warming to the idea of calling on the IMF to help Greece. One plan being discussed is for the eurozone countries to provide the funding used by the IMF. Since much of the IMF financing comes from the US, eurozone financing would avoid the EMU appearing to ask the US for assistance. Although the European Central Bank opposes this indirect route of helping Greece, the hope is that the IMF is more capable than the EMU of imposing stringent restrictions on Greece's spending and taxation.
Some commentators have drawn analogies between the fiscal difficulties of the United States and Greece and other weak members of the EMU. As Posner shows, the US and Greece have many similarities in terms of fiscal deficits and the rate of annual turnover of its government debt. However, one crucial difference is that the US has a much more robust economy, and greater growth prospects.
The other absolutely essential difference is that the US debt is denominated in dollars, a currency that it controls, while none of the EMU countries can issue more Euros. If push came to shove, the US could consider meeting its obligations to creditors by issuing additional dollars, and partly inflating away its international debt burden. Inflation is a potential weapon for the US Treasury, almost regardless of whether its debt is in the hands of Americans or foreigners, although both groups would protest against seeing the real value of their assets greatly reduced by inflation. Greece can probably force domestic holders of its government debt to take severe haircuts, but aside from bankruptcy, it is much more impotent than the US against international creditors.
Perhaps, as Posner suggests, Greece and possibly also the other fiscally weak members of the EMU should be allowed to declare bankruptcy, although this is not without serious consequences for the future of the EMU. Still, the monetary union might well be stronger in the long run if its weaker members were forced out, or were forced into more responsible behavior by having to bear the consequences of irresponsible actions.
Greece's Economic Crisis—Posner
I'll describe the crisis briefly, then address two questions: whether the nations of the European Union, such as Germany, should try to bail out Greece; and what the Greek crisis tells us about what is in store for the United States.
In the easy-money years of the early 2000s—for which we have Alan Greenspan, other central bankers, and President Bush and his foreign counterparts to thank—the Greek government borrowed a great deal of money from banks, mainly in Europe, to fund its huge public sector. Greece has chronic difficulty in funding its government expenditures out of tax revenues because of rampant tax evasion. And its bureaucracy appears to be either corrupt or incompetent or (probably) both, and as a result its published financial data are inaccurate and misled and continue to mislead lenders. The global downturn, which has driven up unemployment in Greece (to 10 percent) as elsewhere, has weakened the Greek economy further, but what has precipitated the country into de facto bankruptcy is the realization by lenders that Greece, like so many other countries, is dangerously overindebted. Its national debt, most of it owed to foreigners, of some $400 billion is greater than its Gross Domestic Product, and its current annual budget deficit is almost 13 percent of GDP, which means that its indebtedness is growing rapidly. Greece like other borrowers has to roll over its debt continuously. In 2010 it will have to replace some $65 billion in public debt, and fear of default has driven up the interest rate on new Greek government debt to 6 percent.
The Greek government has taken drastic-seeming measures to reduce its deficit. It has imposed new excise taxes and increased existing ones, reduced wages and pensions of government employees and increased their retirement age, and reduced public services. Greece has a huge public sector—40 percent of GDP is generated by the public sector, and 25 percent of Greek workers are public employees—and so the government can effectuate big reductions in public spending virtually by a stroke of the pen, though not without inciting riots.
Despite the measures taken by the government, it is desperately seeking financial aid from EU countries or failing that the International Monetary Fund: that is, it wants to borrow more money, and at lower interest rates than are available from private lenders, in order to avoid defaulting on its public debt or, alternatively, reducing government spending even more sharply than it is doing, with potentially serious political consequences.
Assuming that the Greek government, without foreign assistance, cannot avoid defaulting on its public debt because it has reached the limits of what the Greek people will acccept in the way of austerity measures imposed by their government, there is not much difference between a default on the one hand and borrowing—whether from EU countries or from the IMF on what undoubtedly would be onerous terms—on the other hand. Either way, Greece will be broke. Default would be the cleaner and simpler solution. A cascade effect from a Greek default can be avoided by EU nations' bailing out any creditors of Greece whose failure, because of a Greek default, would have macroeconomic significance.
Default would be a wake-up call for the Greek nation and put it on the path to competent economic management. A bail out of Greece would be administratively complex. The Greek government would try, for compelling domestic political reasons, to substitute bail out money for cuts in spending and tax increases, and the bailers out, whether EU nations or the IMF, would struggle to prevent the substitution.
Comparisons are being drawn between Greece and the United States. Our national debt of $12.5 trillion is approaching our GDP of about $14.5 trillion and will probably exceed it within the next couple of years, as the debt seems likely to grow by about $1.5 trillion for several years to come, especially with the enactment of the health care bill and the spur that that enactment will impart to other spending programs. Our annual federal budget deficit is now more than 10 percent of GDP. We do not have the same tax-evasion problem as Greece, but we have low taxes and intense resistance to either raising them or reforming the tax system to obtain more revenue with less economic distortion. Our public finances are transparent, so we will not slide into national bankruptcy inadvertently. But we seem incapable either of cutting existing public spending or avoiding costly new public-spending programs.
What we have sustaining us is the status of the U.S. dollar as the major international reserve currency (plus the fact that, since our debt is in dollars, we can reduce it by inflation, though not without cost; Greece can't do that because it doesn't have its own currency). Many international transactions are in dollars even when the transacting parties have no American connection. (There are other reserve currencies, mainly the Euro and the Yen, but the U.S. dollar accounts for about two-thirds of the world's total reserve currency.) If a Saudi Arabian oil company sells oil to Singapore, the sale will be in dollars, and this will require the central bank of Singapore to hold dollar reserves that it can exchange with Singaporean merchants for the local currency to enable those merchants to make purchases in dollars. With the world's central banks awash with dollars—and for the further reason that many foreign countries, such as China, Japan, Germany, and the oil-producing countries of the Middle East, export much more to the United States than they import from us and as a result accumulate large dollar balances—the United States can easily borrow to finance its public debt. Greece doesn't have its own currency, and so is in the approximate position of a private borrower.
This happy situation will enable us to avoid defaulting on our enormous public debt for the foreseeable future. But it will perpetuate our fiscal improvidence.