Monday, November 29, 2010

The Euro -- Breaking Up is Hard to Do

Many of the international monetary experts are weighing in on the future of the euro.  While I might not be an international monetary expert I do need weighing, so here goes. There is little reason for the euro to implode, for Spain to leave the euro, or for there to be separate clubs for euro-weak and euro-strong countries. While the euro might weaken more in the near future I think it will remain the currency of at least 16 countries for the foreseeable future. I agree with Neil Sedaka's 1962 tune from the good old days -- Breaking Up Is Hard To Do. 

Notice that when a hurricane devastated much of Louisiana, that state was not kicked out of the dollar alliance of 50 states plus others. That was true even though it might have helped folks in New Orleans if they had their own currency and it depreciated a bunch. Just think of all the Japanese tourists with their Nikons who might have been able to afford a neat trip to Patty Obrien’s, including a swamp boat ride and all the ‘Gator-filled Po-Boys they could suck down. Of course, let’s not forget a midnight beignet at the Café Du Monde.  But I digress.

You might retort that Louisiana is part of country called the USA and Greece, Ireland, Spain, and Portugal are part of a monetary union called the Eurozone. To be part of this monetary union all 16 members of the Eurozone signed a treaty in Maastricht that is a very formal document with pretty lettering and no smiley faces. I agree that it doesn’t have the force of statehood but it clearly is not trivial – and was not entered into lightly. All members of the Treaty drank copious amounts of Belgian coffee with delicious French pastries over many years and I am guessing that on more than one occasion a German official pointed out after one-too-many Schnapps that all members were not created equal.  Clearly they spoke of contingencies and escape mechanisms.

But even if they didn’t and some of what has transpired in the way of country debts and economic contractions was not expected, there is still little reason to break up the Eurozone. At least until recently there was a line-up of countries that wanted into this elite club – and for good reason. The Eurozone did what it was expected to do – it removed a major irritant from international trade between a growing number of European countries whose economies were becoming much for economically integrated. I am among millions of travelers who remember how stupid and irritating it seemed, when traveling around Europe, to have separate little piles of lira, pesetas, deutsche marks, etc. To businesses, this inconvenience was multiplied into unnecessary transactions costs. Of course, when these European currencies were sometimes changing in uncertain ways this really hurt business planning and it made a lot of sense to eliminate that risk by adopting one common currency. Wow! How cool can you get! As there is still much integration to unfold in Europe, these benefits will continue to hold and grow.

There is much more to the benefits of the euro – and countries like Greece, Ireland, Spain and Portugal reaped some of them more than others. Clearly from the standpoint of currency credibility these four and some of the other members gained when they gave up currencies with bad reputations for one that seemed a much better bet for the future.

Still you might say, wouldn’t the weaker countries benefit if they could depreciate their own currencies? And the answer is probably not.  All countries have policies tools to help when things go wrong – monetary, fiscal, immigration, financial regulation, and many more. While it is true that exchange rate management can be a powerful tool for a country, there are many countries that never use it. Many prefer to peg to the dollar or some other currency or bundles of currencies. Many simply do not believe it is wise to try to fine-tune their economy with the exchange rate.  So it is not a universally accepted best-policy. Whatever could be accomplished by depreciating their currencies in the current crisis could be managed with other traditional policies.

And one could argue that such exchange rate management policies or dirty floats come with great risk. There are numerous recent historical examples where speculators or hedge funds have caused devastating impacts on countries that waited to use depreciation as a tool of macroeconomic or trade policy. Right now the euro is taking a little beating from the markets – but certainly nothing like non-Eurozone countries have experienced in the last couple of years. I doubt that Ireland, Spain or Portugal would be better off with their own currencies depreciating by the likes of 50% right now!

And then there is the case of the strong countries, like Germany. Why not boot the scofflaws? Why should German citizens bear part of the brunt of weaknesses in neighboring countries? For one thing, Germany, France or the other stronger countries cannot really escape the fate of their weaker trading partners because of interdependencies. While the euro might be stronger today with a smaller club, contagion would still impact a wider group of countries whose economies are linked. Clearly the banks of the stronger countries hold the liabilities of the weaker ones. Business firms engage in cross-border trades in myriad ways. If Spain, for example, applies a fiscal remedy that slows economic growth in that country, clearly with or without the exchange rate impacts, this slower growth will spill over into its European trading partners. This is the price one pays for economic integration. If you want to receive the benefits of the relationships then you sometimes have to suffer through the costs – whether they come through exchange rate effects or not.  Furthermore, just because weaker countries might be asked to leave the Eurozone, they would still be members of the European Union. The EU might, in that case, be involved with policies to bailout or otherwise assist the weaker members.

In short, the benefits of the euro continue and neither the weaker nor the stronger countries will be better off by reducing the number of countries participating in the Eurozone. The best bet is that the Europeans will do what they often do – eat more croissants with that wonderful Spanish ham and debate until well into the night over cognac and brandy. The EU started a long time ago. The Eurozone is newer but has already endured much. In all, European countries show an ability and readiness to hash it all out and move forward. I bet they will continue to do the same now.  Don’t look for any pesetas anytime soon. 


  1. Put that in the same context as the states....look at Florida...without a strong state like New York ...who would buy retirement homes and go to Disney? But if Florida were to weaken as it has...then citizens from more economically viable states can come in and buy retirement homes for cheap. Fortunately the same banks in Strong New York were the ones who funded those now foreclosed retirement home sin Florida ..but if Florida decided to bail then it would hurt New York because those banks would need another bailout.

  2. Slow down, will ya? I'm still trying to assimilate the thing about aggregate supply!

  3. Crash,

    Full throttle ahead baby.


  4. You may not like the guy, but he has an interesting take:

  5. Crash,

    Thanks for finding that one. It perfectly illustrates that most interesting economic issues have two sides! Buchanan raises relevant and spooky points which do have some probability of happening. But I am sticking to my story. I doubt that Europeans want to see more than 60 years of union trashed over one crisis. Populism, nationalism and extremism are alive and well. I think sensibility is quiet but stronger. It is time for leadership and good solutions both in Europe and the US.