Safe European Currency

Last week, the United States got its first genuinely good jobs report since January 2008: The Bureau of Labor Statistics reported an increase of 290,000 jobs in April. By the weekend, however, the economic forecast was once again cloudy, this time due to renewed concern over Greek debts. On Sunday evening came news that key European politicians and central bankers had ended over a year of inadequate action and finally come up with a two-pronged solution to the crisis. Large loans would be granted to ailing countries at favorable interest rates, and central banks would take coordinated action to buy European government bonds. The announcement of this plan has succeeded in alleviating the crisis atmosphere, but the underlying structure of the European monetary union remains rickety. More crises are certain to come until the Eurozone either breaks up or undertakes a much deeper program of integration.

The nature of the problem is multifaceted. The European plan most clearly deals with the Greek government’s ability to pay its debts in the short term, the most pressing issue at hand. But the interest rate Greece would need to pay in order to borrow money skyrocketed because of fears Greece would default. Higher interest payments, in turn, make a default more likely.

And a Greek default would call the European monetary system into question. Greece largely owes its money to French and German banks, some of which might be pushed into insolvency that would be met by government bailouts. For France and Germany, a bailout of some form was inevitable: It was really just a choice between giving the money to the Greek government so that it could give it to banks, or giving it straight to their own banks. The complication here is that a Greek default would cause massive runs on Greek banks. The conventional wisdom has long been that no country can leave the Euro without sparking massive bank runs. But if you’re already experiencing massive bank runs, then why not leave the Euro and let devaluation boost your exports to cushion the ongoing terrible economic situation?

An event like that would raise all sorts of questions about other countries’ commitment to the Euro, with all kinds of unpredictable consequences -- few of them good -- for European politics and the global economy.

But to say that the crisis is primarily about short-term Greek fiscal policy is rather narrow-minded. The larger issue is that a big set of European countries, including not just Greece but also Portugal, Ireland, and even Spain and Italy, are going to have trouble paying their debts without economic growth. While the fiscal crises in Greece and Portugal are largely driven by irresponsible budgeting, governments in Spain and Ireland were conducting themselves in a perfectly reasonable way prior to the global downturn. They just weren’t counting on skyrocketing unemployment and massive economic contraction to push their tax revenues through the floor.

The problems here go right to the origins of the Euro. Before the EU's formation, poorer countries on the European "fringe" had gotten in the habit of maintaining economic competitiveness by devaluing their currencies, and some had defaulted on debts. Germans didn’t like the way this hurt their own competitiveness, and over time it also made banks reluctant to lend money to governments or individuals in southern Europe, driving interest rates up. Since monetary policy is largely about credibility and expectations, it was very hard to do anything about this. The Euro was the solution to this -- basically southern Europe agreed to appoint one country as designated driver for the whole continent and handed over the monetary-policy keys to the highly credible hard-money Germans.

Many economists, especially in the U.S., worried that this would create a Europe that couldn't respond to an economic downturn. And many Germans worried that it would leave them on the hook for other people's debts. But for a while, it worked fine. Cheap debt fueled booms in southern European consumption and construction that, in turn, fueled an export boom in Germany. Then came the crash.

Now Spain, Ireland, Portugal, and Italy can't count on cheap debt to fuel their economies. And they can't devalue to grow. But without growth, it will be extremely hard to pay what they owe over the long run no matter how responsibly they budget. This leaves Europe with essentially three choices. One is for the Eurozone to break up, allowing poorer countries to devalue and regain competitiveness. The other is for the Eurozone to integrate more deeply, creating EU bonds, large fiscal transfers, and measures to increase labor mobility to something closer to American levels. Last, and most likely, we'll see repeated efforts like this one to kick the can a bit further down the road and hope that someone else can figure out how to deal with it. This last option sounds a bit disreputable, but the fact of the matter is that there are difficult logistical questions to be asked about the other two possibilities, so delaying choices makes some sense. One can only hope, though, that Europe's elites are quietly exploring backup plans for when the time for choosing really comes.

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