Monday, October 4, 2010

Stelzer, Euromess, and "Eurosud"

All over Europe officials are doing the same thing over and over again and expecting different results, writes Irwin Stelzer in the Wall Street Journal.

Greece led the peripheral countries in piling up debts that it had little hope of ever repaying. Non-peripheral countries, most notably Britain and France, joined in the fun. Then, given that national cupboards are bare, the Euroland authorities stepped in with a cunning plan to handle excessive debt: borrow more to repay the previous wild borrowing. The Irish government thus will drive its deficit to 32% of GDP to bail out banks hit by the inability of property developers to repay excessive borrowings.

The current chosen path combines austerity with borrowing by Euroland as a whole. The borrowing in effect transfers the debts of the broke countries to Germany’s balance sheet, while austerity concentrates the burden of repayment on the current recipients of government outlays – public-sector workers, benefit recipients, and private sector contractors for whom the government is a major customer. And it lets the creditors, who made the excessive loans in the first place, off the hook.

However, “history suggests that austerity without loose monetary policy can be self-defeating. Never mind: Eurocrats will pay any price to avoid the humiliation of restructuring and unleashing inflation worries in Germany. So a combination of austerity and tighter credit is in store …”

"Euroland politicians think they can (1) fight markets, (2) inflict infinite pain on voters in democratic countries, and (3) whip the profligate into line. They can do none of these" because markets set the borrowing rates and voters turn out politicians who push them too far.

Sensibly, Stelzer advocates a currency depreciation, large enough to restore competitiveness of the peripheral countries (and maybe of the others also I would argue) to avoid debt “restructuring” and a heavy dose of inflation. But the currency he has in mind would be a newly created “Eurosud”, the result of partitioning the eurozone into two smaller areas.

That would prove, in my opinion, doubly illusory. First a new currency limited to the countries of southern Europe would not constitute an optimal currency area any more than the current eurozone, and the Eurosud "one size fits all" monetary policy would thus not prove adequate for anyone of the member countries. And second, it would raise all the problems of creating a new currency in the middle of a confidence crisis, a daunting task, much harder than a simple return to national currencies (for which national monetary institutions and central bank are still in place) that would soon have to be repeated later, when each country would have to turn back to its own former national currency. It would be much better to proceed directly to that second stage now, especially because the euro is again gaining strength relative to the dollar, losing all the benefits of its beginning of the year depreciation to more reasonable levels.

And meanwhile, interest differential between peripheral countries and Germany keep growing, reflecting the increasing risk of their government bonds.

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