Thursday, December 2, 2010

Pro-euro Eichengreen Joins the Euro-criticism Bandwagon

Kevin O’Rourke (The Irish Economy) has translated Eichengreen’s paper in today’s Handelsblatt.


« I’m probably the most pro-euro economist on my side of the Atlantic. Not because I think the euro area is the perfect monetary union, but because I have always thought that a Europe of scores of national currencies would be even less stable. I’m also a believer in the larger European project. But given this abject failure of European and German leadership, I am going to have to rethink my position.
The Irish “program” solves exactly nothing – it simply kicks the can down the road. A public debt that will now top out at around 130 per cent of GDP has not been reduced by a single cent. The interest payments that the Irish sovereign will have to make have not been reduced by a single cent, given the rate of 5.8% on the international loan. After a couple of years, not just interest but also principal is supposed to begin to be repaid. Ireland will be transferring nearly 10 per cent of its national income as reparations to the bondholders, year after painful year.
This is not politically sustainable, as anyone who remembers Germany’s own experience with World War I reparations should know. »

My comment: It is easy to blame politicians now that things are turning so wrong, as correctly forecast from the start by euroskeptic economists, but wrongly denied by pro euro promoters, among whom Eichengreen and the (ECB funded) CEPR clique in Europe. But the current difficulties were unavoidable, independently of the quality of European leadership, given a strong macroeconomic shock, and that conclusion was well known long before the launching of the euro. Thus, shouldn’t economists who consistently advocated the creation of the euro, applauded politicians for doing so, and fostered illusions about its sustainability for years, consistently misleading the public opinion, share a large responsibility for the coming disaster?

Furthermore, Eichengreen also recognizes, belatedly, that (a) austerity further deteriorates the economy and the fiscal position of countries that adopt it, and (b) a depreciation of the euro is absolutely necessary and would improve the Irish situation. An analysis that the readers of this blog have been exposed to for quite a while.

« Nor is the situation economically sustainable. Ireland is told to reduce wages and costs. It must engage in “internal devaluation” because the traditional option of external devaluation is not available to a country that lacks its own national currency. But the more successful it is at reducing wages and costs, the heavier its inherited debt load becomes. Public spending then has to be cut even deeper. Taxes have to rise even higher to service the debt of the government and of wards of the state like the banks.
This in turn implies the need for yet more internal devaluation, which further heightens the burden of the debt in a vicious spiral. This is the phenomenon of “debt deflation” about which the Yale economist Irving Fisher wrote in a famous article at the nadir of the Great Depression.
For internal devaluation to work, therefore, the value of debts, expressed in euros, has to be reduced. »

As explained in this blog, a large enough depreciation of the euro would then permit an exit of national currencies from the euro straitjacket without the apocalyptic consequences that Eichengreen has predicted, even pretending – wrongly again - that it was just « impossible » to exit from the European currency after entering the zone.

By the "rethinking of his position", Eichengreen is just the first to try avoiding a well deserved blame. Let's wait now for Wyplosz, Giavazzi, Pisani-Ferry, Sinn, and other euro supporters including in particular almost all the French economists, to try both to totally reverse their long held dogmatic position while avoiding at the same time a total loss of credibility. Quite a challenge, indeed.

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