Periphery’s Problem with the Euro

Growth Rates IT GR SW UK

Embattled Economies Cling to Euro –

This is a very interesting article from the Wall Street Journal. The one question that I had been asking myself as the Eurocrisis dragged on is why are the people of the peripheral countries so intent on remaining within a currency union that is so damaging to their economies?

The answer is that they associate the euro with economic growth and view it as a check on their own corrupt governments. Citizens in the PIIGS overwhelmingly favor retaining the euro by a margin of over 3 to 1, so these countries will not voluntarily revert to their national currencies anytime soon.

The view on the euro is succinctly stated in the piece:

Across Europe’s southern rim, people recoil at the idea of returning to national currencies, fearing such a step would revive inflation, remove checks on corruption and derail national ambitions to be part of Europe’s inner circle.

Italy is used as an example of these widely held opinions. Several Italians give their views including businessmen and a geologist. The article reports the misconceptions that citizens have about the euro.

These people associate the euro with economic growth, but the association is based on the luck of timing. When the euro was adopted, the West was emerging from a mild recession. In the chart above, we see that euro countries and non-euro countries both experienced good growth up until the Great Financial Crisis. Sweden may have exhibited the most robust economy during the time in question.

Mr. Martinetti said he doubts Italy would have been able to finance its huge national debt with a sinking lira and high interest rates: “I think the euro saved Italy.” Mr. Martinetti thinks that the euro saved Italy, but this is a misconception. What the euro did was push off the day of reckoning for Italy’s massive debt pile. Adoption of the euro forced down Italian interest rates. By reducing the yearly interest expense paid to finance itself, Italy was able to continue on this path for several more years exacerbating the situation until it finally exploded in 2011. Today’s crisis fighting efforts are merely a temporary respite from the march to default. Italy must drastically restructure government spending and its economy in order to arrest the crisis. So far, it has not made much progress in its pursuit of these goals.

“We haven’t done as well under the euro as Germany has because we’re not led by people who are able to bring the potential benefits to Italy,” said Mr. Grasso, the winemaker. This is the key problem with the euro. The Italians, Spanish, Portuguese and Greeks do not have the German political system. The FANG countries have less red tape and corruption. If the periphery wishes to share a currency with those countries, then it needs a political system that is able to create and implement the necessary reforms to make their own economies and governments as efficient.

People get the government they deserve. Whenever a government has attempted to curtail state entitlements and job protections, it has summarily been thrown out of office. This has happened in each of the PIIGS, France and, yes, even Germany.

The people want two conflicting things. They want to remain in the euro, and they want to avoid the consequences of doing so. This not unlike Americans who think the large budget deficit is a problem but do not wish to reduce Social Security, Medicare or defense spending.

“The answer is not to throw the euro out, it’s to look at what’s not working and fix that,” said Giovanni Ricci, a geologist from Turin. What is not working is that several different economies are sharing a currency. The peripheral countries need to make theirs as efficient as the others, but they refuse to do so. This is creating two eurozones, a rich and a poor.

“Italy without the euro would be far worse off.” We have no way of knowing if this is true. Is there an parallel universe where Italy does not join the euro and Monti wears a goatee?

Maybe in this hypothetical place, Italy is forced to deal with the debt problem in 2004. The Bank of Italy devalues the lira by monetizing the debt and causing inflation. As the country spirals deeper into economic disaster, the great statesman Berlusconi enacts a serious of harsh economic reforms. The country returns to growth courtesy of an export-led boom. In response to economic good times, the Italian birthrate rises reducing the severity of the demographic situation ahead. Italy avoids the eurocrisis and grows nicely while Spain and Greece burn.

Since life is a statistical sample of only one, we will never know what would had happened had Italy not joined the Eurozone. A few years ago it received benefits from the currency, and now it is dealing with the consequences.

The Eurozone could work, but no one seems willing to do what is necessary. All of the countries need to reform their economies while they become joint and severally liable for each others debts and banking systems. At this juncture, none of these conditions seem likely to be implemented.


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