David R. Henderson  

Wolfgang Kasper on the Euro

Europe's soft underbelly... Macroeconomics in small econom...

In following the Greek economic crisis, I have very little to add that has not been said. But one economist who said it well three and a half years ago is Australian economist and German native Wolfgang Kasper. His Econlib Feature Article, "Nothing New on the Euro Front," is still well worth reading. An excerpt from his conclusion:

Over the long term, there is but one solution to the Euro crisis: Flexible shock absorbers must be built into the Euroland cart again, as the road ahead may well become bumpier. This could mean that the Germans and some of their Northern neighbors quit the Euro, which would be a noble solution on the part of the strong economic regions. Or it could mean that the Greeks and Italians are invited to take 'a holiday from the Euro,' while the French and Spanish governments rein in their expensive welfare policies for citizens, industry and agriculture in order to keep pace within a new Hard Euro.

But wouldn't such an exit be messy? Yes, says Kasper, but other countries have been there before:
Both solutions would create hairy legal problems for owners of monetary assets and partners in credit contracts. But such problems are not new. They have been solved before when monetary unions were dissolved. Maybe European central bankers should apply for instruction in Singapore and Kuala Lumpur about how the split-up of the Straits dollar into the Singapore dollar and the Malaysian ringgit was handled, or they might learn how Prague and Bratislava did it during the 'Velvet Divorce.' Meanwhile, loan contracts are already being designed that anticipate devaluations after the introduction of the Nea Drachma, and wealthy foreigners in Tuscany are scrambling to match the value of their holiday homes with mortgages from Italian banks, so that their losses after the slide of the Lira Dura are minimized.

And his suggested step forward:
The technical and administrative problems with an introduction of a New D-Mark could also be solved: The government can declare that to forestall an imminent crisis, it has, most regrettably, no other option but to withdraw legal tender status for all Euro banknotes that do not carry a German identifier (all banknotes show a national code). All other Euro notes and coins will be exchanged at a fixed rate within three months. Political leaders can, after all, explain that it is free travel, free trade, free capital and enterprise movements, and the freedom for young Europeans from different countries to marry that matter for European integration, prosperity and lasting peace, not the artificial bond of an imposed unitary currency.

COMMENTS (3 to date)

I have never understood why formation of a monetary union implies formation of a credit union. It seems to me that several countries could start to use the same currency in their trade without those countries taking responsibility for each others' debts.

Since the US dollar has become a prominent currency in many poor countries which fail to maintain their own stable currencies, it seems to me that this set of countries (including the US) might be regarded as a currency union (albeit spontaneously formed); it is a set of countries all employing the same currency. But it is a union in which the participants do not take responsibility for each others' debts. This example proves, at least to me, that a currency union does not need to imply a credit union.

It seems to me that the people who organized the Euro had collectivist aims extending beyond formation of a mere currency union.

Am I mistaken?

ThomasH writes:

US economists, left center (Krugman) and right center (Feldstein) saw no good from the Euro project, for basically the same reason: without much greater movement of labor and automatic fiscal transfers cost structures could get out of line with no way (devaluation) to put them right without deflation.

Nevertheless, neither foresaw four additional problems:

1) Private lenders treated the disappearance of currency risk as a disappearance of country risk. This might have been moral hazard foreseeing a bailout (as ultimately happened!) of just stupidity; I always tend to go with the assumption of stupidity.

2) The ECB failed miserably to maintain the trend level of NGP during the 2008-2015 recession. It was worse, it did not even maintain the PL trend. It was worse in 2010 it raised interest rates. It was worse, only in 2014 did it begin modest QE (still not enough to restore NGDP or the price level to trend).

3) Euro policy makers treated the threatened Greek default on its sovereign debt in 2010 as a threat to the Euro instead of just a threat to the prodigal banks that had lent Greece the money (and by so doing may have actually made it so).

4) Euro policy makers actually bailed out the banks and imposed an "austerity" program on Greece that failed to keep private sector debt growing enough to keep NGDP growing.

Stieglitz's charge of "criminal" responsibility of European policy makers (with the IMF's acquiescence) is not much of an overstatement.

Urstoff writes:

Why don't we ever see similar dynamics (or do we?) within the US? For example, with Texas as an economic powerhouse and Alabama as a rather anemic state economy. Is the Federal government much more pervasive and leveling than anything the EU does?

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