Last time, we argued
that monetary expansion is necessary to pull the PIIGS out of recession and the
debt crisis. In the final post of this series, I’ll discuss the outlook for the
European Monetary Union. While this crisis is an opportunity to address the
deep-rooted problems in the eurozone, European leaders must decide at what cost
they’re willing to preserve the currency union.
An Opportunity to Achieve
Closer Integration
After two world
wars, Europe came to realize that prosperity can only come with continental
peace and stability. Since then, closer cooperation and integration have been
Europe’s goals. The eurozone was set up in the late 1990s as part of the
efforts to promote peace and integration.
However, the
eurozone has always had structural problems, since it comprises vastly diverse
economies which without fiscal union shouldn’t be allowed to use the same
currency. The problems, which were obscured in good economic times, have
been exposed in the financial crisis. It’s now clear that the absence of
two institutions threatens the stability and sustainability of the eurozone.
First, to improve
financial stability and market confidence, Europe needs a unified banking authority that monitors the industry and
recapitalizes troubled banks when necessary. Second, a central authority with
power over taxation, which ensures fiscal responsibility and provides a
framework of fiscal transfers, is necessary to any sustainable monetary
union.
Their absence has
long been an obstacle to European integration, but only in a crisis can these structural problems be addressed. The current
challenges have made it clear that the continued existence of the euro depends on
the success of reforms. This sense of urgency and the high stakes involved have
presented Europe with a perfect opportunity for closer integration.
Conflicting
Interests among Euro Members
However,
integration incurs painful sacrifices and is easier said than done.
On one hand, the peripheral countries have to endure the pain of austerity
measures and labor market reforms, which include cutting welfare
spending to improve labor market efficiency and reduce economic
distortions. Germany, on the other hand, is burdened with costly bailouts.
On top of the
sacrifices, euro members have found it extremely hard to reach an agreement due
to conflicting interests. Basically, Germany wants to spend the least
possible to prop up the eurozone, while other euro members (with the exception
of the Netherlands) are trying to get the most from Germany. Given the
difficulty of cooperation, few concrete steps have been taken to solve the
crisis.
Indeed, European
leaders are still deeply divided on how to save the euro. Though deposit
insurance may be the only way to save the currency union, Germany’s reluctance to insure over 2 trillion euros worth of deposits
in Italy and Spain is perfectly reasonable.
Germany opposes the
idea of euro bonds as well. The objection is justified though. The issuance of
euro bonds will take the pressure off politicians and slow down structural
reforms. More importantly, countries like France and Italy propose debt
mutualization because they want Germany to share the cost of future spending. No wonder Germany
rejects the deal.
Meanwhile, Germany
is taking measures to minimize losses in the event of a breakup. Some argue
Germany is bailing out Greece for its self-interest too. By propping up
Greece’s banks, Germany can spread out the debt burden of Greece across all euro members.
Ironically, what was
intended to create peace and prosperity has turned into a dysfunctional
partnership that threatens the world economy. But it’s hardly surprising
that every euro member is protecting and fighting for its
self-interest. After all, the eurozone is composed of independent
sovereigns with people of different national identities.
Breakup not the End
of the World
If euro members lack
the commitment to closer integration, then the exit of some countries, or even
a breakup of the euro, is the only feasible option in the long term. Both a
German exit (which some believe to make more economic sense than a Greek exit) and the exit of
the “Club Med” countries could work.
In the case of a
German exit, politicians can sell the idea abroad as a noble sacrifice to correct the imbalances within the eurozone.
Internally, they can persuade voters that an exit means they no longer have to
waste money on rescue packages.
The bottom line is
the same rule applies in love and in politics: If different parties can’t
settle their differences, then a breakup is all for the best. And a breakup of
the euro doesn’t have to be the end of European cooperation. Members can remain
good friends even after breakup, just like what couples do.
P.S. Sorry for the
delay of this post. I was busy preparing for the CFA exam, and I just had a
trip to Phuket last week. Now I’m ready to blog again. Please stay tuned for a
series of new posts on personal development next week!
(Entry 4 of 4 in the
Update
on the Euro Debt Crisis series)
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