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Robert Samuelson on Real Clear
Politics says Europe at
the Abyss
It has come to this. A year after rescuing Greece from default, Europe is staring into
the abyss. The bailout
has proved insufficient. Greece needs more money, and it can't borrow
from private markets where it faces interest rates as high as 25 percent. There is no
easy escape.
What's called a "debt crisis" is increasingly a political and social crisis. Already, unemployment is 14.1 percent in Greece, 14.7
percent in Ireland, 11.1 percent in Portugal and 20.7 percent in Spain.
Some causes of Europe's plight are well-known: the harsh recession following the 2008-2009 financial
crisis; aging populations
coupled with costly welfare states. But there's also another less recognized culprit: the euro,
the single currency now used by 17 countries.
Launched in 1999, it aimed to foster
economic and political unity. For a while,
it seemed to succeed. In the euro's first decade, jobs in countries using
the common currency increased by 16 million.
It was a mirage. For starters, the euro fostered a credit bubble that led
to booms in housing, borrowing
and consumer spending. But one policy
didn't fit all: Interest
rates suited to Germany and France were too low
for "periphery" countries (Greece, Ireland, Portugal and Spain).
Money poured into the periphery countries. There was
a huge compression of interest
rates. In 1997, rates on 10-year Greek government bonds averaged 9.8 percent compared
to 5.7 percent for similar German
bonds. By 2003, Greek bonds fetched
4.3 percent, just above
the 4.1 percent of German bonds.
"The markets failed.
All this would not have occurred if banks in Germany
and France had not lent so
much," says economist Desmond Lachman of
the American Enterprise Institute. "It was like the U.S. housing market." Both American and
European banks went overboard in relaxing credit standards.
"Markets Failed" Says Desmond Lachman
Few economic statement make my hair
stand straight up more than that
bit of complete nonsense from
Lachman. The markets did not fail. Bureaucrats who dreamed up the Euro failed.
Those bureaucrats devised a currency union with nothing more than suggestions on fiscal controls.
Making matters far worse, countries in the Euro-Zone have widely differing political philosophies and policies.
That currency union was
not brought about by the market.
The free market would never have done such a silly
thing.
Every major currency
union in history without
a political and fiscal union has failed. There is a nice Table of Monetary Unions
on the site Euro Know that shows just that.
Bureaucrats, not the free market
knew better. Bureaucrats, not the free market
failed.
Not Different This Time
Potential problem were recognized well in advance by many. In February 1995 The
Independent wrote a misguided
editorial Why we say
Yes to a single currency.
The rationale of The Independent was "It's different this time".
The economic
arguments that, on balance, Britain
will be better off inside the currency union than outside are persuasive. The discipline of a permanently fixed exchange rate
would significantly reduce the risk of a return to high inflation and create greater certainty for companies and investors. There would also be
lower transaction costs.
There is no doubt that a successful single currency would strengthen Europe's position on
the global economic stage.
The opponents of the single currency
do not agree. They argue that the experience of the ERM
and events since Black Wednesday show that to be locked into
a single currency is damaging. Exchange rates, they point out, can act as important "shock absorbers" in times of unexpected
crisis. These are powerful arguments. They are most powerful when applied to some EU members - notably Spain, Portugal and Greece
- whose less developed economies would make the exigencies of a single currency
regime punishing, unpopular and potentially disastrous.
But this is not the
condition of Britain today.
In 1992 the needs of the British
economy were at odds with
the priorities of the Bundesbank. They were trying
to control inflation, we needed
to get out of recession.
By contrast, in 1999 six
or seven countries will find themselves at the same stage in the cycle,
with very similar economic priorities. So things are likely to be different.
Points of Failure Predicted In Advance
Things were not different were they?
Ironically, in that 1995
article, The Independent pointed out the
exact points of failure: Spain, Portugal and Greece.
Tony Dolphin, Chief Economist of AMP Asset
Management, wrote a response
to that article less than a week
later. Please consider, European monetary union: the benefits, the problems and the
traveller's tale
The potential
benefits of European monetary union are questionable,
the potential costs could be very
serious. A successful monetary union requires that the economies joining it are broadly the same, especially in regard to their response to external and internal inflation shocks. This
is not the case in Europe. Take
two examples: oil and housing.
The effect of a sustained,
steep rise in the oil price will
be very different in Germany, which is highly dependent
on imported oil and gas; in France, where nuclear power is used to generate a high proportion of energy needs; and in the UK, where the
North Sea sector of the economy would actually benefit. Imagine trying to set
an appropriate, anti-inflationary
interest rate policy for
a monetary union including
these three economies should the oil price double.
The housing sectors of European economies also differ, with the UK's high level of home ownership financed by variable
rate mortgages not being found elsewhere. It is easy to envisage a situation where the interest rate policy of a European monetary union was entirely inappropriate for the housing sector of the UK economy.
These and other structural
differences between European economies will not disappear over the next four years, nor at any
time in the foreseeable future. Until
they do, the economic
argument against European
monetary union is powerful, and far more clear cut than the political arguments for or against.
Yours faithfully,
Tony Dolphin
Chief Economist
AMP Asset Management
Failure of the "One Size Fits
Germany Policy"
I have no idea what Tony Dolphin is doing
today but put him in the
class of those who can say "I told you so."
Here is the key paragraph:
"It is easy to
envisage a situation where the interest
rate policy of a European
monetary union was entirely inappropriate for the housing sector of the UK economy."
The UK did not adopt the
Euro but Spain did. Interest
rates in Germany were not appropriate
for Spain. The result was
a Spanish housing bubble of epic proportion that has now collapsed.
One interest rate policy simply does not work. For further discussion, please see ECB's "One Size Fits
Germany" Policy; Rate Hikes to Stress PIIGS
Compounding Spain's misery, Trichet has embarked on
a rate-hiking campaign at the worst possible time, with Spanish unemployment in excess of 20%,
and youth unemployment near 40%.
Housing Market
Nonsense
Note that Lachman also blames US banks for the housing bubble.
"It was like the
U.S. housing market."
Both American and European
banks went overboard in relaxing credit standards.
That too is nonsense in that it does
not place the blame where
it belongs, on the Fed.
The Fed held interest
rates too low, too long. Money was too loose, banks
lent.
Blaming banks for lending when real interest rates are hugely negative is tantamount
to placing a bottle of
vodka in front of an alcoholic, telling
the alcoholic it is the best vodka in the whole
world, then blaming the alcoholic for what happens next.
Fed is the Problem
Not only did the Fed hold interest rates too low, too
long, the Greenspan Fed endorsed derivatives, subprime loans, and adjustable rate mortgages. Meanwhile Bush was praising the "Ownership Society" and Barney Frank was in the back pocket of
Fannie Mae and Freddie Mac.
Ben Bernanke was totally clueless, in complete denial about the bubble, going so far as to say home prices were "based on fundamentals".
None what has transpired
has had remotely anything to do with the failure of the free markets. We have a failure
of regulation, not a failure
to regulate. Lachman, like Bernanke, really needs to get a clue.
You cannot fix a problem until you understand what the problem is. Unfortunately, politicians and economists in both the US and Europe are still
in denial. Statements by those blaming markets instead of politicians and the Fed, do not help.
Addendum:
The biggest failure of
regulation was the very creation of the the Fed. That should be be obvious
but the sad state of affairs
in regards to economic understanding
says I need to spell it out.
Those screaming about the
free market need to answer this question: Could the free market possibly have done any worse the serial bubble-blowing moral-hazard policies of the Fed?
.
Mish
GlobalEconomicAnalysis.blogspot.com
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