As everyone
knows by now, Greece, Spain and the rest of the PIIGS countries can't fix
their economies because they can't devalue. If they were still using their
old national fiat currencies, so goes the conventional wisdom, they could
just mark them down by 30% and instantly see their exports surge and their
deficits shrink. Et voilà, they'd once again be
fully-functioning members of the global economy.
But the euro
is beyond their control, leaving them with only austerity, which in this
context is another word for Depression. Hence all the speculation over
radical-but-suddenly-conceivable ideas like a Greek or Spanish exit, fiscal
integration with Germany in charge, and eurobonds
guaranteed by the eurozone as a whole.
This is all
wasted effort, however, without the final piece of the puzzle: The ECB will
have to flood the system with newly-created currency, which is another way of
saying that the euro itself will have to be devalued.
Acknowledging
this inevitability, Martin Feldstein, Harvard professor and former chairman
of Ronald Reagan's Council of Economic Advisers, calls explicitly for a euro
devaluation in today's Street Journal:
A
Weaker Euro Could Rescue Europe
Devaluation
is the only way to save the single currency.
The only way
to prevent the dissolution of the euro zone might be a sharp decline in the
value of the euro relative to the dollar and to other currencies. European
politicians' dreams of political union and permanent fiscal transfers are not
realistic solutions to the multiple problems of the euro zone's peripheral
countries -- especially on the tight schedule needed to halt the collapse of
the single currency. The European Central Bank (ECB) may continue to provide
additional liquidity, but experience has already shown that it cannot reduce
sovereign bond yields to sustainable levels.
The peripheral
countries -- Italy and Spain, as well as Portugal, Ireland, Greece, Cyprus
and perhaps others -- can only remain in the euro zone if they solve four
difficult problems. First, fiscal deficits must be permanently lowered to
reduce the interest rates on sovereign bonds to levels that can be financed
in the long run. Second, economic growth must be revived to create employment
and sustain political support for that fiscal consolidation. Third,
commercial banks must be recapitalized to stop the deposit runs and preserve
lending capacity. Finally, large trade deficits must be eliminated so that
these countries are not permanently seeking transfers or loans from foreign
creditors.
Politically
difficult decisions could solve the first three of these problems. Less
government spending and higher taxes could reduce fiscal deficits. Changes in
labor laws and other institutional barriers to productivity could produce
stronger economic growth. And sufficient growth would give governments the
fiscal capacity to recapitalize their commercial banks.
But
implementing these policies would not solve the fourth problem: the
periphery's staggering trade and current-account deficits. Those deficits
reflect the peripheral countries' lower competitiveness after a decade of
slow productivity growth compared to Germany and other northern euro-zone
members.
If the
peripheral countries were not locked into the euro but had their own
individual currencies, they could follow the strategy of combining
devaluation and fiscal consolidation that has been successfully adopted by
countries in Latin America and East Asia and more recently by Britain.
Devaluing currencies would boost exports and reduce imports, simultaneously
eliminating trade deficits and spurring growth. Higher GDP would offset the
depressing effect on aggregate demand caused by the higher taxes and reduced
government spending needed to eliminate the fiscal deficit.
This route
out of the trade and current-account deficits is not currently available
because the members of the euro zone are locked into a single currency.
That's why euro-zone officials argue that member countries must force wage
levels to decline under the pressure of unemployment so as to achieve
"real devaluations" of as much as 20%. But even with persistent
unemployment rates of more than 20% in Spain and Greece, there has been
little progress in reducing real wages. A strategy of massive real
devaluation through high unemployment is simply not feasible in democratic
nations.
This
structural impasse could be bypassed if the peripheral countries left the
euro zone, returned to national currencies and devalued. But that dissolution
of the wider euro zone could be avoided by a substantial decline in the value
of the euro versus other non-euro-zone currencies. Euro devaluation would not
change the trade imbalances within the euro zone but would increase the
global exports of the peripheral countries and decrease their imports from
non-euro-zone nations. This in turn would raise the GDP of peripheral
countries, allowing them to achieve positive growth while also reducing
fiscal deficits.
A weaker euro
would also render German products even more competitive in global markets
than they are today, increasing Germany's already large trade surplus with
the rest of the world. Increased demand in Germany might put upward pressure
on German wages and prices. But the net effect would be an even stronger
German economy.
Although a
decline of the euro would mean higher import prices in euro-zone countries,
it need not mean higher inflation or even a higher overall price level. The
ECB could in principle continue to aim at a 2% inflation rate with lower
prices of domestic goods and services offsetting the higher prices of imports
from outside the euro zone. At worst, the ECB could allow a one-time
pass-through of the higher import costs but prevent any further increases in
inflation rates.
A one-time
fall of the euro that eliminates the current-account deficits of the
peripheral countries would not solve the ongoing competitiveness problem
caused by stronger productivity growth in Germany and other northern
countries. But a combination of policies that accelerate productivity growth
in the periphery and slightly slower wage increases there would prevent a
return of large current-account deficits. Eliminating today's large
current-account deficits would make small annual adjustments in the future
feasible.
A major
decline of the euro does not require explicit action by the ECB or other
euro-zone institutions. If major global investors in euro bonds conclude that
there will be either a breakup of the euro zone or a sharp decline in the
value of the euro, they will reduce their holdings of euros, driving down its
value. In that way, the bond market may by itself deliver the conditions needed
to eliminate the current-account deficits of the peripheral countries and
prevent the dissolution of the euro zone.
Some thoughts
Let's put it
bluntly: devaluation is theft. When a country borrows too much and then marks
down its currency it is stealing from its savers and the trading partners who
were naïve enough to think the currency was a trustworthy store of
value. So calls for the eurozone or anyone else to
devalue rather than live within their means are simply enabling the breaking
of what should be seen as a serious promise.
Devaluing the
euro will absolutely smooth the integration process -- for about two weeks,
until the US, Japan, China, Brazil and all the other trading nations that are
hurt by a falling euro retaliate with devaluations of their own. Then we're
in Jim Rickards' Currency War III (the first two
happened during the Depression and in the 1970s), complete with rising
volatility in prices, interest rates and pretty much everything else.
Feldstein: "Although
a decline of the euro would mean higher import prices in euro-zone countries,
it need not mean higher inflation or even a higher overall price level. The
ECB could in principle continue to aim at a 2% inflation rate with lower
prices of domestic goods and services offsetting the higher prices of imports
from outside the euro zone. At worst, the ECB could allow a one-time
pass-through of the higher import costs but prevent any further increases in
inflation rates." Oh yeah, right. Central banks have absolute,
razor-sharp control of capital flows enabling them to decide which categories
of prices will rise or fall by how much. Strange that these omnipotent beings
allowed today's troubles to happen in the first place...
Anyhow, one
of the guaranteed results of a currency war commencing with today's
stratospheric debt levels and systemic fragility will be capital controls of
a variety and scale never before seen. Each combatant will try to trap its
citizens' wealth at home in order to confiscate it through inflation,
taxation or direct expropriation. So geographic diversification is more
important than ever.
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