Lots of people keep struggling in the attempt to understand what is the basic issue with the Euro currency. Here my views on it, based on a layman common sense methodology…
If you follow the money from the beginning, it becomes pretty clear what happened in the past and what will happen in the future. Let’s start from yesterday, when the Euro was introduced.
The EU, when introducing the Euro, has basically decided that all countries members of the club were going to have the same kind of economy – stable, with a balanced import-export, financially healthy, and so on. So, from a purely financial viewpoint, German and Greek economy were considered to be equal as the way they were operating.
Quite obviously, the above is an heresy – everybody with a bit of knowledge of different European economy would have understood from the beginning that the basic assumption was wrong. The results however were pretty clear.
Greece, Spain, Portugal and Ireland, with Italy and Cyprus, were used to create a continuous internal deficit, by selling government debt to its citizens. In that way, they were financing fancy stuff like pensions at 45 for public employees, infrastructure works, lack of a proper taxation system and a few other things. The more the State was indebted, the less its currency (the Greek Dracma for instance) was worth. The less it was worth, the more the country could export as concurrency prices to other countries. In the case of Greek, the country could offer cheap tourism to the wealthy Germans and UK people.
The same was applied to all countries. Irrespective of the amount of debt produced by each country, the deriving issue was limited to the internal economy and solved by a continuous process, market lead, of de-evaluation of the local currency. In the worst case scenario, the local currency would have reached such a low market value that the debt with parties outside of the country would have become worthless, realising a default. But, since external parties could have negotiated a loan to Greece on the basis of a weak currency, they could have imposed conditions geared to avoid that the default could take place, or stopping lending money altogether.
The system in place was based on one-to-one agreements between States – so Germany could have accepted to loan money to Greece against, for instance, a tax friendly approach to German companies and products (Ireland did this after the introduction of the Euro with some US companies, becoming a very wealthy economy for a while). In other words, the existence of local currencies made it possible to negotiate and to re-balance obvious unbalances in wealth between different economies.
Following the money, you would have seen that Nikos, Greek citizen, would have had a decent salary within Greece, not paying taxes, but buying State obligations against a decent interest. So the Greek State would have had income not from taxes but from selling debt to its citizens. When the Greek government decided to spend more money than available, it would have gone to say Germany and proposed a deal like outlined above. German money, converted into Dracmas, would have flown into Greece, keeping the balance within a certain range. Nikos would not have felt the effect of that deal as long as he did not try to buy other currencies or products or services based on other currencies, as they would have been too expensive for him. He would therefore prefer buying local products and services, keeping the economy afloat.
The introduction of the Euro took away completely the possibility to rebalance unbalances between economies. The Greek government, when lending money from outside of Greece, must deal in Euro – the same currency as everywhere else. As a result, the more the Greek State borrows money, the more the value of the Euro decreases – and not only for Greece, but for everybody, including Germany. The same applies now also to internal debt. While before the internal Dracma based issue could be considered, to an extent, a Greek problem, now it has become a European problem. Imagine Greece selling its debt against say 10% interest rates. Nikos would buy tons of it (instead of paying taxes) in order to preserve his wealth and build a pension. But the debt Greece is selling to its citizens is now not a Greek debt. As it is based on Euro, Greece is actually selling something that can be defined a common good – European wealth.
Left unchecked, Greece and other countries continued to sell debt internally and to borrow money from external sources, and in doing so decreasing rapidly the value of the common Euro currency. As a result, Europe had to pay through its nose for most critical resources like oil, steel, and many other things that are in insufficient quantity in Europe. Since the Euro decreased in value v. other currencies, in particular the US dollar, the Greek decision to build a fancy motorway between nowhere and nowhere in Greece is now being felt by all other nations using the Euro to deal with international non European partners. As a consequence, Europe decided that since all countries are in the same boat, thanks to the Euro, all countries has to paddle in the same direction and with the same rhythm, the so-called stability pact and the infamous 3% ceiling to “internal” debt which is by now not internal anymore. On paper, it makes perfect sense. The message was clear, do not overspend OUR money. But there was something that the European bean counters did not consider…
The basic assumption, as described at the beginning, was that the various European economies were somehow similar. So Germany for instance assumed that each country could have financed its needs (like pensions) with the income derived from taxation, which in turn is related to the economic power of each country’s economy. Greece, and other countries as well, soon realize that the amount of money they have available to finance stuff they are already doing is far above what comes out of taxes. Since they cannot borrow money anymore, they have one solution only, to raise taxes in order to pay for debt they already made – pensions, public salaries, road maintenance, public services in general.
The deriving tax hike depress the economy, for two reasons. To start with, a higher taxation always results in less investments and in more risk. Nikos could have considered starting a business (and produce money) with a 10% gross margin… but with a 3% gross margin after taxes, it is simply not worth it. Secondly, the money deriving from taxes now flow out of Greece and go back to the original lender, Germany and the EU in general. Nikos sees its salary and pension going down and stops buying. The companies relying on Nikos purchases go bust the one after the other, creating unemployment and therefore less money produced in general. Prices are going up, further depressing the internal market, and making Greece non competitive – remember now a week in a Greece tourist resort is in Euro, and it became so expensive tourists simply move slightly to the south for sun and sea. Money coming from taxes decreases, and so the amount of money repaid to Greece lenders.
So Greece becomes officially insolvent, every day more so. Its economy grinds to a halt, and the EU is left contemplating a debt issued to Greece that simply is not going to come back anytime soon. This in turn makes the Euro weaker – exactly the same result before the stability pact, but now the matter is much worse as the Greek economy, already weak before, is now completely gone.
In short, the stability pact fails completely to achieve any result – it makes in fact the situation more complex as it destroys economies and creates mistrust in the Euro – the “internal” debt in Europe affect the Euro just like the “internal” Greek debt affected the Dracma before the Euro. Greece is bankrupt, and the Euro value would go down the drain in a day if Greece would be declared in default. This would impact all European countries, including the richest ones, those exporting in particular.
The EU, as the sum of all European economies, decides then to lend money to Greece and to other countries against even tighter conditions. Nikos now has no money and he is very angry. His anger, misdirected against Germany (and not against previous Greek governments) goes on world TV, and the mistrust in European ability to fix the mess it created increases exponentially.
Furthermore, there is a question related to the origin of the money now lent to Greece to avoid it goes completely bust – where is it coming from? A part of it comes from the richest European countries, obviously. Another part comes from external parties buying “European” debt. And a third part comes from simply printing more money (but nobody talks about it, the European version of quantitative easing).
It is fairly easy to see that the bottomline of the whole sad story is a devaluation of the Euro and an internationalization of a localized problem. Before the Euro, Greek problems were limited to Greece and to its voluntary lenders. After the Euro, Greece problems are for all European countries and for voluntary international lenders.
The impact of the Euro on Greece is already now impacting all European countries. In order to avoid Greece default (which is in fact already happened), all European countries are paying for Nikos pension. In order to do so, all European countries have already raised taxes, which in turn depressed all European economies. The value of the Euro decreased against all other currencies in net terms (so without considering other factors) and caused an import continent like Europe to pay more than before for needed resources not available locally, which of course depresses economy even more. Thanks to the decision of expanding the EU to nations barely in the position to produce anything worthwhile (the so called east European countries), most of Europe now has more debts than anything else. This is the present, more than the future.
Since European economies are shrinking, very much like Greek ones did before, Europe will soon need serious loans from outside. Consider that the Greek problem is, from a global perspective, a relatively small one. There are other countries which are in deep troubles. France, for instance, has been already downgraded. Italy is a well-known mess. Germany has already reached its limits (and passed them probably) in the ability to finance Greece through the EU. Strangled by the need to offer products and services in Euro to the rest of the world, and the need to repay an impossible amount of debt, the known PIIGS economies continue to spiral down as non competitive on the international markets.
Since the Greek conditions have now become an European issue, it is easy to see that the next step in this story is an European default, or better said, a Euro default. The combination of factors already in place will decrease the value of the Euro, every day more. This will eventually lead the EU to become insolvent against its current lenders, particularly the external ones. Since there is already a lot of money in EU debt that has been sold to people like Russians, Chinese, and US, the EU problem will increasingly become a worldwide problem, affecting all countries either directly or indirectly.
For those who have ever been climbing a mountain together with others, all connected to the same rope, it is very much like having an increasing number of climbers unable to hold on to the rocks with their hands and being supported by those who can. How much weight can the remaining ones keep holding, and for how long?
If we look at it in its true terms, the issue here is that there is only one rope – the Euro. In a situation like the above, an experienced climber would just order the ones hanging to nail a spike in the rock, hang to that and leave the rope before the whole group goes down. The group would split in two, with the strongest ones reaching safety and then arranging a rescue mission for those still hanging.
Translated in European terms, the solution is quite the same. Countries that are in difficulties (the PIIGS) must simply leave the rope and re-introduce their local currencies. EU debts must be frozen for any foreseeable time, and external debts repaid as soon as possible to avoid that the Euro debacle takes a serious toll worldwide.
If you think about it, such solution takes care of a number of issues. First of all, it would allow Greece to start selling its products and services to others on competitive conditions. The Dracma, if reintroduced, would have very little value against most other currencies, and would allow the country to be born again as a preferred tourist location worldwide. This is what Greece is and what it has always been. The internal debt issue would become again a real internal one, without affecting everybody else. Freeing the Greek debt would allow the Greek government to decrease taxation and jump-start its economy.
Germany, on the other side, would have to take a temporary hit on its borrowings to Greece and the EU. However, since Greece is now a dirt-cheap country and since it is now possible to negotiate favorable conditions (also due to the currency difference), it could use Greece as a very competitive production site for German products and industries, very much as they already do with other countries in Asia and in Africa, but with some serious logistic advantages. The same applies to all other non PIIGS countries. Although their debt could possibly never been repaid as such, the economic advantages deriving from one (or more) European country that are as cheap as much farther destinations will in time compensate for any temporary losses.
The Euro as a currency would, once the troublesome PIIGS countries are out of it, reacquire value, helping exporting countries (the richest ones) which could decrease taxation and start stimulating their internal economies, for everybody’s benefit. All countries not demonstrably able and strong enough to access the Euro currency club would have to follow the Greek destiny.
The above is, in a more simplified form, very similar to the “two-speeds” Europe that has been proposed already in the past, but with a difference. What this proposal is all about is to recognize the existence of great differences between European countries and to act according to those. One part of Europe, the more stable and controlled ones, could very well decide to keep the Euro if they want to, on condition that their economies is indeed marching at the same pace and in the same direction. This would in fact create a smaller monetary union, healthy this time, with all the advantages that such union carries with it (and there are many). All those left out of it would get back to their own currencies, and be left free to do with their economies and countries whatever they like. I can easily foresee Greece becoming again a tourist paradise for wealthy Europeans, free to devaluate the Dracma when they see it fit, to borrow money from anywhere if they want to on conditions that depend on market movements and not on political desires and wishful thinking. Should countries like Greece go back to their bad habits, they would default as many others did before them but without creating pandemic consequences.
Would all the above be a failure for the European dream?
It is perhaps advisable to look back at the origin of such dream. It started with the dream of a Europe of peace. It was expanded to a Europe as common market, where goods and services could have been traded freely. Up to then it worked very well. The introduction of the Euro was a logical next step, but it was taken too soon. Similarly, plans to transform Europe into a place with common fiscal, agricultural, political and social policies is far too soon. Europe is not “one place”. It is made of dissimilar countries, each with their own peculiarities. Whoever travelled just a bit across the continent knows it much too well.
The Euro, in the way it was introduced, was a mistake and for a number of reasons. Its partial dismantlement will be embarrassing, for sure, and would carry consequences for everybody. Among those, however, there will be massive positive ones, that most commentators keep ignoring. There is a common understanding that Europe and Euro is almost a synonymous. That is not true and the many years of Europe without Euro witness for the possibility to have the one without the other.
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