The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
NEW YORK (
) --Monnet's original conception for the European Common Market sounded sensible. As separate nations, we have little power, but together, we will be a significant global/political force. However, as is often the case, the devil is in the details.
The eurozone, with a single central bank and currency, is a subset of the European Common Market conception. It is not working out for at least four of its 17 members.
The euro leaders are currently engaged in a dance that will ultimately mean nothing.
In the first part of this two-part series, I will explain why. In the next piece, I will get into the details of how these four countries can and should leave.
Because the European Central Bank (ECB) issues the currency and sets interest rates, the individual eurozone nations have no control over monetary policy. If laborers migrated between countries, this would be a manageable problem.
With migration, unemployment and other economic imbalances could be worked out. But because of language and cultural differences, there is little migration between eurozone countries. So huge economic imbalances exist, and there is no effective equilibrating force.
Consider first unemployment rates. The rates in the eurozone powerhouses (Austria, the Netherlands, and Germany) are low. But look at the bottom four. These rates have been high for some time, and such high rates cause serious socio-economic problems. Spain's unemployment rate of 19.4% is particularly grim. It means that one in five Spaniards looking for jobs. The OECD reports that for men in the 15-24 age range, the unemployment rate is 43%! This is not healthy. It invites civil strife.
A Keynesian might say that while eurozone countries have lost control over their monetary policies, they still can exercise fiscal independence by running government deficits large enough to get back to full employment. Unfortunately, since they do not have their own central banks to buy up the resulting debt, their deficits will be limited to their governments' currency reserve holdings and the willingness of others to buy their debt. The four "weak sisters" currency holdings are limited. And as evidenced by the skyrocketing interest rates, they must pay to sell new debt, nobody wants it.
Let's now look at two more indicators of problems facing the "weak sisters" -- the size of their budgetary and current account deficits. Table 2 below provides data on government deficits. The deficits of Austria, Germany and The Netherlands are manageable. There are willing buyers for the new debt generated by their deficits.
It is a different story for the "weak sisters." Their deficits are much larger, and nobody wants to buy their debt. On top of this, Greece, Ireland, and Portugal have entered into agreements with the ECB/IMF to reduce their deficits.
, the IMF estimates that a fiscal consolidation of 1% of GDP will result in an increase of .3 percentage points in the unemployment rate. This is crazy and it will be political suicide for the leaders of these countries to continue supporting these agreements.
It is finally worth examining the current account balances of these countries with the rest of the world. Negative balances means they are buying more than they are selling. The U.S. runs a large current account deficit (-3.1%). But as I have noted
in a recent piece
, it has been offset by the global demand for U.S. financial assets, specifically U.S. Treasuries and equities. Nobody wants the financial assets of the four "weak sisters."
As a consequence, the current account deficits of Greece, Portugal and Spain are not sustainable. This means euros will drain out of the countries to make up the deficit. And this is effectively reducing the money supplies of these countries, making their unemployment problems even worse.
Root of the Problem
What is really wrong here? Labor costs in "weak sister" countries are too high to clear labor markets. More specifically, the euro is too strong for these countries. It makes their imports too cheap and exports too expensive to reduce trade deficits and increase domestic employment. This is a classic case of the "Dutch Disease," a term coined to explain why other industries do poorly in mineral exporting countries.
In the eurozone, Austria, Germany, and the Netherlands are the "mineral export industry": the euro is quite strong because of them. But other euro members will not fare well because the strong euro makes them too costly to compete on world markets.
Now in theory, this problem could be resolved if the "weak sisters"' producers (capitalists and laborers) got together and agreed to reduce their euro costs by 30%. In other words, if they all agreed to take a pay cut of 30%. But this will never happen.
What Should Be Done
How can the "weak sisters'" costs be realistically reduced so that their workers can find jobs again and their trade deficits become manageable via lower imports and higher exports? They should leave the eurozone and go back to having their own central banks. Why would this help? Because with their own currencies and central banks, their currency exchange rates would fall so their labor would be cheaper and they could compete again on world markets.
And instead of having to reduce their government deficits as they are obliged to do under ECB/IMF mandates, they can launch new stimulus packages to get people back to work. These stimulus packages would be financed by their central banks buying up the increased government deficits.
Of course, this is just another way to get labor and capital costs down in the "weak sister countries." With their new currencies, their imports will be much more expensive and their exports more competitive than under the euro regime. But this is a workable way to reduce their costs. And yes, their standard of living will fall by 30%, but it has to if they want to put people back to work.
This might sound grim, but what is the alternative?
- Stay in the eurozone, and get the French and German governments, working on behalf of their banks, to squeeze all they can out of the "weak sisters";
- Watch unemployment rates continue to rise with accompanying civil disorder/riots becoming more intense;
- Watch the leaders of the "weak sisters" commit political suicide by continuing to support the ECB/IMF mandates.
Concluding Comment: View from Germany
I quote an informed German friend:"You are asking whether the euro will survive. I hope that it will not, but apparently the German and the French governments will try to save it at any costs to their people. It appears that the bureaucrats in Brussels are pushing hard for a Western European Soviet Union. They do not care about the deep seated cultural, economic and language differences on this continent and they do not respect the sovereignty of nations. They aim for a super power with enhanced centralization in Brussels."
In the second part of this series, I will address the technical questions of how the "weak sisters" can extract themselves from the eurozone.
Elliott Morss is an economic consultant and an individual investor in developing countries. He has taught at the University of Michigan, Harvard University, Boston University, among other schools. Morss worked at the International Monetary Fund and helped establish Development Alternatives Inc. He has co-written six books and published more than four dozen articles in professional journals.