Just when it seemed that things could not get worse, it appears that they have. Even some of the ostensibly “responsible” members of the eurozone are facing higher interest rates. Economists on both sides of the Atlantic Ocean are now discussing not just whether the euro will survive, but how to ensure that its demise causes the least turmoil possible.
It is increasingly evident that Europe’s political leaders, for all their commitment to the euro’s survival, do not have a good grasp of what is required to make the single currency work.
The prevailing view when the euro was established was that all that was required was fiscal discipline — no country’s fiscal deficit or public debt, relative to GDP, should be too large. However, Ireland and Spain had budget surpluses and low debt before the crisis, which quickly turned into large deficits and high debt.
So now European leaders say it is the current-account deficits of the eurozone’s member countries that must be kept in check.
In that case, it seems curious that, as the crisis continues, the safe haven for global investors is the US, which has had an enormous current-account deficit for years.
So, how will the EU distinguish between “good” current-account deficits — a government creates a favorable business climate, generating inflows of foreign direct investment — and “bad” current-account deficits? Preventing bad current-account deficits would require far greater intervention in the private sector than the neoliberal and single-market doctrines that were fashionable at the euro’s founding would imply.
For example, in Spain money flowed into the private sector from private banks. Should such irrational exuberance force the government, willy-nilly, to curtail public investment? Does this mean that government must decide which capital flows — say into real-estate investment, for example — are bad and so must be taxed or otherwise curbed? To me, this makes sense, but such policies should be anathema to the EU’s free market advocates.
The quest for a clear, simple answer recalls the discussions that have followed financial crises around the world. After each crisis, an explanation emerges, which the next crisis shows to be wrong or at least inadequate. The 1980’s Latin American crisis was caused by excessive borrowing, but that could not explain Mexico’s 1994 crisis, so it was attributed to under-saving.
Then came East Asia, which had high savings rates, so the new explanation was “governance.” However, this, too, made little sense, given that the Scandinavian countries — which have the most transparent governance in the world — had suffered a crisis a few years earlier.
There is, interestingly, a common thread running through all of these cases, as well as the 2008 crisis: Financial sectors behaved badly and failed to assess creditworthiness and manage risk as they were supposed to do.
These problems will occur with or without the euro. However, the euro has made it more difficult for governments to respond. The problem is not just that the euro took away two key tools for adjustment — the interest rate and the exchange rate — and put nothing in their place, or that the European Central Bank’s mandate is to focus on inflation, whereas today’s challenges are unemployment, growth and financial stability. Without a common fiscal authority, the single market opened the way to tax competition — a race to the bottom to attract investment and boost output that could be freely sold throughout the EU.