Mark Blyth — The Future of the Euro (After Triaging, for the Moment at least) Greece

While the Greek crisis has occupied much attention in recent weeks, in terms of the Eurozone’s longevity, the Greek crisis will prove to be a sideshow. Greece’s threat to the Euro, once Finance Minister Schaüble’s “temporary exit” was unveiled, was reduced to questioning whether a currency union ‘with exits’ is still a currency union? The short answer is yes, it still is, and it shall remain so. If one accepts that the only Eurozone economy that is bankrupt is Greece, and that Greece will be treated as a ward of the Union for the foreseeable future, then with the rest of the Eurozone finally in recovery thanks to a de facto end to austerity policies via massive central bank interventions, the Future of the Euro, at least in the medium term, seems assured.

Yet according to much academic commentary, the Euro’s weakness lies in Europe’s fractured institutional design, rather than in its Greek entanglements or its exit vulnerabilities. Upon such a view the unexpected depth of the recession was caused by a lack of common fiscal institutions, a banking union, common deposit insurance, and a genuine Euro bond. So when the crisis hit, deprived of institutions that would have acted as surrogates for domestic inflation or devaluation, the Eurozone economies were forced to adjust internally and simultaneously, and austerity became the only game in town. Yet despite the depth of the recession, the Eurozone has made great progress since 2010, with, for example, the construction of the fiscal compact and the banking union. But fragilities remain because of these incomplete institutions.

There is much to commend in this view. It is far from wrong. But it may be flawed as a guide to the Euro’s future since it fails to take into account one very important factor. Once the Euro was introduced, what was once a political union based around ‘the big five’ of Germany, France, Italy, Spain and the United Kingdom, became a far more diverse economic union of 27 members. Yet within this apparent cacophony of interests and agendas we can see a new Europe emerging from the crisis where the dividing line will shift from North versus South to those that can run consistent current account surpluses and those who cannot. Those who can will prosper with the Euro. Those that cannot - deprived of their own currency - will have to keep making painful internal devaluations, or will have to head for the exit.

The kicker.

Given that domestic demand is given short shrift in Eurozone economic policymaking, the long-term future of the Euro rests upon the ability of member states to compete with the Americans and the Asians in global export markets. In such a world domestic demand necessarily plays second fiddle to price stability. Specifically, as the Asian countries continue to move up the product ladder and the Americans continue to dominate the top end of the value chain, the ability of export-led Europe to prosper depends upon continual product quality improvement tied to price stability, and in this regard the recent article by Prof. Schuknecht, the Chief Economist of the German Federal Finance Ministry, in Süddeutsche Zeitung is correct. Keynesian style reflation undermines this policy mix because in an export-led economy you need someone else to stimulate while you control prices and wages. Boosting wages and prices simply makes your exports more expensive. In such a world the Euro has very different effects on different countries, and blocs of countries.…

"It's the asymmetry, stupid."

With the EZ, Japan and China being net exporters, the global economy relies on the rest of the world running corresponding deficits. The US runs a chronic trade deficit that chiefly supporting this. The question is therefore how long the USD zone can soak up the production in excess of domestic demand in the EUR, JPY and CNY zones when the US economic policy is focused on reducing the fiscal deficit.

…this new system may be robust locally but fragile globally. After all, it relies upon everyone else not having an excess of savings over investment. This new Europe is effectively free riding of consumer spending elsewhere, which leaves its economic fate in the hands of others. With the Asians and the Europeans all exporting simultaneously, if the remainder of the world stops consuming [read US], then the whole system could come off the rails rather quickly.

In sum, the Euro is quite secure from Greek defaults and British exits and other near term risks. But its own new growth model may prove to be its weakest link over the longer term.

Süddeutsche Zeitung

The Future of the Euro (After Triaging, for the Moment at least) Greece

Mark Blyth | Eastman Professor of Political Economy, Brown University