As the crisis in the Eurozone drags on, with summit after summit and agreement after agreement, the dangers of a disorderly break-up continue to rise. Despite Friday’s supposedly successful EU summit detailing treat changes in the EU, the fundamental problems in the currency remain.
These problems are twofold. First, there is a severe discrepancy in economic competitiveness between the Northern European countries grouped around Germany, and the Southern European countries . German workers are simply much more efficient and competitive than the Southern countries of Portugal, Italy, Greece and Spain (sometimes called the “PIGS” in financial circles). Germany is an exporting machine, and it is sending a huge amount of goods and services to the PIGS, and therefore running a huge trade surplus with those countries.
The PIGS, meanwhile, are importing huge amounts from Germany, and hence run large trade deficits. Ideally, the normal way out of a crisis such as this would be for the PIGS countries to allow their currencies to depreciate against Germany’s, thereby making their exports cheaper in Germany whilst Germany’s exports become much more expensive in the PIGS. Over time, the trade imbalance between the two would gradually start to even out.
Currency depreciation and an increase in exports eventually allows countries in recession to start growing again, and is the standard economic and monetary prescription for countries in a crisis. However, since the PIGS are locked into the Eurozone, they have no control over their own currencies and hence cannot follow the traditional route to regaining economic competitiveness. Hence they are prescribed “austerity” – cut spending, cut salaries – which will condemn these countries to years of recession.
In addition to the imbalance in competitiveness between the Northern Eurozone and the PIGS, the second major flaw in the Euro is that it has no true “lender of last resort.” Normally, this role is filled by a central Bank such as the Bank of England (BOE) or the US Federal Reserve (FED). These institutions have the dual mandate of both controlling inflation AND fighting economic recessions and unemployment. Hence, during the worst of the economic crisis in 2008 the BOE and the FED were able to engage in what is called Quantitative Easing, or QE.
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