November 14, 2011
One of the great American popular economists of the last century was Herbert Stein who combined journalism, policy work; he flirted with academia and dabbled in all sorts of private ventures. He also held the prestigious position of Chairman of the Council of Economic Advisors in the US during the 1970s. His greatest contribution to economic was the simple rule “when things can’t go on forever, they stop’.
Thinking of the endless crises within the Euro whether it is Greece, Italy, Belgium, Ireland or Spain, whether it is bank debt, household debt or sovereign debt, whether it is Germany’s taxpayers of France’s banking system — Stein’s law comes to mind. This can’t go on forever, so it will stop one way or another.
Increasingly, as events overtake and eclipse all previous “bailout”/”rescues”, it is becoming evident that the option of the two-speed euro is now on the cards. Ireland will be firmly in the “softer” euro camp.
No one has mentioned this specifically yet, but it is likely because Europe has always had a core/periphery dimension. In times of crisis, such as the last financial crisis the 1993 currency crisis, the European elite’s instinct is to save the core and deal with the periphery in as expedient a manner as possible.
Faced now with a meltdown of their system, Europe’s elites need a solution that snatches a political victory from the teeth of financial defeat.
Apocalypse — in the guise of a country being ejected from the euro – is not a political option because the risk of everything falling apart are simply too high. In addition, a two-speed euro, with a hard euro for the core and a soft euro for the countries in trouble, relieves the pressure on the whole European financial system.
Arguably, for the average citizen such a deal is preferable to the choice we face now. That choice is either a complete, chaotic break up of the system with huge negative implications for savers; or ten years of austerity with huge negative implications for borrowers.
A two-speed euro — involving two distinct but related currencies — keeps the entire euro project together and gives the EU donkey the carrot of moving forward and the stick of promised economic reform. It is important to understand the perpetual forward motion idea lies at the heart of the EU. As long as the project seems to be moving forward slowly towards the nirvana of more integration when the time is right, “Europe” is progressing.
A break up of the Euro means the project has stalled and this is unacceptable to the people who make the rules in the EU. They are believers; and like any ideologues, these true believers are driven by the utopian notion that the future is always brighter than the present. Incidentally, heaven is based on the same premise.
This weekend we are at a tipping point and it has been a long time coming. Don’t be suckered into the spin that this crisis came out of the blue or was unforeseen. It has been brewing
For many years now this column has pointed out that the Euro could/would breakup, presenting Ireland with a big dilemma. At the time it was pretty radical even to question the economic legitimacy of Euro. It was unfashionable to suggest that the currency might be dogged with internal inconsistencies centered on inter-country trade and capital imbalances, national idiosyncrasies and profound economic differences. More radical still was to follow this logic by predicting that the system would implode.
As is typical in Ireland, the dissenter is dismissed as a crank or worse an enemy.
But after all the insults we are where we are, the euro in its present form is doomed. So lets look at what is likely to replace it.
Consider what the two-speed Europe might look like.
The first thing we know is that the peripheral countries can’t keep up with Germany. Take Ireland as an example. When we had the Punt linked to the Deutsche Mark we devalued six times in thirteen years just to try to keep up competitively with the Germans. Conversely, when we joined the Euro and could not devalue, we lost 30% competitiveness against Germany. It could not be clearer.
For the other peripheral countries the situation is worse.
So we all need a change in the value of the currencies we trade in to make our companies more competitive and thus, more likely to export. In tandem, we need to make imports more expensive so we don’t buy too many of them. The weaker exchange rate achieves this. Devaluations work. And to any one who doubts this, just point to the lasting competitive gains garnered by Finland and Sweden after their 1992 devaluations.
Without currency change, we can’t keep up with the Germans and this makes the EU’s promise of economic convergence hard to achieve without huge borrowing. Up till now, we borrowed to achieve a lifestyle and a level of economic activity. Now none of us can pay this money back.
So we need debt forgiveness or some debt deal. Accompanying the new euro would be mass debt write downs because if you reduce the value of the currency that the people get paid in but you don’t commensurately reduce the value of their outstanding debts, the people will simply not be able to pay and the country will default after the devaluation. This would not be clever. Everything must be done together.
So let’s think about the new euro. The new soft euro would trade at 70% of the old one (my figure plucked out of the air). This would mean that relative to Germans, our standard of living would be cut by one third overnight. We would achieve in one night what the present policy seeks to do in five years.
We would be extremely attractive place to investment in because our labour would be much cheaper. But don’t forget that this reduces our income by the same amount.
All our debts would be reduced by 30% because they would be in a new currency. Obviously, the banks that lent in hard euros and would now get paid in soft euros would carry a huge exchange rate loss. This would need to be dealt with. Possibly, the banks in each country could issue bonds backed by the EU and redeemable for new euros at the ECB. These bonds could be considered capital so that the banks didn’t go bust.
What about the savers who lost out on their stock of old euro saving which would be devalued by 30% when converted into the new euro? They could be given new inflation-linked euro bonds issued by the State and redeemable from the ECB but not straight away. There would be an incentive to keep them in the banks as savings. This is normal because if you think about it, most people don’t touch their savings. The State would have to make sure that the new bonds were credible enough so that people wouldn’t want to cash them straight away.
There is no easy way out of this mess. There is no way we can wave a magic wand and promise that no one will be affected, but it is clear that the euro is on its way out and will at best, mutate into something else.
The two-speed euro idea, at least prevents the chaos of a messy implosion and the rushed reintroduction of many currencies. It achieves the competitive devaluation, which for us with the majority of our trade and investment coming from and going to, America and Britain, it would give us a shot in the arm. The debt forgiveness element would also give the heavily indebted commuter generation — the Pope’s Children — a break.
There is never a best way to do things in a crisis, simply a least bad way. Maybe this is it.
One thing we do know for sure is that “when things can’t go on forever, they stop”.