“Now that the EU has made it clear it will bail out any nation in trouble, it is faced with a choice: Either help its member countries return to growth, or run out of bazooka shells bailing them out one by one. If Ireland alone costs close to E100 billion to stabilize, the cost of bailing out a medium-size European economy starts to look downright terrifying.” ‘Europe Takes out the Bazooka” The Wall Street Journal, November 23, 2010
A currency union represents a strong form of monetary arrangement between different countries or regions within a country. The use of a single currency as the medium of exchange characterizes this kind of an arrangement. Members of a currency union share a common currency and relinquish independent control over monetary and exchange rate policies. Frequently, members of such a currency union are also constrained with respect to independent fiscal policies, notably by rules that limit the ratio of budget deficits to gross domestic product. Euroland is such a currency union, containing a majority of the members of the EU.
Whether or not such a currency union will survive through a sequence of business cycles depends critically on whether it is optimal or non-optimal in nature. If it is optimal – or has time to transition to optimality – it has a good chance of long-term survival. If it is non-optimal, it is likely to fracture and disintegrate as its members’ economies react differentially to cyclical diusturbances and inside shocks. The nature of the member economies, and the domestic institutions available to adjust to shocks in the absence of independence over monetary and exchange rate instruments, determine the issue of optimality.
From the outset it was clear that Euroland was a non-optimal currency union (See JenniferMartin Das* 2002). None of the other members was ever likely to respond effectively to the efficient economic behavior of the dominant member, Germany, while the European Central Bank would clearly operate under conservative German criteria. Worse still, the peripheral members of Euroland – notably Portugal, Ireland, Greece and Spain, the appropriately-abbreviated PIGS – were essentially adventurists hopeful of benefiting from German-induced low interest rates to fund highly speculative financial and fiscal adventures. So two incompatibilities would challenge Euroland, namely German exceptionalism and a center-periphery divide.
Jennifer Martin Das’ 2002 prediction has come to pass. Euroland is on the verge of unraveling as a consequence of the financial crisis and economic contraction that began in September 2008. The first to collapse was the weak sister of Euroland, Greece, the indolence of whose citizens and the prodigality and corruption of whose fiscal institutions constitute an international disgrace. The second to follow was the Emperor Without Clothes, Ireland, whose dramatic growth rate had been grounded on a Bernie Madoff style Ponzi- banking system that was exposed, just like Bernie’s, and Iceland’s, once the bubbles began to burst.
Where do the bazooka’s feature in all this? Well, in July 2008, when Treasury Secretary (ex-Goldman Sachs operative) Hank Paulson explained why he needed power and money to rescue Fannie Mae and Freddie Mac, he advised Congress: ‘If you have a bazooka in your pocket and people know it, you probably won’t have to use it.” Congress gave him the bazooka; and Congress is still reloading it to prop up those corrupt mortgage-finance bankrupts .
Ignoring the Hank Paulson experience, in May 2010 Euroland acquired its own bazooka – almost over the dead body of wary German Chancellor, Angela Merkel – in the form of a E750 billion stabilization fund for euro-zone members confronting unsustainable amounts of fiscal debt. The bazooka failed to serve its purpose. It has now fired twice, in attempts to bail out Greece and Ireland, to the disgust of hard-working, fiscally prudent German voters. These shots have failed entirely to reduce borrowing costs in Madrid and Lisbon, whose governments now wait anxiously in the wings for more bazooka shots. If Spain and Portugal should collapse, there goes the entire bazooka, and with it, Euroland. Back to the original ‘magnificent’ EU six, may be the ultimate outcome. Charles de Gaulle may have had the right idea.
How wise the United Kingdom was to stay out of this monetary cess-pit! The decision to stay out, of course, does not entirely insulate the UK from the economic repercussions of chaos in Euroland. But it surely helps a lot, as German Chancellor, Angela Merkel, must now truly understand.
* Jennifer Martin Das, The European Monetary Union in a Public Choice Perspective, The Locke Institute Series, Edward Elgar Publishing, 2002.