Thursday, February 16, 2012

The Failure of the Euro and the Way Forward

In a past life I campaigned against the creation of the Euro because I believed that the countries in Europe were too different for a one-size-fits-all solution in terms of monetary policy.

A British politician from the UK Independence Party called Nigel Farage had very similar ideas 13 years ago when the Euro was created. Yesterday in the European Parliament, he gave a fiery speech on the situation in Greece, the Euro and the erosion of democracy. Greece's current Prime Minister, Lucas Papademos, is not an elected politician, and some EU officials are currently trying to get Greece to delay elections scheduled for April, so that more austerity measures can be put in place without the say of those pesky voters.

Papademos is currently trying all he can to appease the EU so that the Euro can be saved, which is why Farage is referring to him as "Puppet Papademos" in the video below:

Farage is one of the very few voices in Europe and the world who are speaking plainly and honestly about the situation of the Euro. What he is saying is in essence this: it's the euro's fault that the immense European crisis came about and the Euro must be broken up if the situation is going to be resolved.

I believe that he is completely right.

The current situations in Greece, Portugal, Ireland, Spain and Italy are very similar. These countries now all have very high unemployment, plunging real estate prices and soaring debt. They all also have suffering populations and no options in terms of monetary or fiscal policy to improve their situations.

So how did the Euro create this crisis? It's quite simple:

These weak countries have a currency that is massively overvalued. That makes them uncompetitive in the global market place. The overvalued currency made it so that they could borrow much more money than before they were in the Euro, which created bubbles in real estate, stock markets and many other sectors.

A very high level of debt was discovered in Greece in 2010, which sparked the crisis. The debt-fueled bubbles burst and unemployment went up. Unemployment reduced tax revenue, which increased the debt. The austerity measures increased unemployment even more, further eroding the tax base, increasing the debt, and the vicious cycle we see today was started.

It was actually pretty easy to see that all this was going to happen if you knew anything about economic history (which is a taboo subject for Wall Street-loving politicians, how could stock market speculation possibly be bad for the economy???). Having the Euro as a currency is essentially the same thing as having your currency tied, or pegged, to another, bigger country's currency. When smaller countries have tied their currencies to the U.S. dollar, the result has often been declining international competitiveness, real estate bubbles and unemployment. Just a few examples:

Thailand, 1997: The country had fixed its currency to the dollar, which enabled it to borrow more, creating multiple bubbles, which all popped and threw Thailand into economic crisis.

Latin America crisis, early 1980:s: This crisis, involving multiple countries defaulting on their loans was caused by something that also leads to the same situation as Greece and the other weaker countries are in now: countries such as Mexico and Ecuador took loans in U.S. Dollars instead of their own currencies. This, again, created much more borrowing, asset bubbles and so on.

So, the common factor here is that smaller countries have had their currencies linked to the currency of a much bigger and more powerful country. The short analysis of this is: that doesn't work.

Every country needs its own currency so that its competitiveness and ability to borrow can be adjusted according to the country's economy. Would it make any sense for my creditworthiness to be determined by my neighbor's credit history?

So how do you solve the crisis?

The way that countries have almost always come out of these crises is to remove the peg to the bigger currency, which is the same thing as leaving the Euro. So, you have to break up the Euro and forget that the experiment was ever attempted. For a country like Greece, the resolution of the crisis in Thailand provides an excellent example of the way forward. Both countries are very dependent on tourism, and when your currency becomes cheaper, more foreign tourists will come.

When Thailand got rid of the peg to the U.S. Dollar, it experienced a big increase in tourism from foreign countries. If Greece left the Euro, it would immediately cost half as much to go on vacation to Greece for most foreign tourists. Most of the tourists in Greece are only looking for a holiday in the sun, and don't care whether they go to Greece, Italy or Spain. If, all of a sudden, a holiday in Greece costs $500, versus $1,000 in Spain, where do you think those beer drinking German and British tourists are going to go?

Another aspect of bringing back Greece's old currency, the Drachma, is that imports would become more expensive. That is obviously a problem for Greece, but it could also boost production in Greece itself. There will be things that Greeks can produce themselves instead of importing, and that will create new jobs in Greece. When Thailand got rid of the Dollar peg, manufacturing and exports increased.