Austrian National Bank, Vienna, completed in 1925 by Ferdinand Glaser and Rudolf Eisler

The Euro was a grand experiment in real time much observed by economists. If you create a single currency you take away the two most important tools of governments to steer the economy, namely the exchange rate and the interest rate. In the first years the single currency system was working well, but that was no real test because there were no economic shocks. The first big shock was 2008 and all the fears of economists came true. Europe was not able to respond adequately.

Before the euro was created the question had to be posed: What are the conditions for a single currency? And unfortunately Europe did not satisfy any of those criteria. First, if there is a shock where regions are differently affected, is there true free labour mobility? In the US people move if there is not enough work in one region or state; there is no real identification with those places. That is totally different in Europe. Greece does not want an “empty” country with all the young moving to other parts of Europe. Second, there should not be too many economic differences for a single currency to work, but the idea was that the European countries would move more closely together with the euro and unfortunately that was a wrong assumption. The Maastricht criteria of 60% stock of debt and 3% flow of deficit should have moved the economies closer together, but there is no economic theory on these figures; they are completely arbitrary. On the contrary, there is evidence that even above 90% debt-GDP ratio there is no negative effect on growth. In the post-World War II years the US had 130% debt-GDP ratio and GB 250% and the Eisenhower administration reacted with an investment programme instead of an austerity programme, e.g. the GI bill which offered free higher education for everyone who needed it or the Highway bill with extensive investment in infrastructure or the R&D bill with government investment in scientific research. With these measures the debt GDP ratio went down to around 50% in a few years due to these governmental investments in human capital, infrastructure and science. Due to high economic growth rates these two countries got rid of their debt without any crisis.

The creation of the euro took away the exchange rate and the interest rate mechanism and Europe tied its hands further with the Maastricht criteria. So there were no tools left to react to a shock. There is no individual fiscal policy mechanism left for the national governments to steer against the crisis. The fixation of Germany on low inflation due to the experience of the interwar years is just one part of the picture. The real problem for Germany in the interwar years was unemployment which then gave rise to the Nazi regime. The inflationary shock happened already in 1925 and was more or less remedied. If a group of economies gets more integrated the externalities become more important, which means how do actions of one country affect the others; what are the real costs on the others, e.g. pollution, tax competition, subsidies that give rise to unfair competition. This undermines the functioning of these integrated economies. Before the crisis of 2008 the southern economies were growing fast on the basis of lower standards of living. Export surplus and export deficit were balanced worldwide and of course also Europe-wide. With its export surplus Germany forced other countries to take on debt to be able to purchase German goods. Their debt augmented and weakened their economies. If such a process continues year after year, you end up in a crisis. In addition the German export surplus increased the value of the euro, which made it more difficult for the other countries to export to world markets. A correction of the German policy would have taken away the pressure from countries like Italy or Spain. The German policy had direct consequences for the economies of the other euro countries. Export surpluses were never only achieved due to market mechanisms; they were driven by policies of the countries. Germany could have for instance changed its labour market policy, allowed wage increases, invested more in its infrastructure or research and it could have stopped its one-sided savings policy to help the other countries recover.

A common European economic policy would be necessary. Europe needs a common industrial policy that supports weaker countries. With the help of the European Investment Bank investment in Europe could be boosted. That would also be in the interest of Germany because in the long run the weakness of the Eurozone also weakens Germany. Governments do need tax resources for investment to boost growth, above all research investment. The internet was the result of US governmental research. Without it there wouldn’t be Apple or Google. The founding fathers of the euro expected that capital would flow from the rich countries to the poorer ones and by that economic differences would be eliminated. But in liberal market economies capital always flows to rich economies, to banks with powerful and wealthy governments in the background. Rich economies offer better infrastructure, better education and more modern technologies. On top of that the founding fathers of the euro burdened the governments in the single currency with austerity which exacerbated the differences. The idea of 3%+60% was fashionable at the time of the conception of the euro, but already in 1990 the theory was disproven by the East Asian crisis. Spain and Ireland had high growth rates and a budget surplus before 2008 and yet they experienced the crisis. The following unemployment and low GDP growth rates caused the sovereign debt crisis there and above all, the bail out of the banks. The ECB even forced Ireland to bail out its banks.

Greece was the only country where it was not clear what the deficit really was. The Greek banking oligarchs had effectively hidden, with the help of Goldman Sachs and other financial institutions, the true dimension of the deficit. In 2008 the Greek debt-GDP ratio was 110%, which the new government of Papandreou disclosed. The government also exposed the deception of former governments and admitted that Greece had cooked the books in previous decades. The new government developed a great reform programme and tried to break the vicious influence of the Greek banking oligarchs on politics. But the Troika never did away with the influence of the oligarchs on the banking system in Greece and rejected the reform programme. There had never ever before been austerity like the one that was demanded and imposed on Greece in 2010. The Troika’s demands meant suicide for Greece: in 4 years’ time they were asked to go from a 15% primary deficit (without interest payments) to a 6% primary surplus = a difference of 21%, which was impossible. What happened after this prescription was a decline of GDP of 25% in real terms, worse than that during the time of the Great Depression. This meant that your mortgage payments in euro remained the same, but your salary was slashed by 25% from one day to the next. The Greek debt-GDP ratio was much higher after the “reform” programme than in 2008. If Europe had helped Greece then to restart its economy and had invested in a growth programme in Greece no one would later have had to help Greece by lending money.

The ECB’s mandate is only to keep inflation low at around 2%. The idea is if you keep inflation low and the deficit, low the market will take care of the rest, which is simply wrong economically speaking. Markets often don’t work efficiently, e.g. due to imperfect competition or wages and prices don’t move quickly enough because there is not enough flexibility for markets to work efficiently. There are lots of conditions that have to be satisfied for markets of work properly. If they fail to work properly this is called a market failure. In contrast to the ECB the US FED’s mandate includes inflation, employment and growth and the FED focuses on current problems and uses the tools necessary to combat a crisis. The FED lowered the interest rate in 2008 / 09 when the ECB actually raised the interest rate in a double dip recession. This lowered the value of the dollar as compared to the euro which helped the US economy to grow, whereas the European economy slowed down. In effect the ECB’s policy had helped the US economy to recover. A mild inflation of 4 % or even more that is anticipated is not negative; on the contrary it is beneficial to the economy. The real worry of Europe since 2015 is deflation. But the ECB can’t do anything anymore; they can’t stimulate any more. European governments would have to end austerity. Europe is focused too much on “moral hazard” and these are false incentives. No country would otherwise submit to the burdens of austerity just to receive some funds from another country. If the European governments resorted to a proper financial policy to boost growth and help the economies of Europe to recover, the burden would not be just the on the ECB’s monetary policy. As long as governments like the German one refuse to invest and stimulate the economy, the ECB is helpless to solve the crisis. It’s the governments’ fault because they don’t make an effort to boost growth. They force a monetary policy on the ECB which they then criticize. That’s why they have to end the current financial policy of surplus, saving and no investments.

The problem lies in the current institutional arrangement, which fosters economic divergence and not convergence within Europe. The countries are drifting apart economically. The contrary of the intention of the euro when it was created has occurred: economies are drifting far apart. They tied the governments’ fiscal hands and now they cannot react. That’s why you need common institutions if you want the euro to work, such as Eurobonds, a Europe-wide common bailout of banks, but that is politically unrealistic. The current situation is not economically sustainable. If you want the euro to work you need common institutions and the attempts at implementing them are much too hesitant and too slow. A banking union is the corner stone and indispensable for the stability of the single currency. The now proposed common deposit protection scheme is not enough. Without a banking union capital will flow from the weak countries to Germany and destroy the banking systems in Italy, Spain and other countries. This damage cannot be repaired. Without a true banking union capital will leave Italy, Spain, Portugal and Greece. As a consequence small and medium size enterprises will not be able to take out loans; private demand will decrease together with public demand, so that private austerity will accompany public austerity. There is a very high price to be paid for the current “muddling through” or brinkmanship (practice of trying to achieve an advantageous outcome by pushing dangerous events to the brink of active conflict). The danger is that you can easily go over the brink! Calculations of The Economist’s think-tank are predicting the chance of a survival of the euro until 2020 is less than 40%.

The alternative is less Europe and an amicable divorce. What kind of restructuring would be easiest for Europe to handle? It will probably be the only way because governments don’t seem to have the willingness and power to correct the wrong and harmful policies. So what remains is a separation of the euro zone. Germany together with the northern countries could leave the euro zone. That would tackle the problem at its core and would be economically beneficial for the euro zone. The national currency of Germany and the Netherlands etc. would immediately appreciate substantially which would dramatically reduce the export surplus of Germany. The southern European currency zone, namely the euro, would immediately depreciate, which would boost its exports and these countries would be able to pay back their euro debt more easily. So there would have to be a debt restructuring for southern Europe. Overnight these countries would gain again competitiveness and would return to normality. Theoretically that would be the best solution for Europe as a whole, but Germany will never agree to it.

Inequality is rising fast in Europe and the US. Large parts of the population haven’t done well. They are disillusioned. Globalisation and deregulation should have brought prosperity, but that was only true for very few! The median income of a full-time male worker in the US is now the same as 40 years ago! Male life expectancy in the US is going down due to social reasons and that’s why the people in the US are angry. In Europe the euro was another promise that was not fulfilled. It did not bring prosperity for the majority of Europeans, on the contrary. So there is a lot of discontent in Europe, too. This has contributed to an erosion of democracy and the rise of populism. This should be a wake-up call to address the current problems and start the necessary reforms. Otherwise we won’t be able to control the fire.

The cost of capital was brought down close to zero with the ECB’s and FED’s interest rates close to zero, which encouraged firms to replace labour with machines. This exacerbated the already high unemployment rate of unskilled workers both in Europe and the US. In car manufacturing manpower is greatly replaced by robots and cashiers are replaced by costly check-out machines, although they are cheap labour. Why? Because the cost of capital was so much reduced due to austerity. Employment is the key problem of today. That’s why we need to raise funds from automation via taxation for public spending on education and research and development, especially when labour costs are so high. We should not subsidise capital with zero or close to zero interest rates.


Literature: Stiglitz, Joseph, The Euro and Its Threat to the Future of Europe, 2016