The Euro Project; a vulnerable union

Anonymous1987

An interesting perspective on the frailty of the Eurozone and what Europe might do to strengthen it here.

When entering a monetary union, member‐countries change the nature of their sovereign debt in a fundamental way, i.e. they cease to have control over the currency in which their debt is issued. As a result, financial markets can force these countries’ sovereigns into default. In this sense member countries of a monetary union are downgraded to the status of emerging economies. This makes the monetary union fragile and vulnerable to changing market sentiments. It also makes it possible that self‐fulfilling multiple equilibria arise. I analyze the implications of this fragility for the governance of the Eurozone. I conclude that the new governance structure (ESM) does not sufficiently recognize this fragility. Some of the features of the new financial assistance are likely to increase this fragility. In addition, it is also likely to rip member-countries of their ability to use the automatic stabilizers during a recession. This is surely a step backward in the long history of social progress in Europe. I suggest a different approach to deal with these problems.

I am in broad agreement with the diagnosis and the prescription. Note the abstract above does not offer the solutions but for an overview go to the conclusions section.

jimmycrackcorm

All unions are frail by their very definition otherwise they would be one....

Hasschu

Europe is about being close to your friends and holding your enemies even more closely. Europe will never be a USA, a good question would be how long will the States be United. Europe can however construct a single currency regime which will have a good prospect of surviving for a hundred years or so. The world needs a reserve currency to replace the increasingly unstable US$ and Europe needs internally seamless borders across which goods, services and currency flow unimpeded. Federations such as USA, Germany, Canada have to be examined in an attempt to find a reasonably successful model. The rigidity that results from a single currency can be ameliorated by "equalization payments" which is a key component of the Canadian model. Our present problems can be attributed in large part to incompetent gov'ts and lazy, corrupt or nonexistent bank regulation. It is a given that business will choke on it own greed with regularity when given free rein. The ECB has to be strengthened by a European wide regulatory agency with the power to audit the Central banks and all banks in all EU member states. Absolutely necessary is the ability to impose sanctions on offending states and institutions.

I am in Berlin today and it would be fair to say that the future of Europe cannot be left in the hands of any given electorate whether they be German or Irish.

later12

I agree with much of the paper, but I wish the author wouldn't begin by constructing an argument comparing Spain and the UK in terms of government debt ratios and currency controls.
He is apparently ignoring that the UK is one of the world's traditional fixed income havens. How can Spain, or many of the other Europeans with the obvious exception of Germany ever live up to that?

I also disagree with him when he says, on the Irish interest rate:

...by charging a risk premium [...] the EFSF signals to the market that there is a significant risk

While I agree that a high rate of interest such as the 5.8% average only adds to our already enthusiastic debt accumulation, I don't think the above is a widely held nor reasonable view. If it does feature at all on the markets' radar, it is way down the list. In fact the premium may - arguably - encourage other Eurozone grey spots to reconsider resort to the EFSF.

Otherwise I do agree with most of his analysis. He has a very credible take on European sovereign bonds ('blue' bonds and 'red' bonds) that definitely merits some attention, as they appear to address concern surrounding moral hazard and the attractiveness that Eurobonds can pose to countries like Germany or Finland.

I like how he credits Martin Wolf, for his assistance with the paper, at the start of it though. It does quite have I told ye so, Europe written all over it!