The Euro Has Its Inherent Risks

The whole drama surrounding Greece and its high chances of default today is quite exciting and necessary. Just at the time, when economists were martyring the US dollar, it has put the euro back into the spotlight. In my earlier post in August on the global currency debate, I had mentioned that it was too early to write off the dollar against the euro, which hasn’t been tested till date. Thus, I say exciting. And necessary because it leads us to understanding the Euro and the innate risks it was born with.

I feel that there is very little we can do to prevent another Greece from happening in the next decade. The euro is the official currency of 16 nations out of the 27 member nations of the EU. Thus the money supply and banking sector is regulated under the common European Central Bank headquartered in Frankfurt, Germany. The euro currency arrangement is somewhat fundamentally similar to the US Federal bank model, where a number of prosperous states, each having the economic capacity to exist as a nation are governed under single monetary regime.

But when we talk of the euro, economists have failed to take into the account the impact of foreign and domestic policies of the sovereign member states. 

The EU as a body has on very few occasions had collective consensus on important foreign affairs and trade related matters. Then how can we expect them to agree on issues as basic as financial regulation, asset bubbles and labour laws.

Simply put, a euro member nation is still functioning as a sovereign state fighting for the same resources and markets as its co-member nations. These guiltless vested interests appear in the form of different growth patterns and asset bubbles in different sectors for different countries. For instance, in Spain and Ireland we saw the housing bubble, which was justifiable before the crisis, as it created jobs and pushed up their economies. But post crisis has put strains on the Eurozone.

The main objective of the ECB under the treaty is to maintain price stability. It keeps with itself target of 2-4% inflation in the Eurozone. But here again comes the problem. Not everybody can be given the same medicine. For instance, Italy, Greece, Spain and others immediately after the crisis had to contend with high unemployment rates upto 10% and sizable drop in exports. If not of the euro, they would have revalued their respective currencies to support export and labour incomes. But instead, they had to grind through a period of deflation and even higher unemployment. On the other hand, France and Germany were first to come out of the recession.

The buck stops here

Hence, I come again to my main point that economists and policy makers have underestimated the impact of political and historical differences within the Euro currency arrangement members.

Firstly they have to stop passing the bill for a Greek bailout. The more indecisive they are, the more Greece suffers. Secondly, there has to be better coordination and transparency among the members. Let us see how the story progresses.