Greece’s Woes: So Goes the Euro

21 July 2011
Article

The Greek crisis has exposed the fundamental flaws in the Euro project: it stripped countries control over the price of money and allowed political elites to undermine Europe's post-war social contract.

I have no quarrel with finding the private financial system and its public enforcers culpable in subjecting Greece to the now standard neoliberal straight jacket of fiscal austerity. Nor do I quarrel with the fact that the wealthy in Greece avoid taxes without shame or threat of discovery. Joining them in avoiding their share of the burden of austerity are, of course, Greece’s bondholders, mostly European banks. What is missing, however, from the discussion in many quarters is the role played by the euro in Greece’s problems.

I am not a late arrival at this conclusion. In 1996 I wrote in an article, “Maastricht: A Bridge Too Far” (SSRN), that “political leaders and opinion elites have found another use for Maastricht [i.e. the euro]: A device to force EU countries to undertake structural economic adjustment.” (The euro was formally commissioned at a 1991 meeting in this quiet, southern Netherlands town, by the river Maas, bordering on Belgium and Germany.)

It was always very problematic to try to unite within a single currency countries of disparate economic condition. Informed views were divided about whether a euro project that tried this was subject to instability and potential catastrophic failure. There was a debate about whether it was best to wait until countries, wanting to become part of the euro, achieved more parity in their fundamental economic status. The counter was that imposing the euro would produce this convergence more rapidly. This was uncharted economic terrain, and it was known that the countries that potentially could not absorb the harsh medicine were in the periphery, mostly Mediterranean countries.

Surrendering sovereignty over [interest rates and exchange rates] means a country gives up control over the price of its money

The reason why it is difficult to unite vastly disparate economies is that becoming part of the euro means giving up two major tools of economic adjustment: interest rates and exchange rates. The one – interest rates – reflects the internal price of money; foreign exchange rates are money’s external price. So surrendering sovereignty over both means a country gives up control over the price of its money. Interest rates are essentially established by the European Central Bank (ECB) and exchange rates by the market for euros vis-avis other currencies.

With domination of the ECB assumed and assured to be in the hands of Germany and France, peripheral countries such as Greece are doomed to have interest and exchange rates set by those powerful economies, suited to their conditions, but not to Greece’s.

The financial systems of Greece and other peripheral countries did not show symptoms of this problem, because financial transfers from the core to the periphery were robust enough to postpone their onset. When those transfers were no longer large enough to camouflage the underlying structural tension, financial markets reacted. Remember Greece was initially turned down in its quest to become part of the euro when it was launched in 1999 and wasn’t admitted until two years later precisely because it diverged too far from any convergent criteria. Even when it entered in 2001 there were serious reservations expressed about its qualifications.

The euro project was the European elite’s wedge into the dismantling of the social market, that unwritten contract between national governments and their citizens.

More importantly, in my view, the euro project was the European elite’s wedge into the dismantling of the social market, that unwritten contract between national governments and their citizens. With the end of the cold war no longer constraining European governments from having to fulfill their social contract, finding a supranational solution to weakening this contract was attractive when national politics made it difficult.

Onto the political stage came the euro, shrouded in attractive language about the European project, competing more effectively against larger economic formations in the United States and elsewhere, lowering transaction costs, and selling it on the basis of making it so much more convenient for people to move among countries of the euro – this last objective it certainly has accomplished.

It became simply easier for a politician to say that a euro member country’s social contract was too generous under the terms of the euro and ECB policy than it was for a national politician to make that same case on other grounds and hope to be elected. But if he or she could reference the euro as a reason for weakening the social contract, it could be sold by alliance with this grander vision of a united Europe, allying oneself with the halo effect of the euro project.

You don’t have to be a Euroist to be a European. The two have been improperly conflated in my view. One can be a staunch Europeanist and also be resistant to the claims for political-economic primacy of the euro. I would indeed argue that the Europe of the “thirty glorious years,” in which the social market was constructed and reached its apogee, is my Europe and not that of the neoliberal-led euro. Even today we have the example of Sweden, outside the euro, doing very well, and retaining its social contract.

You don’t have to be a Euroist to be a European.

Back to Greece: It would be better outside the euro, although the transition is not easy. Greece’s leaving the euro will not make life easier in the immediate circumstances, but it could allow Greece to renegotiate its debt, now very difficult because of the pressures coming from the ECB and the euro. Like other countries that have defaulted on its sovereign debt, Greece could then make the banks absorb some of the responsibility by replacing old bonds with new ones creating some loss to the banks, which is far more difficult while it is still in the euro.

Coming out of the crisis without the euro’s burdens, Greece could once again establish an interest rate and foreign exchange rate appropriate for its economy and not have to use rates appropriate for Germany and France.

Here is a scenario for Greece to exit gracefully from the euro – and perhaps also other countries in the periphery – that starts with a euro wide statement that Greece is temporarily exiting from the euro in order to stabilize its economy. Once this has occurred Greece can re-apply for membership in the euro.

Though not elegant, this could be a functional way to remove a major obstacle from Greece restoring itself to some form of economic normalcy. Absent this I feel it will stumble from crisis to crisis, austerity to austerity, finally hitting that wall of political instability which will make any restoration even more difficult.

The euro is on life support in the periphery; the core can sustain it, and that is where the euro will eventually reside. Will this process be orderly, minimizing pain through a managed austerity, or will it be chaotic, with harsher un-managed austerity leading to potential political instability? Is it time to compose the euro’s eulogy so those European countries in the periphery can get on with the project of reconstructing a 21st century social contract?