Monday, March 25, 2013

The Euro Is Not Going Away: Deal With It, Folks

The eruption of crises on the eurozone periphery starting some time after the 2008 Minsky Moment led to a lot of whooping and jumping up and down by mostly US-based economists of varying ideologies who have forecast that the euro is doomed since before it was ever even adopted.  They were right!  It is no good!  It is doomed!  Among the most prominent of these are Martin Feldstein among more conservative voices and Paul Krugman among more liberal voices.  But, they are wrong about it being doomed.  It is not going away, and they need to deal with it.

Now, let us be clear.  This does not mean that the euro is wonderful.  Since 2008 we have had all kinds of examples of pain and suffering among the euro peripheral countries, the PIIGS, now to have Cyprus definitely added to their lot along with maybe Slovenia as well.  Their crises have led to enforced austerity along with very high interest rates, the latter undoing the main source of gain that most of them got during the period of 2001-07 when things were more or less hunky-dory after the full introduction of the euro.  Nations that had previously suffered from having high risk premia built into their interest rates saw those largely disappear.  Many of the nations now suffering greatly saw substantial booms driven by easy credit during that period.

Also, the criticisms by Feldstein and Krugman and others that the Eurozone does not clearly constitute an optimum currency zone based on the longstanding literature on this topic have substantial validity.  There is clearly not macroeconomic coordination.  There is no unified or central fiscal policy, including a lack of zone-wide social safety nets that automatically redistribute funds from better off to worse off areas as we have in the US.  Most importantly, despite the Schengen zone treaty, labor migration remains low due to linguistic and cultural barriers.  The whole business is not helped by the lack of a central financial regulator as well, despite moves to make the ECB such an entity.  And the outcome of all this has indeed been the pain and suffering of the deficit nations, unable to escape their recessions by devaluing.

However, for better or for worse, it is increasingly clear that the nations who use the euro are not at all likely to exit from the zone, and the leading nations and institutions of the zone are clearly set on doing what is needed to cut the deals needed to keep those who might be wanting to exit from doing so.  The latest Cyprus deal is the clearest example yet, given that this tiny nation's exit from the euro probably would entail little damage to the rest of the zone.  Cyprus is not Spain or Italy.

Nevertheless, those in charge of the euro have done it again, yet another muddle through, even if as is likely it will need further adjustment down the road, possibly quite soon.  The trick of imposing much of the short term cost on Russians suspected of being criminals or at least shady has just made it all that much easier.  Now, of course, there will almost certainly be a sharp decline in Cypriot GDP, just as in Greece and other victims.  But Cyprus will not leave, and the euro will continue.

Oh, and for all those claiming that the Cypriot euro is now a different euro, that Cyprus has in effect "already left the eurozone," sorry, not so.  Yes, sure, the capital controls mean that nobody in their right mind who is not a Cypriot will put any money into Cyrpiot banks.  But, if one has a euro coin that was minted in Cyprus (and I note that one can identify the national origin of euro coins by the images on them), there will be no problem whatsoever in using it in Germany to buy goods there at full value.  Cyprus is still on the euro, and will stay there, muddling through and all that.

Barkley Rosser


Unknown said...

Interesting thoughts. Where I think we perhaps disagree is the willingness of nations to either indefinitely accept declining economic prosperity or the ability of those nations to resume growth. For example, if Greece unemployment continues to rise and GDP continues to decline for the next 5 years, will they still remain on the Euro? If so, why? said...

I would agree that there are limits. As it is, it will have to be internal politics responding to chronic severe depression that would lead to a nation leaving the euro (and probably also the EU), and Greece has long been the leading candidate. Part of why I think the euro is so strong is that Greece has not left yet, which I thought would happen by now. As it is, even if Greece were to leave, the euro as a whole would probably survive.

The biggest threat that could blow things has been Italy all along. The recent election and the good showing by Beppe Grillo (advised on economics by my friend and occasional coauthor, Mauro Gallegati) shows that an anti-euro campaign has some appeal. Berlusconi has also made noises, so we shall see. OTOH, while noises are one thing, actually moving to pull out is quite another.

Unlearningecon said...

I think you are right that the technocrats will not let the Euro go down, but what about the people of these countries? There are protests every day, and were the population to get their hands on the levers of power somehow I expect they'd be more than happy to jump ship.

Christiaan said...

Money is more than coins and pieces of paper. Especially in today's world, money is made up more of digital bits than of metal and paper. And those bits, when "minted" in Cyprus, currently cannot be traded with the rest of the Euro area. So there is a definite cost in the exchange of Cypriotic money and money from the rest of the EU. You know what it would cost to get a few thousand Euros in bunches of EUR 100 per day and move it physically from the island, as opposed to wiring it from your office computer? That cost is effectively an exchange rate.

Dan said...

This post hits the bulls eye. I do think the first commenter raises an important question as well.

Why have BOTH the leaders of the countries and the populace done whatever it takes to stay in the Euro?

Yes, unemployment is high. However, the immediate first order problems with unemployment are not pervasive. Citizens have Healthcare, some sort of unemployment benefits to cover food and necessities, and housing (I haven't seen many stories of a surge in homelessness).

Those are all huge differences to the earlier era of unemployment episodes.

I agree with you that the Euro area leadership will do what is necessary to preserve the Euro (always the minimum and always at the last minute), I have less confidence in the populace.

What odds would you place on an Euro break up beginning in the next 12 months? 5%? or 0%?

Thank you said...

I must admit that I remain somewhat mystified that the populations have not moved more clearly to get their countries out of the euro, and as I noted in my earlier comment, this may still happen. But it has been the experience of Greece that has led me to the current conclusion. They have suffered more than any nation in the eurozone, and they have had massive and extensive riots in the streets. But somehow when it has gotten down to elections, governments that commit to staying in the euro get in.

Regarding the money, I keep seeing people saying that a Cypriot euro is worth less than one elsewhere. The sense in which this is true is for euros in bank deposits in Cyprus, particularly certain kinds of deposits in certain banks. It is not at all an issue for coins and currency, which can move and be exchanged completely freely, no ptoblem. The sense in which the Cypriot euro is worth less is that few outsiders will now want to put their euros into Cypriot banks, but in fact when they are able to get them out, they are still worth the same and will exchange at the same 1 to 1 rate. But one might as well argue within the US that dollars in certain failing banks are worth less than those elsewhere. This is true in this limited sense, but not more broadly. A dollar is a dollar is a dollar, which was not always the case prior to the Civil War, and for now, a euro is a euro is a euro, even if one might have problems accessing theirs in Cypriot banks for now.

Unknown said...

Thank you for the response. The willingness of the Greek people to remain in the Eurozone and persistent optimism that events will soon take a turn for the better has been remarkable.

As a relatively young adult and economics student, the reaction of many Europeans is especially surprising given stories of unemployment during the Great Depression. While poverty levels certainly have different meaning today, unemployment levels in Greece and Spain are well beyond those of most, if not all, countries during the Depression. What do you think might explain the seemingly passive response of people today to 25%+ unemployment?

Bob Nelson said...

Poland is still on course to... JOIN... the euro...

Mark A. Sadowski said...

"Most importantly, despite the Schengen zone treaty, labor migration remains low due to linguistic and cultural barriers."

This is actually low on my list of problems the eurozone is facing.

True the gross migration rate by EU-27 members into eurozone member states averaged only 4.40 (per 1000) during 2002-2011 in contrast to the gross state-to-state migration rate of 20.48 in the US over the same period. But there is foreign migration to compensate and, more importantly, the proper measure for migration as a labor market adjustment mechanism is *net migration*. When these two factors are taken into account, the net migration rate (the weighted average of the absolute values) over 2002-2011 are 4.06 and 4.90 for the eurozone and the US respectively. And when one re-averages the eurozone over the 63 NUTS 1 regions, to make the divisions in population more similar, the net migration rate rises to 4.35.

So by this measure population migration in the eurozone is almost the same as in the US. Moreover gross migration rates of working age adults suggest that the net migration rate of working age adults in the eurozone relative to the US may be higher still.

Of course it wasn't always this way. According to Ivo Maes (1992) the net migration rate in 1980-85 (prior to the Schengen Agreement) in the EC and the US was about 2 and 7 respectively.