Recently, many, many journalists and commentators have been commenting ad naseum about the deep debt that the so-called PIGS (Portugal, Ireland, Greece, Spain) are in, and the trouble they are having servicing their debt.
The conversation frequently then turns to how various EU member states - most notably Germany - will be forced to bail out their more spendthrift fellow member states. The implied, and sometimes stated premise for this logic is that it is necessary in order to defend monetary union. I'd like, therefore, to explain how this is baseless, and shows a fundamental misunderstanding of European Monetary Union.
The central issue here is that people are missing the point that while these bonds are denominated in euro, they are not obligations of the European Union. It is still sovereign debt, and it is still backstopped by the governments themselves.
What difference does this make? It's akin to the fifty states issuing their own bonds. Sure, it would be bad if California defaulted, or caused other ill to befall their creditors, and it would have deleterious effects on the credit markets for the other states. But, critically, it would NOT constitute a default by the United States, and it would not inherently harm the Dollar as a currency.
The argument about the impact on the Euro area is far more complex, but also less worrisome. The broad point is that when nations cede control of monetary policy through the adoption of a single currency across many economies that are not perfectly integrated (and that do not have very high de facto labor mobility), the constituent economies lose access to monetary policy as a level with which to address their own economic situation.
That means that when a nation such as Greece is not as competitive, they lose the ability to protect their own industry through raising trade barriers, and they lose the ability to devalue their currency to become more competitive. The result is that wages and employment are hurt, and the economy is forced to adjust. Labor mobility would help, but unlike in the US, language and culture are big barriers in Europe.
As a result of these pressures, states engage in deficit spending, which raises the cost of borrowing. This is what got Greece and the other PIGS in trouble, along with the fact that sovereign debt is still subject to the dynamics of contagion, which can worsen the situation rapidly, and take something from being an overly rosey scenario (judged in terms of borrowing costs) to a dramatic overshooting of the market reaction to financial turmoil.
Does this mean it's necessary for Germany and other, stronger states to bail out the PIGS? Not at all. Is it advisable? Perhaps. But the important thing to remember is that it is NOT necessary to defend some perceived creditworthiness of the Eurozone. And don't think for a minute that the PIGS think they would be better off by repudiating their debts and issuing their own currencies again. That is far from being on the table.
2 comments:
Yeah, you're right about the problems of the Eurozone as an optimal currency area (Mundell's big contribution before he went off the deep end, ending up as Krugman's definition of a "crank" economist).
However, there are different reasons for the countries that are in the PIGS club (actually PIIGS if you include Italy). Greece spent too much, Ireland guaranteed it's banks' liabilities during the panic of Sept. 2008 (and had a big popped housing bubble), Portugal, well, I don't know. Spain had a big housing bubble and has a relatively uncompetitive economy (but is used to 20% unemploymnent from years of experieence), Italy is relatively uncompetitive and has many more uncompetitive small firms than most countries. The different countries have different options; for example Spain began with far lower debt than Greece and has a larger economy that can support more debt than Ireland.
I questioned the Euro wen I was at Trinity back in 2001 and I was bored to tears by my economics class on EU economics, but I think it will probably hold together...they probably have enough in the tank (of the EFSF) to get through Spain and Portugal if necessary. However, they haven't understood what you pointed out--that sovereign debt can be defaulted on without Euro collapse (maybe). If every Euro debt were a "Euro debt" it might be a different story, but they are not and if people think of it that way, it will put the credit ratings agencies out of some work (and I've heard they are hurting for work with the structured finance/securitization markets in the state they are).
GLD
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