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Tuesday 19.06.2018 | Name days: Nils, Viktors

Bloomberg: The eurozone must be split to save EU

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On the eve of the American Civil War, Abraham Lincoln famously said that «a house divided cannot stand.» Today, the European Union — committed for decades to the quest for ever closer union — must confront an agonizing truth. Lincoln’s maxim must be inverted. For the EU to survive, the euro must divide, according to Bloomberg.

Author: PantherMedia/SCANPIXThe economic crisis in southern Europe shows that the euro system, at least in its current form, has instead become a mortal threat to both.

Greece, Spain, Portugal, Italy and Cyprus are trapped in a recession and cannot restore their competitiveness by devaluing their currencies. The euro area’s northern economies have had to join in repeated bailouts and put aside their notions of prudent finance. A vicious circle of resentment and populism in the south and strengthening nationalism in the north is tearing the union apart.

And the crisis isn’t yet abating. France, Europe’s second-largest economy, is now sinking into a grave economic slump. Like the southern countries, it must restore its competitiveness; like them, as part of the euro system, it lacks the means. Because of its size and because of the guiding role it has played in the EU’s development, France will be crucial in breaking the vicious circle.

The single currency entrenched — indeed, worsened — the competitiveness gap caused by differences in inflation rates and unit labor costs.

With devaluation ruled out, these imbalances can be addressed in only two ways — through cross-border transfers or “internal devaluation.”

Internal devaluation means that deficit countries try to restore competitiveness by reducing government expenditure and increasing taxes, which they hope will lower prices and wages. The short-term effect will be to weaken domestic demand.

Latvia and Iceland show how steep the economic and social costs of internal devaluation can be, compared with the costs of external devaluation. From 2008 to 2010, GDP contracted only half as much in Iceland (external devaluation) as in Latvia (internal devaluation).

The main alternative is transfers. Deficit countries can cushion their contraction with transfers from surplus countries, rather than internal devaluation. The problem is that such transfers will no longer be painless.

Before 2008, they took the form of cross-border private lending to governments and banks, which in many cases lent the money on to borrowers offering real estate as collateral. Since the credit bubble burst in 2008, these private financial flows have been replaced by state budget transfers, ballooning budget deficits and growth in the implicit liabilities of peripheral countries in the European Central Bank’s settlement system (known as Target2). The fiscal position of many uncompetitive euro-area economies has become unsustainable without transfers from Germany and the others.

Such transfers will be of taxpayers’ money — provided either directly through the European Stability Mechanism or indirectly via banks in the creditor countries.

This prospect is political dynamite. Such transfers are therefore made conditional on strict budgetary discipline and structural reform. Despite that tough conditionality, taxpayers/voters in creditor countries such as Germany might never be reconciled to the idea, creating the risk of an anti-EU backlash. Such a backlash would become certain in the all-too-likely event that the rules were bent or shelved.

Many debtor governments would prefer their transfers in the form of money printed by the ECB — with fewer, if any, strings attached.

So the outlook for the euro-area debtor nations is one of relentless fiscal tightening and years of deficient demand. This will result in shrinking or, at best, stagnating output and living standards. Meanwhile, anti-EU and specifically anti-German sentiment is building — witness the scenes on the streets of Nicosia after Cyprus fell into crisis.

Could a United States of Europe save the day? Some early proponents of the euro acknowledged in the late 1990s that the project involved “economics getting ahead of politics.” They saw the single currency as a way to put the continent on an irreversible course to full political union — a goal that Europe’s electorates would have rejected had it been put to them directly.

Greater labor mobility might be one feature of such a union. One could imagine the populations of depressed countries such as Greece, Portugal, Spain and Italy migrating to rich Germany and Finland. In this scenario, whole countries could end up resembling depopulated rural regions — such as those in France, which the young and well-educated largely abandoned in the postwar years, moving to the cities and leaving behind an aging population heavily reliant on social insurance. Language and cultural barriers make this form of economic adjustment unlikely, however.

Bloomberg says that something has to give — and it will have to be the euro system itself. To preserve the EU, the monetary union must be dismantled. The all-too-relevant historical parallel is the defense of the gold standard in the interwar period, which came close to destroying democracy all across the world. Only one country can plausibly take the lead in advocating a controlled segmentation of the euro system by means of a jointly agreed exit of the most competitive countries. That country is France.

A splitting of the euro system would be in the best interests of both France and Europe because it would speed the EU’s return to economic growth — the only sure guarantee of European stability and unity.


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  1. Rod says:

    What a wise man Lincoln was! this article is so right…divided is Europe and country by country the EU will fall.

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