Tuesday 21 April 2015
“There is no historical precedent for such an arrangement. It involves each country’s giving up power over its internal monetary policy to an entity not under its political control. Such a system has economic advantages and disadvantages, but I believe that its real Achilles heel will prove to be political; that a system under which the political and currency boundaries do not match is bound to prove unstable.”
Commentary & Analysis
Will “Grexit 7” be coming to a theater near you? Or is déjà vu all over again, really over?
“The introduction of the Euro currency notes in 2002 was in fact the most destructive economic event of the postwar era.”
As you likely know for many years I’ve said the euro would do more harm than good as the collection of countries which embody the single currency regime was, and still is, not fertile ground for a viable common currency regime. More importantly, Milton Friedman said it long before me. And so did Criton Zoakos. Both provided solid rationales for their views—it all continues to play out before us in dramatic fashion.
As we scan the news, waiting for more tidbits on the Greek exit/stay/default saga, we should remember the single currency regime has deep structural flaws. We witness masterful triage, but vital signs indicate the patient is dying a slow painful death; euthanasia doesn’t seem a consideration. Thus, financially, the Eurozone lurches from one seeming crisis to the next…drip, drip, drip…adding fuel to potential political crisis.
I think George Freidman’s missive today, titled, “The ‘Grexit’ Issue and the Problem of Free Trade,” does an excellent job of cutting to one of the core issues: Comparative advantage—the theory from David Ricardo on which the theory of free trade was built (granted it has many flaws in a modern era with instant and massive capital flows crossing borders)—is effectively non-existent in the Eurozone.
Years ago, I started using the phrase “the straight jacket of the single currency regime.” It is one reason Greece is in trouble, as it can’t rely on a falling currency to make its goods relatively competitive; but George Freidman’s analysis cuts much deeper and is a powerful reminder of why this Eurozone problem is very much political as well as economic, and dangerous [my emphasis]:
… But it [comparative advantage] has not run that way in Europe, because Germany has been forced by its economic reality to pursue exports of not only those products where it has a comparative advantage internally, but many products for which it lacks an internal advantage but has a comparative advantage externally — these are not necessarily the things it does best, but it does them better than others. Since Germany is efficient in multiple senses, it has advantages in many products and takes that advantage. Germany has a staggering export rate of more than 50 percent of gross domestic product. Comparative advantage assumes it will want to export those things that it produces most efficiently. It is instead exporting any product that it can export competitively regardless of the relative internal advantage.
Put another way, Germany is not following the law of comparative advantage. Social scientists have many laws of behavior that are said to describe what people do and then turn into moral arguments of what they should do. I am not doing that. Germany empirically is not driven by Ricardo's theories but by its own needs. In other words, the law of comparative advantage doesn't work in Europe. As a result, Germany has grown faster than other European countries, has accumulated more power than other countries and has managed to distribute wealth in a way that creates political stability.
The result is that Greece is answerable to Germany on its debts. In the same way that no moral judgment can be drawn about Germany, none can be drawn about Greece. It is what it is. However, whatever problem it has in maximizing its own exports, doing so in an environment where Germany is pursuing all export possibilities that have any advantage decreases Greece's opportunity to export, thereby creating a long-term dysfunction in Greece. The German superiority perpetuates itself.
It is important to note that Germany did not operate without protections after World War II. It protected its recovering industries from American competition. The United States, an economic colossus that exports a relatively small amount of its production, also was heavily protectionist in the late 19th century. Similarly, the United Kingdom maintained tariffs to protect the British Empire's markets. Greece has no such protection.
So, we have no comparative advantage in the Eurozone, an environment whereby German is “perpetuating itself” and Greece has no levers to protect itself, in the broader sense. [Be clear, this is the way the system is structured; it is flawed. Any country with Germany’s advantage would press such an advantage. It is what it is. It is not a moral judgement of Germany to point this out, as Friedman makes clear.]
If Greece is treated with kit-gloves, Italy or Portugal or Ireland et al. will be next in line to pressure the Eurozone for more concession and “Grexit 2” will soon be coming to a theater near you.
If Greece is thrown out of the single currency regime and survives, the euro skeptics across the rest of the zone will lobby their respective governments even harder to follow the Greek path. And with the US economy (the one pulling the wagon) seemingly losing a bit of momentum; Japan still not exactly a source of global demand, and China in the midst of restructuring which will take time, it appears tepid global aggregate demand will continue to pressure the zone—debt relative to GDP could rise quickly again creating the next Greece, i.e. a solvency issue, not a liquidity problem.
That ugly scenario could be “game, set, match” for the euro. But, the amazing thing we have learned from these crises is European politicians are indeed flexible and ingenious in the way they keep keeping hope alive in there single currency dream.
And who knows, if the Eurozone economy does continue its local growth momentum, as we are seeing in the numbers, it could be one of those “slasher” films—I can just see “Grexit 7” playing to a packed crowd sometime in 2019.
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