Euro recap

June 16, 2012

With Greek elections around the corner, I thought I’d provide a perspective in Europe that steps back a little from the mass of information now coming our way.  No question it’s a mess, but behind it are some ambitious ideas, some good, some less so.  My take:

1. Replace war with peace.  The grand idea behind the European Community and its precursors was to tie countries together economically that had been at war for a good part of the first half of the last century.  It’s hard to see this as anything but a great success.  We got peace, prosperity — and even better food and wine in Britain (who knew it was possible?).   Great idea, well executed.  Even the addition of central European countries after the fall of the Soviet Union was, I think, mostly a success.

2. Nations still rule.  Despite this, and the growing EU governmental structure, power still lies with the member states.  It’s Angela Merkel and her colleagues in other countries that matter here, not the EU infrastructure.  One consequence is a haphazard collection of European and (mostly) national authority.

3. Exchange rates are tricky.  The common currency has enormous symbolic value, but it was always a risk.  What stands out, now and at inception, is the odd combination of European monetary policy (the common currency and European Central Bank) and national politics, legal systems, bank regulation, deposit insurance, tax collection, etc.  This was always a somewhat awkward combination, more so in a time of economic stress.

One of the things we’ve learned the hard way is that when you try to control exchange rates, they can  blow up on you.  I recall an exchange at NYU Stern in the 1990s between Domingo Cavallo, former minister of finance in Argentina, and Jaime Serra Puche, former finance minister of Mexico.  Jaime had the misfortune to be in office when the Mexican peso blew up, leading him to look for another line of work.  Domingo suggested he should have implemented a fixed exchange rate, as he had done in Argentina.  Jaime replied that things that are fixed tend to become unfixed, and that’s indeed what happened in Argentina several years later.  None of this is new:  the people who set up the Euro Zone knew well the risks they were taking, but no one bothered to come up with an exit plan.

4. Bank runs.  The combination of national deposit insurance, the ability to move money easily between countries, and a fixed exchange rate is a recipe for bank runs, which is the symptom de jour.  Would you keep your money in Greece or Spain, when you could move it elsewhere in the EU?  It’s easy to see why money is moving quickly out of troubled countries into others.  The only puzzle, really, is why it took so long.  If there had been an EU-wide insurance system, we’d likely see a lot less of this.

5. Where from here?  This has always been about how much to centralize and how much to leave to member states.  We’ll likely see a modest move toward greater centralization in some areas, but anything more than that is the work of decades, not months or even years.  We’ll likely see piecemeal attempts to hold things together.  How well they’ll work is hard to say.  I wish them luck.  It’s been an ambitious experiment, even when they didn’t get everything right.

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