All eyes are on the euro. I surveyed two professional groups
of economists on LinkedIn. My question was whether they think that the euro would
collapse. The majority of responders (60)
said no, and a handful (5) said yes.
In Robert Mundell’s theory of the Optimum Currency Area, a
single currency among trading regions maximizes efficiency. But for regions to form an OCA, they ought to
have open capital and goods accounts, asymmetric shocks must be small in size, and
labor must move freely across boarders. Almost
all economists agree that the euro is not an Optimum Currency Area. The euro is a political project.
Nevertheless, many European countries, the so called
periphery countries such as Greece,
Ireland, Spain,
and Portugal,
benefited economically from joining the euro.
They were considered risky countries by investors before joining the euro.
Investors demanded higher returns on their investments, and therefore high real
interest rates. Those risky countries became
equally safe as Germany
after joining the club. They borrowed money comfortably and spent a lot more
than their incomes. However, somebody benefited
from the debt and the expenditure frenzy.
Not that anyone complained when things were hunky-dory.
Figure 1 shows the real 10-year bond yield differential
between Germany
and some of the troubled European countries. Note how the differences were
large before the risky countries joined the euro, died out when they joined the
euro, and how they have begun to increase recently. The 10-year bond yield is a complex variable. It reflects expected inflation and risk among
other things.
 |
Figure 1 (Source ECB) |
Figure 2 shows the indebtedness of the periphery nations,
and the IMF forecasts up to 2016.
 |
| Figure 2 (Source IMF) |
The euro was created by politicians and it will survive and
die by them. Thus, in the end the people in any member country (including Germany)
will decide whether they want to stay in the euro or not. However, the factors that influence voters are
the key. Elections are almost surely
affected by economic conditions.
Incumbent politicians stay in power if the economy is healthy and people
have jobs and they depart if the opposite is true. Clearly, Europeans in general are not happy
with the economic conditions. The French
already replaced their government with a socialist one, which has major
differences with Germany.
The Greeks will, and the rest will too.
Some French and Greek voters went to the extreme left and
right. It is reported that the French legislative body’s majority is socialist,
but the extreme right occupies 35 percent. The Greeks will be, highly probably, voting for an anti euro government on Sunday 17 June, 2012. These trends might grow in Europe; and
when they do, which is very likely because they are associated with
calamitous economic conditions, new governments not fond of the euro will be
elected and things will change. Because the exchange rate is persistent and the European labor markets
are inflexible, the adjustments will be long and painful.
