This morning via Adam I read a great article by the nobel laureate Paul Krugman who happened to win the nobel prize for his work on international finance.
I’m going to walk through this article and try and break down some of the points because I think it is worthwhile to understand the workings of a currency and a federal-style system.
No, the real story behind the euromess lies not in the profligacy of politicians but in the arrogance of elites — specifically, the policy elites who pushed Europe into adopting a single currency well before the continent was ready for such an experiment.
The narrative that I have been reading primarily follows the line of fiscal irresponsibility on the part of Greece and Spain or the recession for Ireland. Some have also tried to blame speculators for the troubles plaguing the Greek government. The opinion that the article goes on to argue is that monetary inflexibility across borders amplifies these small issues when adjustments cannot be made at the national level.
The result was rapid growth combined with significant inflation: between 2000 and 2008, the prices of goods and services produced in Spain rose by 35 percent, compared with a rise of only 10 percent in Germany.
And there’s not much that Spain’s government can do to make things better. The nation’s core economic problem is that costs and prices have gotten out of line with those in the rest of Europe.
Sustained inflation can prove quite damaging for an economy. Think – if the cost of your goods increase by 25% more than your neighbor of an 8 year period, then your value menu goes from $1 to $1.35. As prices increases, wages also have to increase so those fast food workers can afford to pay an extra $0.35 for part of a meal. Spain’s goods just don’t stay within the country’s borders though. Now, all of the goods Spain exports are relatively more expensive than other parts of Europe, making them less competitive.
Central bakers have well-tested tools for combating inflation. Control of the money supply and the ability to devalue the currency could have assisted Spain. Had they retained their own currency this would have been possible. Of course, had they retained their monetary system, they wouldn’t have experienced the advantages of participating in the Euro. So, I’m not arguing and neither is this article that Spain should abandon the Euro to reinstate some form of monetary sovereignty, but for the Euro to be sustainable through financial and economic crisis, the EU will need tools to deal with problems like this.
It’s an ugly picture. But it’s important to understand the nature of Europe’s fatal flaw. Yes, some governments were irresponsible; but the fundamental problem was hubris, the arrogant belief that Europe could make a single currency work despite strong reasons to believe that it wasn’t ready.
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