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Punch “end of the American era” into your search engine and watch the hits mount up. Recession or no recession, there is never any drop in the demand for promises of American decline–or any curtailment of the supply.
Eager anticipation of America’s financial doom, however, dangerously distracts us from a more imminent and ominous threat to the global economy: the risk of a breakdown in the euro.
Europe now does business in a single currency from Lisbon to Berlin. The trouble is that economic conditions vary enormously between Lisbon and Berlin–and the single currency tightly narrows the policy options available to local governments.
As originally designed, the euro would have forced important reforms on the member states. But in many countries, those reforms have been shirked.
Take Greece for example: All this week, Athens has been wracked by the worst mob violence since the advent of Greek democracy in 1974. Riots are the work of idle young men, and Greece has plenty of them: Youth unemployment is 19 percent and rising fast.
The Greek state cannot do much to help them. Greece already runs a huge budget deficit–in fact, Greece’s public debt is the highest in Europe, 91 percent of GDP. At that level, bond buyers begin to whisper aloud about the risks of default–and charge commensurate interest rates.
Before joining the euro, Greece had an additional policy lever: monetary policy. Greece could cut interest rates and allow its currency to decline. As the drachma fell, so too would the real wages of Greek workers. Greeks would bid for more work by working for less.
Under the euro, though, this option is foreclosed. Greece no longer has its own central bank. The euro is governed by a European Central Bank, which has to balance the interests of the whole continent. The ECB has to weigh Greece’s desire for cheaper currency (and its willingness to risk more inflation) against, say, Germany’s need for lower inflation (and thus a stronger currency).
No prizes for guessing who wins that contest.
As recently as five months ago, the ECB was still actually raising interest rates. Since the spring, the Bank of England has cut its most important interest rate by 325 basis points; the ECB, by just 150. The Federal Reserve and the Bank of England are lending now at rates just north of zero; the ECB is lending at more than 2 percent–and is signalling that no further cuts should be expected soon.
From the institutional point of view of the ECB, all of this makes perfect sense. But imagine now that you are the prime minister of Greece–or Spain or Italy. You are contemplating double-digit unemployment, crashing national income and overwhelming debt. Might not the ECB’s flinty commitment to the integrity of the currency begin to look a little hazardous to your political health?
Quitting the euro might seem radical and traumatic, at least at first. But it might occur to you that threatening to quit the euro could pressure the Germans and French into paying you more economic aid. And once Greece secures more aid, Spain, Italy and the others will queue up too. Could the day come when the hard pressed German taxpayer finally says no? And when that happens, do the incentives abruptly shift for the leaders of the Eurozone’s laggard countries?
The euro has been a great invention, and it does real service for Europe’s big economies. As originally designed, the euro would have forced important reforms on the member states. But in many countries, not just Greece, those reforms have been shirked. Greece failed to reduce its budget deficit, failed to reform its dysfunctional social security system–all without penalty. Spain too.
If enough small countries continue to cheat, the big countries will pay the bill, not only in the form of economic aid, but also imported inflation. That too may shift some incentives.
In these hard times, there may be fewer North Americans planning European vacations. But if you are, you might want to rummage through the back of your bureau to find any overlooked drachmas and pesetas, Italian lire and French francs. They may prove surprisingly handy, surprisingly soon.
David Frum is a resident fellow at AEI.
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