Professor of Economics Lord Mervyn King (London School of Economics) argues that the basic problem of the European Monetary Union (EMU) is its single interest rate. In an article of The Telegraph he shows that this monetary union among differing nations leads inexorably to divergences in competitiveness.
The current situation in Greece is worse than the situation in the US during the Great Depression: the ratio of government debt to GDP has continued to rise in Greece, and is now almost 200%. This debt is denominated in a currency that will probably rise in value relative to Greek incomes. It is mostly owed to public-sector institutions such as the ECB, IMF, or other member countries of the Eurozone.
Lord Mervyn King writes:
It is evident, as it has been for a very long while, that the only way forward for Greece is to default on (or be forgiven) a substantial proportion of its debt burden and to devalue its currency so that exports and the substitution of domestic products for imports can compensate for the depressing effects of the fiscal contraction imposed to date.
He explains that Germany and other taxpayers will have to absorb substantial losses. The alternative would be naïve, Lord Mervyn King says: the countries of the Eurozone should not haggle over how much to lend to Greece so that it would be able to pay them back some of the earlier loans, because circular flows of payments make little difference to the health, or lack of it, of the Greek economy.
The situation in Greece is closely connected to the historical development of the EMU. Some countries entered the EMU with a higher rate of wage growth and inflation than others. The real interest rate in these countries was therefore lower than in others with lower inflation. That lower real rate stimulated demand and pushed up wages and prices further. Differing interest rates would have helped these countries to bring inflation to the same level. Instead, divergences were exacerbated by the single rate.
As a consequence, the southern members of the EMU lost their competitiveness against other European countries. Full-employment trade deficits increased in countries where competitiveness was being lost, and trade surpluses increased in countries where competitiveness was being gained. Until today, borrowing from abroad finances these trade deficits, and trade surpluses are invested overseas. This means that countries in southern Europe have become substantial debtors, and countries such as Germany large creditors.
Moreover, the EMU has created a conflict between a centralized elite on the one hand, and the forces of democracy at the national level on the other. This is extraordinarily dangerous for Europe and will lead to not only an economic but also to a political crisis. The EU’s approach of creeping transfer of sovereignty to an unelected centre is deeply flawed and will meet popular resistance.
Germany faces a terrible choice now: it could support the weaker brethren in the Eurozone at great and unending cost to its taxpayers, or it could stop the project of monetary union across the whole of Europe. Obviously, a middle course is not working. Greece leaving the euro area may be the only way to plot a route back to economic growth and full employment.
Lord Mervyn King concludes:
It would be desirable, therefore, to create a mechanism by which international sovereign debts could be restructured within a framework supported by the expertise and neutrality of the IMF, so avoiding, at least in part, the animosity and humiliation that accompanied the 2015 agreement on debt between Greece and the rest of the euro area.
AECR member Joachim Starbatty MEP co-organizes a cross-party conference on the economic state of the Eurozone tomorrow in Brussels. The conference takes place in the European Parliament (room A1E2) from 10 am to 5:30 pm. If you need access to the parliament’s buildings, please register in advance by sending an email to firstname.lastname@example.org.