“We must hang together,” Benjamin Franklin once said of the colonies that formed the United States. “Else, we shall most assuredly hang separately.”
At a market in Lisbon. Portugal scaled back its short-term borrowing, roiling world markets.
The countries that use the euro should now be wondering if they face a similar decision. The central core of the 16-nation euro bloc — most notably Germany and France — looks solid. But some countries on the fringe of the zone are in deep financial trouble, with high unemployment, clearly unsustainable budget deficits and economies that no longer appear competitive with their European counterparts.
How Europe chooses to deal with the problems of the countries on the edge, among them Greece, Spain, Portugal and Ireland, may determine the future political shape of Europe, and the future of the euro itself.
World markets shuddered Thursday in the face of signs that skittish investors were growing more fearful of lending to Portugal. That country had to scale back a short-term borrowing plan, something Europe is not used to seeing.
If investors were to walk away, or demand truly exorbitant interest rates, that would put pressure on France, Germany and others in the euro zone to decide just what they would do. Would they bail out their troubled neighbors? Or would they simply allow them to default — an outcome that would have major repercussions for Europe and financial markets worldwide?
At the heart of the problem is Europe’s unwillingness more than a decade ago to choose either unification or separation. It wanted economic unification and continued political independence of nation states.
In short, it wanted the best of both worlds, and for a time it seemed to have succeeded in that goal. The success amazed many economists, most of them from Britain and the United States, who had argued that a single currency would require much more political unification.
There remains a widespread view that the fringe countries can count on their more prosperous neighbors for a bailout if one is necessary.
But such a bailout, if it comes, will raise the question of terms. How much political sovereignty will the bailed-out countries be forced to surrender? Will they be forced to cut spending, or raise taxes, more than the local voters are willing to accept? Will the rest of Europe force major changes in government pension plans, or the firing of state workers? How can they do that, even if they wish to do so, if national Parliaments will not concur?
There would also be political questions within the core. Many West Germans were appalled by the cost of national unification when East Germany merged into the current German state. If they did not like subsidizing people who in some cases were their cousins, how will they like subsidizing Greeks or Portuguese?
Perhaps of more importance, how can the troubled economies regain competitiveness within Europe? Before the use of the euro, when Europe tried to maintain exchange rate stability but kept separate currencies, there were periodic sharp devaluations of some currencies, most notably the Italian lira. That made those countries competitive again, for a time.
Europe’s Growth and Stability Pact, which sets the rules for euro membership, limits the size of budget deficits. It was supposed to prevent such problems. But it was largely toothless, especially after Germany and France found it convenient to violate its terms when it suited their economic needs.
Political union would not cure the underlying economic problems, but it would make it easier for a European government to provide assistance to ailing areas through transfers of tax revenue and special spending programs, and for Continentwide laws to be enacted even if they were deeply unpopular in some areas.
Even then, problems could arise. In the United States now, some states, including California, are in severe financial straits. California represents a larger part of the American economy than Greece does of the European one, but even if it did default it would not create a national debt crisis, and Washington could provide help.
The world has sought currency stability across national borders many times. The gold system was such an effort, but it retained separate national currencies whose value against gold could be adjusted if need be. Some economists think that maintaining artificially high exchange rates was a cause of the Great Depression.
More recently, Argentina tried to use a currency board to maintain stability with the United States dollar. That eventually blew up.
What could be different in the current euro zone is that the legalities provide no possibility of departure. It is supposed to be the “roach motel” of currency unions, a name taken from a pest trap that used to advertise that once the roach checks in, he can never check out.
Floyd Norris comments on finance and economics in his blog at nytimes.com/norris.
Read Full Article »