The Decline and Fall of the Euro?

Great empires rarely succumb to outside attacks. But they often crumble under the weight of internal dissent. This vulnerability seems to apply to the eurozone as well.

Key macroeconomic indicators do not suggest any problem for the eurozone as a whole. On the contrary, it has a balanced current account, which means that it has enough resources to solve its own public-finance problems. In this respect, the eurozone compares favorably with other large currency areas, such as the United States or, closer to home, the United Kingdom, which run external deficits and thus depend on continuing inflows of capital.

In terms of fiscal policy, too, the eurozone average is comparatively strong. It has a much lower fiscal deficit than the US (4% of GDP for the eurozone, compared to almost 10% for the US).

Debasement of the currency is another sign of weakness that often precedes decline and breakup. But, again, this is not the case for the eurozone, where the inflation rate remains low – and below that of the US and the UK. Moreover, there is no significant danger of an increase, as wage demands remain depressed and the European Central Bank will face little pressure to finance deficits, which are low and projected to disappear over the next few years. Refinancing government debt is not inflationary, as it creates no new purchasing power. The ECB is merely a “central counterparty” between risk-averse German savers and the Italian government.

Much has been written about Europe’s sluggish growth, but the record is actually not so bad. Over the last decade, per capita growth in the US and the eurozone has been almost exactly the same.

Given this relative strength in the eurozone’s fundamentals, it is far too early to write off the euro. But the crisis has been going from bad to worse, as Europe’s policymakers seem boundlessly capable of making a mess out of the situation.

The problem is the internal distribution of savings and financial investments: although the eurozone has enough savings to finance all of the deficits, some countries struggle, because savings no longer flow across borders. There is an excess of savings north of the Alps, but northern European savers do not want to finance southern countries like Italy, Spain, and Greece.

That is why the risk premia on Italian and other southern European debt remain at 450-500 basis points, and why, at the same time, the German government can issue short-term securities at essentially zero rates. The reluctance of Northern European savers to invest in the euro periphery is the root of the problem.

So, how will northern Europe’s “investors’ strike” end?

The German position seems to be that financial markets will finance Italy at acceptable rates if and when its policies are credible. If Italy’s borrowing costs remain stubbornly high, the only solution is to try harder.

The Italian position could be characterized as follows: “We are trying as hard as humanly possible to eliminate our deficit, but we have a debt-rollover problem.”

The German government could, of course, take care of the problem if it were willing to guarantee all Italian, Spanish, and other debt. But it is understandably reluctant to take such an enormous risk – even though it is, of course, taking a big risk by not guaranteeing southern European governments’ debt.

The ECB could solve the problem by acting as buyer of last resort for all of the debt shunned by financial markets. But it, too, is understandably reluctant to assume the risk – and it is this standoff that has unnerved markets and endangered the euro’s viability.

Managing a debt overhang has always been one of the toughest challenges for policymakers. In antiquity, the conflicts between creditors and debtors often turned violent, as the alternative to debt relief was slavery. In today’s Europe, the conflict between creditors and debtors takes a more civilized form, seen only in European Council resolutions and internal ECB discussions.

But it remains an unresolved conflict. If the euro fails as a result, it will not be because no solution was possible, but because policymakers would not do what was necessary.

The euro’s long-run survival requires the correct mix of adjustment by debtors, debt forgiveness where this is not enough, and bridge financing to convince nervous financial markets that the debtors will have the time needed for adjustment to work. The resources are there. Europe needs the political will to mobilize them.

Copyright Project Syndicate, the world’s pre-eminent source of original opinion commentaries. (Follow PS on Facebook and Twitter)


  1. Karin Daubner says

    Shockingly poor analysis in my opinion … Why?

    1) Talking about “great empires” as an analogy for the Eurozone (!) …

    2) “Key macroeconomic indicators [may] not suggest any problem for the Eurozone as a whole” but the problem is, the (economically homogenous mass of the) “Eurozone” only exists in the minds of the neoclassical economist (or monetarist at the ECB …).

    For in the real physical world the Greeks, the Italians, the Spanish, etc. live in their respective countries … their governments still have to deal with “national economies” with different priorities, different cultural, regional and social conditions, different political histories, etc. Looking at the artificial “Eurozone” data diverts attention away from the real systemic problem of the EMU: a “one size fits all” currency like the Euro simply does not work in the real world, where Germany has practised a beggar-thy-neighbour policy towards “the periphery”: which is constrained by the EMU / SGP economic straightjacket (loss of control over adjustment mechanisms like the interest rate and the exchange rate) so is forced to resort to “internal devaluation”: of course labour has to make the painful adjustment to make the theory of the “optimal currency area” seem viable, who else …)

    BUT the big irony is: Greece, Italy and the rest … they all use(d) “derivatives” to “cook their books”, excuse me “manage their debts”, so what’s the point of looking at balance sheets (whether private or sovereign) when they all suffer from “Enronitis”?

    The whole accounting scam needs to be addressed and the ridiculous “equilibrium” models (where the role of finance is "passive"!) used to predict the economic future (there is hope in the dark as “renegade” economists come out of the wood, i.e. Steve Keen – who predicted the debt crisis) must be exposed as what they are: a fantasy (not applicable in the real world …)

    3) The balanced current account of the whole Eurozone does not help the “PIIGS” since their accounts are mostly negative (mirroring the surplus of the “core”, notably Germany) and their debt (due to loss of sovereign control over monetary policy) has the same effect as debt in a foreign currency: they become slaves of the monetary policy of the ECB (which again focuses on the whole EMU and is not concerned with national peculiarities. The massive ideological blinders at work here prevent the questioning of the economic system as such (neo-classical / neoliberal orthodoxy) so any problems must derive from the wrong policies of the government (“budget sinners”, “lack of reforms”, etc.) since “the market forces” (and its priests and worshippers) cannot be wrong …(The ECB should perhaps establish a "Holy Officium" to punish the heretics?)

    4) Stagnating or even declining real wages (in Germany and Austria) and financial deregulation have ensured the increasing transfer of wealth (real or “phantom”) to the upper “1%” … while the lack of domestic purchasing power ("aggregate demand") worsened by insane “austerity programmes” (preventing government stimulus) will lead to prolonged recession.

    5) To mention the “much lower fiscal deficit of the EU” (compared to the US) is no consolation either, since it only proves that the “markets” don’t give a shit about fiscal deficits as long as there is a reliable “lender of last resort”, ready to throw endless rounds of “QE” if the financial system needs to be rescued from its own delusional “innovation” … (the joke is of course, that the ECB provides “self-service” cheap liquidity to the European banks, but not to the governments)

    6) Sure, there is no actual “currency debasement” in the Eurozone but the “sign of weakness” cannot be missed: while the Euro is, in this sense, “too big to be forced to fail”, the speculative attacks focus on the sovereign bonds instead, working their destructive way from the periphery to the core (aided and abetted by the “rating agencies”, whose heavily biased mere “opinions” are treated like the prophesies in ancient Greece (today “expertise” without liability)

    7) Seen through the distorted monetarist prism, the “low inflation rate” scam is still working: “wage demands remain depressed” – as if wages were still the dominant factor for rising prices! What about “excessive speculation” inflating asset prices and commodity prices (notably food and energy)?

    The financial system itself has become the greatest driver for “backdoor” inflation (by creating insane amounts of debt to inflate asset prices) In 2008 the “deleveraging” begun, so shouldn’t we worry about deflation (or stagflation) and isn’t it insane to insist dogmatically on a permanent fixed inflation rate (of 2%) – no matter what the economic circumstances are? Moderate inflation can be a good thing in certain circumstances ….

    8) And finally, the great neoclassical delusion: debt (credit creation) does not create purchasing power since it is supposedly just a “transfer of purchasing power” (from the saver to the borrower) –what tosh! Banks create (practically unlimited) credit out of thin air (and look for the “reserves” – which they determinate largely themselves – later …) … so of course they can create more “purchasing power” – (largely for themselves …)where did all the debt financed bubbles come from? Where did the explosion in “purchasing power” for the US housing market boom come from – from “transferred savings”? (

    The “predatory lending” induced debt drove the demand, which increased the prices, which in turn increased the demand further (for houses and derivatives like CDOs, etc.) the PONZI stage of capitalism, indeed …(the Minsky Millenium?)

    The ECB may be able to “sterilize” the monetizing of debt and the reason why the official “inflation rate” is low, is that most of the income was reinvested in the financial system (including real estate), not spent in the real (productive) economy or in other words: the potential “purchasing power” increased dramatically for the “1%” but not for the ordinary consumer …

    The “savings” (unspent income in the eurozone) you talk about, will not “finance the deficits”, if the orchestrated EU sovereign debt hysteria ensures that the flows of funding will be diverted to the perceived “safe haven” of the (astronomically indebted) US …the dollar is rising, how odd …

    9) As if “savers” would independently decide where their money is going to be invested …the “market” does not consist of “perfectly informed” inviduals … with perfect foresight … it resembles more a herd of sheep changing direction whenever the sheep dog (rating agencies, analysts’ “forecasts”) barks at them …

    10) The conflict between debtors and creditors has not become more “civilized” … the debt-slavery has only changed shape: “independence” of the ECB (from democratic control and decision-making), “debt-brakes” forcefully enshrined in national constitutions, unelected former Goldman-Sachs alumni (and members of the Trilateral commission) now determining economic policy in Greece and Italy, " fiscal union" by coercion, etc., sold to the public as “emergency” measures with “no alternative” (a hallmark of neoliberal policies, revealing the totalitarian core …), it must be ensured that the first priority of governments is debt-service, no matter what the consequences for social cohesion, so more austerity for the people, destruction of social systems and erosion of the social contract but guaranteed “fixed income” for the banks and protection of the bondholders …

    11) CONCLUSION: “Money Rule” replaces political democracy step-by-step: What the “debt crisis” (debt trap) has achieved: reducing the realm where political action is seen as legitimate …political leaders must now gain confidence of the "market" not the citizens … the “financialization” of the economy is entering its final phase …

    The absurdity of it all: Why should the state (the ultimate guarantor of all debt and “stability” (social peace, safety, rule of law, etc.) borrow fiat money from the private banks for higher interest when they get it cheap from the ECB and lend to each other recklessly?

    Why not create fiat money for real production in a public institution with democratic oversight?

    Why let the financial system “allocate credit” when it has resulted in one crisis after the other (getting worse every time)?

    WE NEED A NEW FINANCIAL SYSTEM AND FREEDOM of” ECONOMIC THINKING in academic circles .. no longer pseudo-scientific BS and neoliberal tyranny… No longer a fake NOBEL-PRIZE to acquire legitimacy …