January 03, 2002
From the desk of Jane Galt:A Vote of Confidence for the Euro Zone
Perry DeHavilland predicts disaster for the euro. I can't argue with his conclusion -- he's closer to it than I am, and he thinks, per my post below, that the eurocrats will succeed in forcing social policy to the greatest common denominator.
Now that the Euro is a fait accompli, the long slow glide begins, perpetually pointed just below the distant horizon. The interest rates prevailing across a very significant area of the industrialised world will now be set to suit the business cycles of France and Germany. Many predict that once the economies of Europe are integrated like that of the United States, that will cease to be a matter of concern. And of course they are correct, once the fringe economies are flattened.
However, I have to take issue with his monetary analysis:
All that is different in Europe because whereas NAFTA has purely economic objectives, the Euro has mostly political ones. Sophisticated and relatively efficient European core economies will no longer have to deal with defensive depreciation of Spanish, Italian, Greek or Irish etc. currencies and will simply wipe out pools of local capital that might have buoyed up less effective local producers. This in and of itself is not automatically a bad thing, provided the local capital markets can adjust... which of course they will not be able to do. The mid to late 1990's surge in the US economy was a disaster for Argentina, whose currency was pegged to the greenback, because unlike the US, it was not experiencing an economic surge. No mechanism was readily and incrementally available to off-set the asymmetries by allowing the currency to naturally devalue. With the Euro, which is in effect an ersatz Deutschmark/Franc hybrid, this same toxic effect will happen to Greece, Italy, Ireland, Spain, Portugal etc. with one big difference... it will probably happen to many of them at once when the cycle begins, as it surely will.
I've done a little classwork on the Argentinian crisis (a couple of my professors saw this coming last spring), and my impression is that the capital markets are not the greatest problem Argentina faces. Argentina's inability to issue debt was due to its moribund economy, which in turn was due to a competitive devaluation by Brazil which Argentina was unable to follow, and a combination of social and economic policies that left the government unable to cut spending or rationalize inefficient sectors of the economy. With its own currency, it's a (fairly) easy bet that Argentina might be still solvent -- but only because they would be inflating their way out of the problem, destroying the value of financial assets and devastating their capital markets much more thoroughly than dollarization did. We might also explore the "death spiral" effect of repeated competitive devalutations; check Europe in the 1930's.
Yes, Argentina suffered from deflation. But deflation doesn't have to cause suffering -- we had it for quite some time without serious damage, both in the 19th century and in parts of the 20th. Deflation is a problem when it is a) sudden and unexpected and b) accompanied by structural problems in the economy: a speculative bubble and subsequent problems with the banking system in 1930's America, combined with an idiotic obsession with Keynsian economics manipulating gold; a speculative bubble and subsequent problems with the banking system in present-day Japan, combined with an all-too realistic obsession with Keynsian economics and the demographic disaster heading down the pike (their incredibly low birth rate: they're not even replacing themselves. The Japanese thus are determined to save! save! save! for their retirement.) This causes what is known as a "Liquidity Trap", in which the government is powerless to reverse deflation through traditional means because (this is a gross simplification, but well. . . ) because any money they inject into the economy gets stuffed under mattresses instead of spent.
All of which is to say that while I agree that rigidity in the labor and (possibly, if the governments are really slow and stupid) capital markets will make local monetary policy extremely problematic -- as it already did in Ireland (outrageous tax surpluses as they tried to substitute fiscal policiy for monetary policy to keep growth at a sustainable level). Nonetheless, I'm betting Ireland will do okay. The effect of government policy will be much more pronounced, IMHO, than transient currency issues. Business cycles DO harmonize -- witness that Ireland moved off Britain's cycle onto Europe's without major disaster (I think -- I may be treading on thin ground). They can't harmonize if the government interferes. So I predict that government policies will be much more important than monetary fluctuation in the coming years.
Posted by Jane Galt at January 3, 2002 08:24 AM | TrackBack | Technorati inbound links