by Elliott Morss
The “Euro Crisis” is worrying everyone. Concerns include the future of the Eurozone, bank exposures, political uncertainties, and more generally, Chaos. Little attention is being given to the problems facing the citizens of these countries and what can be done to ameliorate them. Follow up:
The Problem - Unemployment
Table 1 provides data on unemployment rates. They are too high. Street demonstrations and riots have already taken place, and more will follow.
Why Are Unemployment Rates So High?
In earlier postings, I have argued that the “weak sisters” (Greece, Ireland, Portugal, and Spain) should leave the Eurozone because production costs in these countries are too high to clear labor markets. More specifically, the € is too strong for these countries. It makes their imports too cheap and exports too expensive to reduce trade deficits and increase domestic employment.
Now in theory, this problem could be resolved if producers (capitalists and laborers) in weak sister countries got together and agreed to reduce their € costs by 30%. In other words, if they all agreed to take a pay cut of 30%. But this will never happen. So how, realistically, can the “weak sisters’” costs be reduced so that their workers can find jobs again and their trade deficits become manageable via lower imports and higher exports?
To answer this question, I looked at what was happening to their currencies relative to the German Deutsche Mark before entering the Eurozone. Data on exchange rate changes between 1990 and their entry into the Eurozone are given in Table 2.
From 1990 until Greece entered the Eurozone in 2001, Drachma declined in value relative to the DM by an annual average of 13.2%. As Table 2 indicates, the currencies of the other weak sisters also declined. Why is this important? Because these “market adjustments” were appropriate corrections for the differences in costs and productivity as compared to Germany. This is no different than what has been happening between Japan and the US: since 1990, the US dollar has lost an average of 2.7% annually to the Japanese Yen. That loss has allowed to US to remain competitive on world markets with Japan.
But back to the weak sisters. Since their entry into the Eurozone, this market adjustment mechanism has been lacking. But the productivity and cost differentials vis-à-vis Germany have continued to grow. So what has happened? Unemployment rates and trade deficits in the weak sisters have continued to grow.
The weak sisters should leave the Eurozone and go back to having their own central banks. Why would this help? Because with their own currencies, their exchange rates would start adjusting again for productivity and cost differences. And with their own central banks, instead of having to reduce their government deficits as they are obliged to do under ECB/IMF mandates, they could launch new stimulus packages to get people back to work. These stimulus packages would be financed by their central banks buying up the increased government deficits.
Will these adjustments be chaotic with moments of panic and frenzy? Yes. But bailouts coupled with austerity are only band-aids that will mean more serious problems later. Time for a reset.
Comparing Sovereign Debt Ratings by Elliott Morss
Notes on European and USA Bank Exposures by Elliott Morss
What Has Really Happened to Euro Debt Insurance? by Elliott Morss