It’s ten years since I first posted on my website the original Ten Reasons the Euro is BAD. It’s time for a quick review, so let’s get started.
Back in 2000 the UK was debating whether to ditch the pound and adopt the Euro as its currency. Broadly speaking, the UK Conservatives were in favor of keeping the pound while Labour and the Lib Dems were leaning towards adopting the Euro. However the No-Euro campaign was launched by a several prominent businessmen to oppose the switch to the Euro. This was, in my opinion, an extremely well run campaign that in agreement with the general skepticism of the British people. In 2002 the No-Euro camp effectively won and the Labour government declared that there will not switch from the UK pound to the Euro in the foreseeable future.
So let’s review each of the “Ten Reasons the Euro is BAD”. The first one is, “One Interest Rate Cannot be Right for Everyone”. Since the Euro is controlled by one entity (the European Central Bank), it must have one interest rate. In general the ECB has set the interest rate to make sure the growth of the larger countries within the Euro zone (i.e. Germany and France), which have over the last ten years required low interest rates. The smaller, and inherently weaker, economies such as Ireland, Portugal and Greece seemed to benefit from these low interest rates. Effectively the ECB backed their debt fueled boom that ran from 2002 to 2008. Then came the downturn – the shock to the system. Money became tight and now, in 2010, it’s payback time. Greece is now grappling with an out of control budget deficit of 12% of GDP – way above the 2% ceiling “demanded” by the ECB. What now? Well since the ECB effectively backed Greece’s debt it needs to pony-up the money to ensure Greece doesn’t default . But where will the ECB get the money from? It has a couple of choices – none of which are attractive.
The first option would be for the ECB to just let Greece default. This would be nothing short of a disaster. Effectively Greece would go bankrupt and government workers would not get paid, leading to riots in the streets of Athens. It is unlikely the Euro would survive such a course of action.
The second option would be for the ECB to go to the larger economies and ask them to assist Greece at their time of need. This isn’t going to happen. The Germans and French are also struggling though the financial crisis and don’t have any spare cash to lend their struggling European neighbors. The key here is the German government is still only elected by the German people, so it will act in the best interests of the Germany people with zero consideration for Greece.
It’s final option is to power up the printing presses and print more money. This will devalue the Euros already in circulation and cause general inflation across the Euro zone. Since the main aim of the ECB is to manage the Euro and ensure its stability this option would warrant a big black mark but looking at its other options this is probably the most likely. It’s the least visible and spreads the misery evenly across the Euro zone.
It’s interesting to also consider what would have happened if Greece had kept the Drachma. It’s likely the Greek economy would not have been able to warrant such low interest rates so the debt fueled bubble wouldn’t have been so big when it popped. Also if Greece still found itself with a budget deficit it could either raise interest rates to attract more investment or devalue the currency to stimulate exports. Neither option is available as it has given up control of its currency to the ECB.
So Greece is a real example of why one interest rate is not practical across so many diverse economies. So we can conclude that one interest rate across all the Euro zone is still a bad idea!