Wednesday 13 June 2012

Euro Zone Update

Since my first posts on this topic in January, the Euro zone situation has gone from bad to worse.

Economic conditions in almost all of the member countries have deteriorated, even after massive bailouts and 'strengthening' measures.

Heads of state from around the globe seem to be meeting on an almost daily basis to discuss the best course of action, but very little has been done to rectify the problems faced.

As I hinted previously, the only way i see out of this is either -

a) Let Greece and the other weaker nations go to the wall and drop out of the euro


b) Make huge inroads towards greater fiscal integration within the Euro zone.

The rhetoric we are hearing from Angela Merkel (Chancellor of Germany) and her peers suggests that they are well aware of this choice.

It seems that they think that choice a) (letting countries fall out of the single currency) would be so cataclysmic that it simply can't be allowed to happen.

Therefore they seem to agree that choice b) is the way to go.

This however is much easier said than done. The kind of integration needed to make this work would basically involve a huge redistribution of wealth from the richer countries (namely Germany & to a lesser extent France) to poorer nations such as Greece and Portugal etc on an ongoing basis.

Why should the people of Germany and France sign up to this? It simply isn't in their best interest.

My personal opinion is that the weaker countries should be left to go bankrupt.

It would be very messy in the short run, but in the long run everyone would be better off.

Greece etc would return to their old currencies, which would substantially devalue and allow them once again to compete in the international marketplace. Germany and the other, more prudent nations would survive as a stronger block.

Further fiscal integration would still be needed between the remaining countries but this decision would hopefully be an easier one to make as it would be more in everyone’s best interest.

A bit of history...

The precursor to the Euro was the ERM (Exchange Rate Mechanism), it was formed in 1979 and worked by pegging members currencies to each other to reduce exchange rate volatility.

The UK entered the ERM in 1990 and within two years dropped out due to the huge strains caused by essentially locking our currency to the German Deutschmark. The Germans had a radically different economy to ours and a fixed exchange rate was never going to work. During our time in the ERM our government spent 6 billion pounds trying to prop up our currency and also we experienced recession, partly caused by heinous interest rates of 10%+

The UK dropped out of the ERM on Black Wednesday (16th Sept 1992) and this was seen as a huge failure, but soon after our economy bounced back and unemployment fell significantly. Was it really such a bad thing falling out? At the time Norman Tebbit, a conservative MP, referred to the ERM as the 'Eternal Recession Mechanism' and I don’t think he was far wrong.

It will be far more complicated for Greece to drop out of the Euro, implementing their old currency for one will be very expensive. I am sure however that it is in their best interest long term to do so, and the sooner they do it the better for everyone involved.