This is a banknote, not a shackle. Photo by Banar Fil Ardhi/EyeEm via Getty Images.
Here, as best as I can sum up, is the popular argument against the euro: It is a straitjacket on southern Europe, robbing countries of monetary policy and forcing them to tackle debt through austerity instead of currency devaluations, dooming Greece (et al) to perpetual fiscal contraction, high unemployment and stagnation. Snazzy-looking charts try to prove the point by comparing GDP growth in euro and non-euro European nations since 2007, with euro-users losing. Pundits and politicians galore argue Greece’s ticket to happiness is a one-way ride on the drachma express. And maybe for Greece in the here and now that’s true, especially if “Grexit” took the path outlined by German Finance Minister Wolfgang Schäuble last week.[i] But the euro itself isn’t the root of economic evil, nor is it destined to fail. It is simply incomplete. Its benefits are many, and while it might take the eurozone years to decide what it wants to be when it grows up, countries in the bloc can do just fine in the meantime—with many opportunities for investors.
The euro is not a straitjacket. Or a noose. Or a ball and chain. Or whatever constrictive metaphor you might use. It is a free-trade marvel, and not just because the 19 eurozone nations trade with each other tariff-free. The euro itself tears down administrative barriers. The hassle of converting currencies goes out the window. Fluctuating exchange rates no longer impact trade flow and make it hard for companies (particularly in smaller nations) to plan. Being part of one of the world’s major currencies also makes it easier for eurozone nations to compete globally, as the euro is more convertible worldwide than, say, Latvia’s old lat. This is why Latvia, Estonia and Lithuania went euro with gusto even after southern Europe’s problems metastasized.[ii] Euro = easier, freer trade = great for growth.
Charts showing comparatively weaker growth in eurozone nations the past eight years don’t disprove this point. All these charts show is that six eurozone nations had varying degrees of debt or banking crises since 2009, hurting their own economies and, by extension, hurting the stronger nations’ export markets. You’d need a much longer dataset, covering multiple cycles, to prove the euro is a drag.
So why has life been so hard for Greece and, to a lesser extent, Portugal, Spain and Italy? Why must all swallow spending cuts, tax hikes and sweeping labor market overhauls? In short, because the eurozone is a mere currency union, not a fiscal transfer union. There is nothing inherently unstable about states with varying degrees of inflation and economic competitiveness sharing a currency and monetary policy. It works fine in the US. Texas and New Jersey—opposite ends of the fiscal policy spectrum—both use the dollar, to no ill effect. California has higher prices than most other states, but divergent inflation doesn’t destabilize the dollar. It works here because the US is a political and fiscal transfer union. Transfers from strong to weak states combine with the free movement of goods, services, people and capital to even things out. This helps keep the whole country relatively stable even though growth rates, prices and fiscal policy can diverge wildly from state to state. The UK, where divergent fortunes between England, Scotland, Wales and Northern Ireland don’t destabilize the whole, is Exhibit B.
The eurozone is not a fiscal transfer union, and economically speaking, this is the trouble.[iii] Fiscal transfers between member states are illegal under EU treaties as a matter of national sovereignty—strong nations don’t want to subsidize the weak. A lot of this is cultural, rooted in old stereotypes of some nations as inherently frugal and hard-working and others as incurably profligate and in love with early retirement and long vacations. These stereotypes aren’t reality, but even so, the only way to make the euro reality was to ensure, via the Maastricht Treaty, that German frugality wouldn’t support 45-year old Greek retirees. In an attempt to prevent the need for fiscal transfers ever, the treaty included the Stability and Growth pact, which set formal debt and deficit limits. Fiscal convergence, the eurocrats pledged, would prevent competitiveness gaps from becoming a problem. But that didn’t happen. Maastricht Treaty limits were toothless, Greece fudged some numbers, and eventually the euro laid peripheral nations’ structural problems bare for all to see.
Note, I didn’t say the euro created problems in Greece, Portugal, Italy and Spain. Or Cyprus and Ireland, to round out the occasionally troubled six. Without fiscal or political union, the euro is basically a currency peg on steroids. Currency pegs might be inherently unstable, but not because the pegs create the problems. Pegs are just impossible to maintain when problems exist. Sooner or later, you must pay the piper. Greece, for example, didn’t suddenly turn troubled when it joined the euro. According to figures compiled by sovereign debt gurus Carmen Reinhart and Kenneth Rogoff, Greece has spent about half of its post-independence history in default or shut out of capital markets.[iv] It defaulted in 1826, 1843, 1860, 1893 and 1932 (and twice in 2012). It was shut out of markets for 53 years after 1826’s default and another 32 after 1932’s. Though it didn’t default in the early 1990s, it came close and was shut out of capital markets for a long stretch. Greek 10-year yields regularly topped 15% in the 1980s and 1990s. The euro switch simply robbed Greece of the devalue-and-pretend approach to managing its corrupt, bloated, inefficient, state-sponsored economy. Instead of seeing the early euro years as a chance to clean house without making citizens’ lives beyond-difficult, successive governments from both ends of the ideological spectrum simply kept up the charade. The day of reckoning was only a matter of time.
Since Greek debt jitters arose in 2009, there have been three potential long-term outcomes for the eurozone: It could become a fiscal transfer union, it could enable debt monetization, or it could shed uncompetitive members who can’t meet membership criteria. Perhaps Greece’s troubles today will force the issue. Maybe they’ll “Grexit.” Or maybe Greece’s sovereign creditors will allow debt restructuring, an implicit fiscal transfer. I would add “or maybe the ECB will direct everyone to fire up the printing presses,” but if you’ve seen their bizarre children’s video on the importance of trapping the “inflation monster,”[v] you’ll understand why there is no point in writing that sentence.
The eurozone’s eventual architecture and membership is a long-term issue that will take years of sociological debate and negotiating to decide—not a market driver in the here and now. What matters for eurozone nations not named Greece is that, for the most part, they’re growing, and formerly weaker members are becoming more competitive. Not because they’re mirroring Germany and targeting surpluses or teensy budget deficits, but because they’re gunning for more open economies with fewer barriers to entry, stronger private sectors and more flexible labor markets. Taxation and government spending get all the attention—austerity!—but market-oriented reforms are arguably more important. Letting shops open on Sundays, making it easier for people to enter licensed professions, reducing administrative hurdles to starting or expanding a business, and reducing corruption can do a world of good. Many eurozone nations are tackling some or all of these areas, and over time, it should foster more growth and tax revenues—revenues these nations can direct wherever their sociological values lead them, whether that’s a budget surplus, more federal investment or a stronger social safety net.[vi]
So most eurozone nations can and will do fine as their leaders figure out how the bloc should evolve over time. The eurozone isn’t doomed to lurch from crisis to crisis, as so many suggest. Nor is it doomed to slow growth perpetually. Some eurozone nations are growing very fast indeed. Spain and Portugal are chugging. The bloc’s marvelous free trade makes it easier for the stronger nations to pull the weaker along. There is a lot of potential in eurozone nations not named Greece right now. Best of all, the euro is unloved and unpopular for all the wrong reasons. Unjustified unpopularity should be bullish for eurozone stocks.
[i] In a nutshell, he advocated for a five-year temporary Grexit, which would allow Greece debt relief via the Paris Club, with the ECB supporting the new currency (presumably drachma) to prevent hyperinflation. Greece would then buy time to reform its entire economy while maintaining a social safety net to ease the transition from corrupt state-run capitalism to free-market capitalism. There would still be austerity—that’s unavoidable at this point—but the country would get more breathing room.
[ii] And, to an extent, why Greece wants so badly to keep it.
[iii] The sociology here is another matter entirely and not the point of this piece.
[v] Hat tip to Michael Hanson.
[vi] At the risk of getting too sociological, this is what Syriza (Greece’s ruling party) misses. The euro and market-oriented reforms needn’t obliterate their core social democratic values. They can go hand in hand if they want. The alleged choice between euro and national sovereignty has always been false.