A shotgun wedding for the United States of the Euro?

"Ummm, you know that Free Trade Agreement we signed with the US and Mexico, a while back? And you know we said NAFTA was just a free trade agreement -- nothing more? Ummm, well, it turns out we were wrong. Because of NAFTA, if Canada, Mexico, and the US don't now join together into one big United States of North America, the result will be the total economic collapse of all three countries. So, we are just going to have to join our three countries together and make the best of it. Sorry about that. But we can't turn back the clock. And there really is no alternative now. OK?"

Any sort of Canadian nationalist would go ballistic if I were to say those words. Especially if they knew I was right.

Like all analogies, it doesn't work exactly. But that's the best I can come up with. Just replace "North America" with "Eurozone"; and "free trade agreement" with "common currency".

If that is how the United States of the Euro gets created, I think it would be the most hated country on earth. Hated by its own people.

In good times, without a solvency and liquidity crisis of sovereigns and banks, it would be possible to dismantle a currency union in an orderly fashion. Difficult, but possible. These are not good times for the Eurozone.

The European Central Bank can't function as an effective lender of last resort without some form of political union. All proposals for saving the Euro amount to political union in a shotgun wedding because she didn't take the pill like she said she did. (Maybe that's a better metaphor).

And the alternative is a disorderly breakup of the Eurozone, after banks and sovereigns have already defaulted.

Those are two very ugly alternatives. And I don't even think the first would work. A country formed in such circumstances would be so resented by its own people I think it would be ungovernable. So I think a disorderly breakup of the Eurozone is what will happen. And that will be very ugly too. And not just for the Eurozone.

This is the sort of thing that can happen when you don't understand monetary theory well enough. Even those of us who thought the Euro was a bad idea didn't really know it was such a bad idea. If we had really known it would end this way, we could have presented overwhelming evidence in a convincing enough manner to have been able to persuade everyone else it would end this way. And we couldn't do that. So we didn't really know it.

There are two big economic problems facing the world economy right now. The problem in the US is solvable. The problem in the Eurozone isn't. It can't get where it wants to be from here.

God it's depressing.

Comments

[Min]

Lady Macbeth: "Stand not upon the order of your going,
But go at once."

Sorry, I could not resist. ;)

[Curmudgeon]

I'm not convinced the outlook for the US problem is any positive than for the Eurozone problem.

In both cases, it's relatively clear to non-hack economists what both entities need to do to put their economies back together. The Eurozone needs either to dissolve or form a political union. The Americans need to stop beating themselves over the head with pro-cyclical spending cuts, reduce household debt burdens by forcing creditors to take a hit (either through cramdowns or higher inflation) and do something to bring wages into line with living costs. In both cases, the political ability to take the necessary corrective action does not exist.

Europe, as you note, is not ready for a political union nor do European leaders have the gravitas to swallow their pride, admit the Euro was a bad idea, and try to unwind it in an orderly fashion. On this side of the Atlantic, the American political class has become utterly dysfunctional on account of at least half of the class belonging to a faction of totalitarian nihilists who are willing to burn their country to the ground whenever they lose an election. None of these dynamics will change anytime soon.

I do not see a positive way out for either America or Europe.

[Simon van Norden]

I think you're much too optimistic, Nick. I mean, when has a currency union ever been dismantled in an orderly fashion?

But let me try to play devil's advocate and argue that things really are not so bad. Remember that two years ago the present crisis was unthinkable, and the problems in Spain and Italy were not much on bondholders' minds just a few months ago. The point is that the long-term outlook and economic fundamentals for these countries really has not changed in the past few months.

If you accept that premise, you'll probably accept the notion that the current crisis is due to a self-fulfilling expectation; interest rates are high because default seems likely -- default seems likely because interest rates are high. But if that's the case, you have to admit that a virtuous equilibrium also exists. So even if we don't know how to move the system towards it, we think it exists.

[Patrick]

I get the sense that the US at least has a viable 'do nothing' option. If they just do nothing (quite literally - just leave everything like it's already arranged) eventually the ship will right itself, more or less. But I don't get the sense from the Eurozone that they have a do nothing option.

Maybe I'm too cynical and/or melodramatic... Based on what I've read in various place over the last couple of years, it seems that they have no good options if/when they face a sovereign default induced banking/shadow banking system meltdown. At least in the US, in the absolute worst case (I dunno - maybe imagine AIG or Citi having gone bust in '09), the Treasury and the Fed could simply recreate a basic financial system by decree. They have (or could get) that power. But in the case of the Eurozone, they really don't have a plane B, and there seems to be a number of plausible scenarios that lead to some truly TBTF institutions going bust, and there is no machinery in place to keep the most basic machinery of a post neolithic society functioning.

[Patrick]

oops - that would be plan B. But a plane might come in handy too. Especially if it could fly to Calgary or Melbourne.

[K]

Nick:"The problem in the Eurozone isn't. It can't get where it wants to be from here."

Simon: " But if that's the case, you have to admit that a virtuous equilibrium also exists. So even if we don't know how to move the system towards it, we think it exists."

I'm with Simon here, except that we do know how to get to the virtuous cycle: 1) ease 2) inflate, 3) still too much debt? Repeat. (Where "ease" likely means helicopter drop). And no, they aren't going to do it :-(((

[Curmudgeon]

@Patrick:

'Do nothing' in the US case assumes that Congress can pass budgets and debt ceiling increases without negating private sector economic growth through public sector spending cuts. The last debt ceiling crisis makes this an uncertain proposition.

[Jason]

I don't think the Eurozone is going to breakup. No politician wants to be remembered as the one who was 'in charge' when the Eurozone fell apart. That alone will save it. Nobody will do anything to fix the real issues; we'll just keep seeing last minute efforts that keep kicking the can down the road. At least that's what I tell myself to help me sleep at night.

[jb]

Sir

On disorderly breakup :

1) The ruble (1991-1993) and the austro-hungarian empire.

2) asymmtric barriers to exit.

[richard]

I wonder what the impact of a dissolving Eurozone will be on 'globalization'? Will we see more protectionist policies in North America and Europe? A return of some manufacturing capacity from China to NA?

[Robert McClelland]

I don't get how the EU can't adopt a unified money policy that wouldn't require anything more than a minor, acceptable loss of sovereignty for its member nations.

[Frances Woolley]

Nick, I'm with Curmudgeon on your optimism. You can think of politics as a kind of social technology - if the social technology to create good policy isn't there, I don't see how the US can put on the brakes and avoid [insert appropriate metaphor here].

From Thomas Friedman's column in the NYT - the final para is particularly relevant to your post.

Kishore Mahbubani, a retired Singaporean diplomat, published a provocative essay in The Financial Times on Monday that began like this: “Dictators are falling. Democracies are failing. A curious coincidence? Or is it, perhaps, a sign that something fundamental has changed in the grain of human history. I believe so. How do dictators survive? They tell lies. Muammar Gaddafi was one of the biggest liars of all time. He claimed that his people loved him. He also controlled the flow of information to his people to prevent any alternative narrative taking hold. Then the simple cellphone enabled people to connect. The truth spread widely to drown out all the lies that the colonel broadcast over the airwaves.

“So why are democracies failing at the same time? The simple answer: democracies have also been telling lies.”

Mahbubani noted that “the eurozone project was created on a big lie” that countries could have monetary union and fiscal independence — without pain. Meanwhile, in America, added Mahbubani, now the dean of the Lee Kuan Yew School of Public Policy at the National University of Singapore, “No U.S. leaders dare to tell the truth to the people. All their pronouncements rest on a mythical assumption that ‘recovery’ is around the corner. Implicitly, they say this is a normal recession. But this is no normal recession. There will be no painless solution. ‘Sacrifice’ will be needed, and the American people know this. But no American politician dares utter the word ‘sacrifice.’ Painful truths cannot be told.”

[Nick Rowe]

I think Patrick is right; if the US does nothing, it will probably muddle along, without getting much worse, and may *eventually* get better anyway. But something like a clear commitment to level path NGDP targeting by the Fed, backed by a commitment to print and spend on anything that moves (not just Tbills) would solve the problem. It's doable.

I see the Eurozone getting steadily (or not so steadily) worse if nothing is done.

Curmudgeon: "Europe, as you note, is not ready for a political union nor do European leaders have the gravitas to swallow their pride, admit the Euro was a bad idea, and try to unwind it in an orderly fashion."

I just can't see any way to unwind it in an orderly fashion.

Simon: that's an interesting idea I am going to file away at the back of my mind and mull over slowly.

Robert: "I don't get how the EU can't adopt a unified money policy that wouldn't require anything more than a minor, acceptable loss of sovereignty for its member nations."

Nor could the proponents of the Euro when it was first introduced. They saw it as just fixed exchange rates, only irreversible. No big deal. But when a crisis hits and the ECB is the only effective lender of last resort (because it has very deep pockets because it can print), you have to face the question: which countries, and which banks, should the ECB lend to? Should it lend unlimited amounts to (say) Greece, so that Greece can spend whatever it wants? Or would it want some sort of control over Greek taxes and spending?

richard: "I wonder what the impact of a dissolving Eurozone will be on 'globalization'? Will we see more protectionist policies in North America and Europe? A return of some manufacturing capacity from China to NA?"

My guess: the disruption to international trade and finance will be so great that protectionist policies will be redundant.

[Nick Rowe]

Frances: Yes. I read that Friedman column last night. It is relevant to this post. Not sure if it was lies though. A lot of people really did believe that having a common currency was no big deal for loss of sovereignty. They were only thinking of the standard "one size fits all" Optimum Currency Area problem. Forgetting about the second thing central banks do: act as lenders of last resort. But Mahbubani does sound a bit like an Austerian. "We have sinned, and must suffer". No, the main problem (in the US at least) is shortage of AD. We aren't being sinful enough.

[Patrick]

BTW, the Brits really dodged a bullet on this one, eh?

[Andrew F]

Doesn't Europe have the option to inflate their way out by monetizing their debt?

Print Euros and distribute them to member governments per capita or in proportion to the size of their economies?

[david stinson]

It seems to me that disorder will hold under all options, including the "deer in the headlights" status quo. Therefore, the criteria should be what regime is sustainable and least likely to create further disorder in the future. Any reforms that place political desires over economic reality or increase already high levels of moral hazard are unlikely to meet those criteria. This implies to me that a euro break-up of some kind is the best solution. It strikes me that the least disruptive way to disaggregate the euro zone would be for Germany to depart unilaterally over a weekend or something like that. That would eliminate lengthy, uncertainty-producing, partially public, highly economically destructive, political wrangling. It may also be enough disaggregation (plus or minus small stuff like Finland, etc?) to make the rest sustainable as a eurozone.

"This is the sort of thing that can happen when you don't understand monetary theory well enough. Even those of us who thought the Euro was a bad idea didn't really know it was such a bad idea. If we had really known it would end this way, we could have presented overwhelming evidence in a convincing enough manner to have been able to persuade everyone else it would end this way. And we couldn't do that. So we didn't really know it."

I think you're being too hard on yourself and your colleagues. One can never know at that level of certainty. One can only use good judgment and weigh the risks. The risks were well known but underweighted because it was essentially a political project, not an economic one.

Also, cheer up. I find this helps:

"The future is disorder. A door like this has cracked open five or six times since we got up on our hind legs. It is the best possible time to be alive, when almost everything you thought you knew was wrong." (Tom Stoppard, Arcadia)

[Nick Rowe]

Patrick: Absolutely! I would like to think it was because we Brits were smart enough to see it coming. But I don't think that was true at all. It was sheer conservative (very small c) Anglo Saxon suspicion of big fancy Continental theory. Chalk up a big victory for the "Stupid Party".

Andrew: that would certainly help. But they would probably have to do it in very large amounts to bail out Greece. Rather like throwing enough money out the helicopter to make sure there's enough inflation that even the worst case can survive.

[Nick Rowe]

Andrew: and it would be rather hard to put the helicopter into reverse gear (change it into a vacuum cleaner to suck money out of pockets) without some sort of central taxing authority.

[Andrew F]

And wasn't the answer obvious all along: allow Greece to default. Allow any of the knock-on defaults as well, in Ireland, Portgual and Spain. Let the banks burn. Bail out depositors, and build new banks. It would be very painful. But it would be ripping the bandage off quickly. Greece and others may leave the Eurozone anyway. They may not be able to borrow. But they have lost the right to have easy access to credit markets. It is time for the Greek people to be accountable for their democratic choices.

[Patrick]

david : "Germany to depart unilaterally over a weekend"

If only they could! I just don't see how it can be made to happen. How do tell the difference between a 'Greek' Euro and a German 'Euro' in a German bank? The logistics would be impossible.

Sounds like the opening line to a bad joke - "Two euros walk into a Hungarian strip club ... "

[Patrick]

Nick: OT but what the hell: No problem here with small c conservative. FWIW, I think the world be a better place with more Nick Rowe's. It's the Rick Perry's I could do without.

[david stinson]

" I would like to think it was because we Brits were smart enough to see it coming. But I don't think that was true at all. It was sheer conservative (very small c) Anglo Saxon suspicion of big fancy Continental theory. Chalk up a big victory for the "Stupid Party"."

Distrust of overconfident utopian elites and respect for an evolved order is often rational, particularly when the elites have a track record like Europe's. The "pretense of knowledge" and "fatal conceit" spring to mind.

[Lord]

If the periphery defaults, is there still reason for them to leave? They would have to operate on a cash basis and they couldn't rely on exchange rate changes, but it doesn't seem their is much advantage to leaving at that point. They might not be welcome, but there is nothing to stop them from continuing to use the currency is there?

[Kevin Donoghue]

How do tell the difference between a 'Greek' Euro and a German 'Euro' in a German bank? The logistics would be impossible.

If the bank is German the liability is a German Euro (unless Germany legislates otherwise).

[david stinson]

' How do tell the difference between a 'Greek' Euro and a German 'Euro' in a German bank? The logistics would be impossible."

Well, presumably it would only get harder if you took longer to do it since it would open up opportunities for gaming and generally send the markets into chaos. Banks would presumably know the addresses and nationalities of the account holders. Alternatively, I suppose all euros held in German banks could be converted to marks. The greater problem might be currency held in Germany outside banks and preventing the gaming of the conversion of that. Perhaps an upper limit on the amount of cash (held outside banks) exchanged for German residents and tourists with evidence of a stay in Germany would present a starting point. It might be a bit messy but then so would be the bailout of German banks. If the eurocrats can generate who knows how many words on regulating the curvature of bananas, I am thinking this doesn't present an insurmountable problem.

If it's logistically impossible for Germany to split off, then presumably it's also logistically impossible for the eurozone to split in any way, in which case fiscal union is the only solution.

[Jim Rootham]

Germany is in nowhere near enough pain to go through the chaos of leaving the Euro. Greece is in enough pain and the sooner they do it the better off they will be. Greek holidays will be really cheap for a while.

This also almost certainly applies to Ireland. Iceland has demonstrated that you need to smack the bondholders to get out of trouble. Since the Euro cannot inflate at the periphery the only solution is to default and exit.

[Kevin Donoghue]

A breakup certainly isn’t logistically impossible. Even notes and coins can be identified by country of origin. But why? Did the Eurocrats foresee that they might need an escape-hatch? In 2008 there were stories about Germans rejecting notes from the “wrong” member states.

[Patrick]

"logistically impossible for the eurozone to split in any way"

Gazing into my totally unreliable crystal ball ...

Yup, that's what I think. A crisis will hit before fiscal union, and then it won't be necessary. Once a country has already blown-up (like Greece - seen the 1 yr yield today? 90%! YIKES!) a little more chaos is no biggie. Greece, Spain, Ireland, Italy seem likely to default at some point. Once they do, they will leave. Germany & co. and France will have to go Swedish on their banks, etc ... It's going to be a hell of mess. But if they do it right (nationalize, guarantee deposits, wipe out shareholder, haircut bondholder, fire management, print money like crazy), it'll all be over with in a couple of years. That's gotta be better than dragging it out for two generations. Otherwise Ireland is going to be a perpetual debt slave, and Spain is going to run > 20% unemployment essentially forever.

[Determinant]

Ireland is a tragedy. How many Canadians have their origins in Irish people who left the Emerald Isle for greener pastures?

*Determinant raises his hand*

It's enough to make you cry.

[Jacques René Giguère]

As Nick said: Brits were right for the wrong reasons. There are few things that can set you up for further troubles than that.

Simon: long-term fundamentals are good. My getting-older ailments are under control and my life expectency is good. There is a big construction project across the street from the College and a lot of trucks paid by the hourly loads tend not to care about the STOP signs.

Euro break up consequences on trade makes protectionnism unnecessary: no. (unless you meant redundant in causing harm). Bad things pile up far more quickly and easily than good ones. See Austro-Hungarian dissolution and 1929-1931 : the solution to the damages caused by the disruption will be seen in autarky. Plus we will need revenge on the "Them " who are responsible. Pray you are not a Them, how heroic your war services were...

[Max]

"If the periphery defaults, is there still reason for them to leave?"

Yes, if they are not running a primary (excluding interest) surplus, which I don't believe any are.

[Kevin Donoghue]

Jim Rootham,
The latest IMF report on Ireland is quite bullish, so I’d say your “almost certainly” (leaving the Euro) is a little too strong. But being Irish myself I’m not objective. With Irish 10-year bonds offering secondary-market yields of 8.7% (down from a high of 14% in July) we aren’t out of trouble by any means.

[Frances Woolley]

Nick "Not sure if it was lies though." - I agree, what I found interesting about the article was the idea of 'don't get too smug about all these dictatorships falling and the triumph of democracy, you're collapsing too'.

"No, the main problem (in the US at least) is shortage of AD. We aren't being sinful enough." - As you know, I really don't get macro, but it seems to me that when almost everything that Americans buy is imported, this has to weaken the link between AD and job creation. (I know I must be wrong because this is just mercantalist thinking, but I don't understand how borrowing to buy imported consumer goods can have any but seriously bad long term consequences. I just can't shake this image of the First Nations peoples being duped out of their land: "Here's some beads, blankets, and guns. Now sign this treaty." Except instead beads and blankets, it's electronic toys and trinkets).

[Determinant]

Actually Frances, I think that is entirely the problem. It wouldn't be a problem if the US had stuff people wanted to buy and China actually wanted to buy stuff with the pile of US dollars it has, but the US is out of luck on both counts.

The money isn't spent; it's hoarded in US bonds. That creates a capital surplus and a consumption deficit in the US when it should be the other way around. Money *should* be neutral in this case but it isn't.

Or put another way, China should be importing planes, machinery and other high-tech goods from the US like crazy. It should not be hoarding bonds.

The US/China trade should be balanced entirely in the consumption account, but it isn't. You can replace China with other countries but China is the biggest and worst offender.

We are living with the consequences.

Before anybody accuses me of China-bashing, Canada is a larger trading partner with the US than China, but our trade relationship is far more balanced and beneficial for both sides. Examining the differences is informative.

[Too Much Fed]

Kevin Donoghue said: "Jim Rootham,
The latest IMF report on Ireland is quite bullish, so I’d say your “almost certainly” (leaving the Euro) is a little too strong. But being Irish myself I’m not objective. With Irish 10-year bonds offering secondary-market yields of 8.7% (down from a high of 14% in July) we aren’t out of trouble by any means."

You might be interested in Bill Mitchell's take on Ireland at:

http://bilbo.economicoutlook.net/blog/?p=15962

It mostly starts at "I created the following Table to show you the breakdown between these aggregates and their evolution between Q1 2010 and Q1 2011 for Ireland using the CSO National Accounts data."

[rsj]

Max,

Neither leaving the EU nor defaulting would require any state to run a primary surplus.

You are confusing the trade deficit with the budget deficit.

Rather, leaving the EU allows the member state to have its own central bank, which can lend at policy rates -- say 3%. It can do this because it makes the money, so if it decides to lend in unlimited amounts at 3% or 2%, then that is something that it can achieve, investor preferences be damned.

In that case, banks will certainly be willing to borrow at the policy rate and purchase government bills and bonds that yield slightly more than the policy rate (taking future policy rates into account).

That is how nations can and have maintained negative real borrowing rates for decades if they want. That is how Japan, with a junk bond rating and an enormous debt level, nevertheless will always be able to borrow at 1% for as long as it wants. There is never going to be a financial debt crisis in any nation that controls its own overnight interest rate. As long as the Bank of Japan is lending unlimited amounts of money at 0%, the government of Japan will easily be able to borrow unlimited amounts of money at 1%. It is really simple, and has nothing to do with the preferences of bond investors. Rather, the preferences of bond investors -- whatever they happen to be or whatever they happen to think of the government of Japan -- are sure to align themselves is such a way as to desire free money.

Arbitrage with the policy rate sets borrowing costs for governments that have currency sovereignty.

There are certainly inflationary, current account, and even domestic political concerns that may well cause nations to maintain higher interest rates and possibly run lower deficits, but it now becomes a policy decision rather than an externally imposed constraint.

[g enauer]

a few things:
Britain has its 500 year old pound history without any default, just a little inflation here and there. Paying down debt of up to 220 % GDP repeatedly ! Something to be very proud of, and you don't give that up easily. And much stronger ties to other countries apart from mainland EU.
For Greece to give up its drachma was a lot easier : - )

I am pretty sure that the German Bundesbank has at least one complete set of emergency currency in a vault. It has significant numbers of own printing presses.
The Euro was agreed upon with "no bailout", "low inflation (< 2%)", and "no budget deficits (<3%)". The northerners (incl. Germany) did what is necessary, resulting in low or no wage increases. Fueled by newly low interest rates and the resulting real estaste (price) boom raised wages and pensions in the periphery by relatively 20 % or more. But they did not become more productive, might be even the opposite. With the Euro at 0.9 Dollar, and not looking too closely at deficits, that worked for a while. Germany was happy with the 0.9 too, because fixing eastern Germany with a lot of spare working capacity (read: unemployment) did cost a lot of money and high taxes. Now the east is fixed and Germany has a huge trade surplus even at 1.4 $/EUR. For the South now the RE boom is over, but the debt is there, and the trade deficits of the south because of relatively too high wages and an exchange rate of 1.4 $ per Euro. With their own currency they would devalue to lets say to 1.1 $ per Euro, effectively reducing wages externally by 30 %, resulting internally by about half of that, but with nominal prices the same or rising (inflation) that doesnt hurt soo much psychologically.

Cutting nominally by 30 % means revolution.

You could also make inflation in Germany (and the other northern countries) to get wages & prices up by 20 %, but that takes time, cheats the people with 2.25% savings plans out of their savings and saving (habits) we encouraged so much, and it breaks massively what we have a contract on, a stable currency. Furthermore it would first require the southerners to end their inflation indexing rules, which they were asked in February and rebuffed very clearly.
With Italy, even at the point of insolvency in August 2011, not being able to plot straight with the ECB, the decision was done.
It will be pain for south, and significantly in the short term, and not inflation in the north. This is the meaning of the Schäuble article in the Financial Times yesterday (7 Sep 2011).

Somehow the wage/price levels have to adjust to economic reality, and any proposals not adressing this and foremost are just distracting.

[Ian Lee]

Nick - I agree with everything you said in this set of posts. You will recall that I made very similar arguments in my paper to EURUS in March 2010 - either a full political transfer union which will not happen as Germans do not "feel the love" for Greeks or Portuguese and if not, Greece, Portugal and possibly Spain and Italy will leave the euro, as it is in their self interest.

However, I disagree with the following comment:

Patrick: Absolutely! I would like to think it was because we Brits were smart enough to see it coming. But I don't think that was true at all. It was sheer conservative (very small c) Anglo Saxon suspicion of big fancy Continental theory. Chalk up a big victory for the "Stupid Party".

Please see Telegraph Peter Osborne's analysis: "Margaret Thatcher knew the single currency would devastate Europe"

"she warned John Major, her euro-friendly chancellor of the exchequer, that the single currency could not accommodate both industrial powerhouses such as Germany and smaller countries such as Greece. Germany, forecast Thatcher, would be phobic about inflation, while the euro would prove fatal to the poorer countries because it would “devastate their inefficient economies”. http://blogs.telegraph.co.uk/news/peteroborne/100064330/margaret-thatcher-knew-the-single-currency-would-devastate-europe/

When Thatcher returned from European Summit of Rome in October 1990 - where she was the ONLY European leader opposed to Delor's vision of a European monetary union - she faced a cabinet revolt over her position concerning the proposed Euro. Her cabinet minister, Geoffrey Howe publicly criticized her for her opposition, she fired Howe and he started the revolt that led to the ouster of Thatcher a short time later.

In her autobiography - published years before the current crisis - Thatcher went into extensive deal explaining that the small, uncompetitive countries of southern Europe would not be able to survive against the German industrial machine.

A quick anecdote. My late father - a Brit through and through like you Nick - bought his sons a timeshare in Portugal before he passed away, as he wanted us to remain connected to Europe. In finally visiting Portugal last year, I discovered that putting Portugal together with Germany in the eurozone, brought together the productivity of rural northern New Brunswick, with the service quality of Ottawa and the prices of Germany - albeit with stunningly beautiful beaches and very old buildings.

In the run up to the last UK election, a British wag said that Gordon Brown should have campaigned each day with a single line: "I kept the UK out of the euro - and then sat down without saying anymore " (he forgot to sit down).

So maybe, just maybe, Polanyi's tacit knowledge or Edmund Burke's recognition of unintended consequences, is operating at a subterranean level in the "stupid party", which is absent in the "smart parties" and the oh so clever European elites that gave Europe the Euro - the gift that keeps on giving.

[Nick Rowe]

g: yep. I basically agree.

Ian: ever the one with all the facts! (As my friend was saying just the other day, talking about Landsdown!) I didn't know how important a role Mrs T. had played in preventing the UK joining the Euro. Well done Mrs T! (And Gordon Brown too).

BUT. If that was Mrs T's argument for predicting failure of the Euro, it is totally inconsistent with the rest of her Monetarist theory. It makes no theoretical sense whatsoever. Her argument assumes some sort of long-run non-neutrality of money (a downward-sloping Long Run Phillips Curve, so that permanently higher inflation allows permanently lower unemployment) that is totally inconsistent with everything she said and did within the UK.

[Good Habit]

"I just can't see any way to unwind it in an orderly fashion."

There are two sides to this question - the political - and the technical. The difficulty is almoust entirely political - can the politicos admit that a common currency had been a bad idea in the first place - (and without a long public debate?). This seems almoust impossible. But... wouldn't it be enough if two out of the four big Euro countries (Germany, France, Italy, Spain) secretly decided to call it quits - inform the other two that they will leave - even if it will create a disaster - and so blackmail them in to a joint dissolution? And if the big 4 decide to quit, the smaller ones will just get informed (they might complain about blackmail, but what can they do..). So, after a surprise summit of the Eurozone, the following decision is announced: (on a weekend):

1. All banks in all Euro countries will remain closed for the next 4 days...
2. While all Eurozone countries continue to use the Euro, as of tomorrow, 12.am, there will be 18 Euros - one international Euro, and 17 national Euros.
3. In each country, all domestic assets and liabilities, and all contracts and prices, are in it's respective "national Euro". All coins form part of the national Euros (they are easily distinguishable). All international debt between Euro nations is (as a bone to the debtors) due in the "Euro" of the debtor.
4. All other international contracts are in international Euros, with a value defined as a basket of the various national Euros. All circulating banknotes are in international Euros.
5. The (former) partners in the Eurozone recommend strongely that the various "Euros" should be freely traded with a floating exchange rate. The big 4 promise to keep there exchange rates floating for the forseeable future. Other countries are free to choose to float, or to maintain a peg (to one of the other "Euros", or the US$, the £ or the Yen, or whatever.
6. If in some countries financial institutions come in trouble, each country is free in it's options - it can bail them out, nationalize them, force a recapitalisation, or let them go bust..
7. Once the inital transition is underway, every country is free to issue it's own banknotes and coins, and use a own "national" name for the currency, in addition or instead of Euro.

This should only pose relatively minor problems (certainly some bank bailouts will be necessary) - but arbitrage with banknotes isn't possible, because from day 3, a 100 € note will be accepted in stores in Germany as D€ 85.-- / and in Italy as €I 115.-- (e.g) - and change will - at least in big chain stores - usually be given in company vouchers (denominated in national € - and widely accepted also by small businesses for cash transactions). No problems with electronic payments.
After some weeks (months at the max) national banknotes will be introduced, and the company vouchers will trade at a small discount, and eventually vanish....

[Determinant]

Ian:

I used to live in rural Northern New Brunswick (there isn't anywhere that isn't rural) and that's a tad insulting to New Brunswick.

[david stinson]

g: "Somehow the wage/price levels have to adjust to economic reality, and any proposals not addressing this and foremost are just distracting."

Yup. Doesn't that require euro break-up?

[Nick Rowe]

Good Habit: That seems to me to be a reasonable sort of proposal. Almost certainly better than the alternative of disorderly breakup. Do you think Angela Merkel has the guts to do it? And the will to see it through? Because I think only Germany could force the issue.

Determinant; hey, Ian works in the service sector in Ottawa currently, so you can't really take offence!

[Good Habit]

Nick: Angela Merkel - and guts? - would come as a big surprise to me - she rather looks as the person who "honestly" believes that ALL countries should run trade balance surpluses... :(

[Too Much Fed]

Good Habit, have you seen this quote from merkel?

http://moneywatch.bnet.com/investing/news/german-ruling-could-complicate-euro-rescues/6291815/

"In an impassioned defense of the 17-nation euro, she told lawmakers that the euro meant more to Europe than just a common monetary zone, saying that no countries with a shared currency had ever gone to war with one another.

"The euro is the guarantor of a unified Europe," she said. "If the euro collapses, Europe collapses."

[Ian Lee]

Determinant - Nick beat me to it.

And BTW, the Baie de Chaleur is stunningly beautiful - but probably not near the top of the productivity list of countries or regions.

And, Portugal is a really lovely place - which made me immediately think of the Maritimes - as very little economic development, many traditional villages and a traditional way of life and good people. But like the Maritimes - and especially NB, lots of shiny new 4 lane highways - courtesy of the EU development ministry.

But Portugal and Greece are so very obviously to the naked eye, not even approximately competitive with Germany (which I have visted many times).

Why Greece and Portugal agreed to join the Euro is a complete mystery. A very ordinary meal in a very ordinary restaurant in Albufeira (not Lisbon) - that would cost $75 in Ottawa came in around $150 - when I converted back from Euros to CDN$.

On the main highway from Lisbon down to the southern coast, there were no factories - but farm after farm after farm. And a lot of what seemed to me to be poverty or at least no prosperity.

Most troubling, there were signs in very public places around Lisbon area, "Nazis - go home" in English.

[Good Habit]

"If the euro collapses, Europe collapses." That's what they all keep telling (and will probably achieve that way). It's just that politicians under no circumstances ever can acknowledge to have made a mistake - therefore, someone else must get the blame - and that's why they need to be able to go to war against each other to brake a currency union. And, of course, Merkel has no real clue about history - countries who have gone to war against each other didn't (mostly)continue to share a currency - but this didn't keep them off.

[K]

Good Habit: Not a bad attempt.  A few things to consider...

I like the idea of keeping the Euro around. The ECB already exists and can't be terminated just like that. So Euros could be something akin to IMF SDRs whose value would be based on the assets on the ECBs balance sheet (in a "real bills" fashion). The trouble is that most of those assets are Greek, Irish, Spanish, etc bonds whose real value would be quite a bit less than the current value of the ECBs (EURO) liabilities. Those liabilities are in large part owned by the Bundesbank which would take a major bath on this arrangement. German banks are going to end up in trouble. Fine, that's going to happen anyways, but it is a major political obstacle to grasping the proverbial nettle and it's going to cause a fight. (20 years ago they had to pay to bring the "Osties" into the 20th century. Now the Greeks. I suspect they are going to be *done* paying for a long time.)

Every contract has a sovereign legal jurisdiction. The only sane thing to do is to convert each contract into the currency of that jurisdiction (if that's what done with other domestic contracts), no matter where the counterparties are domiciled. Even sovereign debt is not always issued in the jurisdiction of the issuer. Such debt is subject to the laws of the the country in which it is *issued*. That country would reasonably convert it to *their* local currency or just keep it in international Euros in a way that is consistent with the way it handles every other domestic contract.  But if all 17 convert to local currency, I don't see that there would be many remaining international-Euro denominated contracts/debt. Likely remaining uses of Euros might be as transitional paper money, as a foreign reserve currency, and probably for OTC derivatives, almost all of which are governed by UK law.  The Euro would basically be gone from public view.

As far as bank deposits go, they should be converted to the currency of the jurisdiction of those deposits' sovereign regulator.

You'd have to expect to find it very difficult to do electronic FX trades for a while.  There is no way banks could be ready to handle international payments in 17 new currencies in 4 days so international trade would be halted for some time. And there'd be tons of trouble with settlements as banks and securities dealers update the currencies of all their securities positions. But you'd hope a market would develop for local currency (deposits, cheques, bank drafts, whatever) to paper Euros within a few days. Local paper money and possibly also electronic FX might follow within weeks? Certainly, there'd be a massive race to be the first to provide the first *extremely profitable* FX trading services. So probably it wouldn't be that long.

Over all though, it all seems like it would be OK, and the Euro just a distant *painful* memory within a year or two.

[g enauer]

"genauer" says:
@ nick, david,

"nu", I proposed Germany to leave the Euro, back 8/17 on kantoos, handelsblatt (in german language).
That didn't come lightly. I am a "European", "Atlantiker", and I was determined to make sacrifices a quarter century ago, if necessary, .... some 50 % devaluation is just laughable, in comparison.

But I think it is the best for all, to break up the Euro now.
I am a german physicist and bean counter : - ) and I read the UBS report carefully (http://www.scribd.com/doc/64020390/xrm45126). Germany should leave the Euro on 3 Oct 2011 (re-unification day) and EVERYBODY will be better off.

"If the euro collapses, Europe collapses." NOOOOOO ! some retrenching and reconfiguration is much better.

Let us go back to Prussian values: " Jeder soll nach seiner Façon selig werden" 1740 Frederick II.
Greece is doing its thing, and we do ours, and don't pay for them.

[rabbit]

Europeans have hitched themselves to the same monetary rope.

But mountain climbers know that doing so is a mixed blessing. It can mean that individuals are saved, but it also risks that everyone is lost, particularly if some of the climbers are completely inept (cough *greece* cough).

[John Thacker]

"The Americans need to stop beating themselves over the head with pro-cyclical spending cuts,"

Exactly what media have you been reading? The Americans haven't made any pro-cyclical spending cuts, or spending cuts of any kind. There have been promises to cut spending in the future, but no spending has been cut right now. There have been more spending cuts in the UK or Germany than in the USA.

The USA has stopped letting its deficit increase even more, but they haven't actually made any real spending cuts, despite all the talk.

Promises of spending cuts are as real as the promises to let the tax cuts expire.