This is (not) how European union ends: options

 Ireland is in trouble. Kevin O’Rourke has written an despairing piece on the country’s woes that is, I think, well worth reading. There is a good analysis of the situation up on Crooked Timber; the comments are well-worth reading. There seems to be some question about the extent of German banks’ exposure to Irish debts, private and sovereign. That matters: the less exposed the foreign banks, the easier a solution. (And yes, that is back-asswards from what you would think.) Tyler Cowen thinks the situation is doomed; he even thinks that a unified banking market (which would have helped a lot) is probably now off the table.

Interestingly, the bars in Southie are not full of discussions about the recent Irish loss of sovereignty, as opposed to an older one.  

 

Yesterday’s Financial Times had a nice recap of the E.U.’s options on page 2. Here they are:

1. Step up ECB bond purchases: this seems to have happened, according to today’s front page. They have succeeded in driving down the interest rate on Portuguese debt by 50 basis points, to 5.82%, and on Irish debt by 25 points, to 8.30%. What I doubt is that the ECB will do enough of this to actually produce any inflation, which would, if there was enough of it, solve the problem. Internal devaluation made easier in the periphery, deleveraging made easier everywhere. But German public opinion hates the idea, so what can you do?
2. Increase the size of the E.U. rescue fund: The fund is not big enough to allow Greece, Ireland, Portugal, and Spain to all simultaneously refinance their sovereign debt, let alone adding Belgium and Italy. (Estimates are that it is short €140 billion.) But Germany is opposed to expanding it, so that’s that. Plus, an expansion could trigger a crisis, by indicating that officials think a Spanish crisis is imminent. In other words, it should’ve been two or three as big to start with.
3. Issue eurobonds: Here the idea is that the E.U. countries would issue collective bonds for which they would all be responsible in some fashion. Basically a bailout in any other name. But as the FT author writes, “They would be seen as an unacceptable large step towards ...”
4. Greater fiscal union: Fiscal union is not going to happen. Even if it did, there would still be the problem of uncompetitiveness in places like Portugal and Spain ... although those could be worked out the hard way if the countries didn’t have to worry about sovereign defaults and the subsequent banking collapses that they could cause.
5. Nothing: “If none of the above works, talk could grow about the eurozone breaking up. But no eurozone policymaker seriously believes an exit by a country such as Greece would make its predicament any easier. ... Even if Germans became fed up with their neighbors, a return to the D-mark would also be economically catastorphic: the currency would soar, pricing its exporters out of business.”

Now, the part about Greece is not quite right. In the short-run, exit would be a disaster. But it would lead to an export boom down the line, and if the banking system had already collapsed then the costs would be relatively low. That however, is really a fairly weak nothing-left-to-lose argument: if we ever reach the point where leaving the eurozone is costless for a country, then that country has already been plunged into something as severe as the Great Depression. The real money line is the one about Germany, as discussed in the previous post: a wave of eurozone exits would devastate the German economy.

I had an idea for another option, but it slipped my mind. Anyone know what it might have been?

Comments

[Alex]

Higher wages in Exportland. The German trade unions are actually having some success implementing this off their own bat - the IG-Metall/Gesamtmetall settlement this year was damn good if you're a German steelworker (or any other kind of German industrial worker, as it acts as a price leader for all the other sectors), and the last lot of figures show a big rise in German consumer spending.

It would be better for everyone if the adjustment burden was split between the surplus and deficit states; if there's the equivalent of a 20% exchange rate gap, there's no reason why the Germans shouldn't meet the Spaniards half-way. Also, if we stipulate that the adjustment must come entirely from internal devaluation, this implies that the adjustment must be deflationary overall. We end up in balance, but at a lower level of national income.

If we relax that constraint, however...

As far as extra-eurozone trade goes, it's worth remembering that nobody ever bought a BMW because it was the cheapest car on offer. German (and Dutch, Finnish, etc) products typically sell because you can't get some kind of recondite and wonderful machine tool anywhere else (Siemens, Rohde & Schwarz, etc), or else because they are at least perceived to be the best in class (Porsche, BMW) or perceived to offer good value for the (high) price (Volkswagen).