You know that something is amiss in the world when the entire Greek civil service goes on strike as an indirect result of hedgefunds speculating against the Euro.
Perhaps an answer might be found in Gordon Brown’s reaction when questioned as to whether Britain might offer financial assistance to Greece, as now appears inevitable for Germany and perhaps other big beasts on the contintent: ‘This is a problem for the Eurozone and its a problem that the Eurozone members will have to deal with…’, he said with just a hint of smugness.
Quite. The UK is not a member of the Eurozone, for whatever complex political and economic reasons, and right now that is looking like a pretty good choice. It is often forgotten in these discussions that currencies, if allowed to, can serve an important role in providing economic feedback to the markets about the health of particular economy. Following the financial crisis, the UK economy was left in a bad way. Sterling depreciated rapidly against the Euro and to some extent the dollar. This naturally helped to make UK industry more competitive in terms of exports as well as encouraging more domestic demand for goods and services – or ‘import substitution’ (more people holidaying in Cornwall and Scotland than Spain for example). This, in turn, helped us with our budget deficit.
But Greece and other less robust European economies – Portugal, Ireland and Spain (the delightfully named PIGS) – have no such economic feedback. Instead, when their economies faltered, they had to borrow more and more in Euros to maintain public spending, with their native industries competing directly in terms of exports with economic powerhouses such as Germany and France.
The late ecological economist Jane Jacobs had a clever biological analogy describing this kind of situation. Imagine the Euzone countries as people each doing different kinds of activities – sleeping, swimming, playing tennis, collecting the rubbish – that require different amounts of oxygen. These people are properly equipped with diaphragms and lungs but share only one single brain and breathing centre. Their ‘brain’ receives consolidated feedback on the carbon-dioxide level of the whole group without discriminating among the individuals producing it. Everybody’s diaphragm contracts at the same time, with potentially catastrophic results.
The Eurozone is made up of discrete economic units at different stages of development. This worked more or less (although Italy would probably disagree) when the Eurozone was growing, as the larger states were happy to make up for the lack of natural feedback to their less developed cousins through large income redistributions and subsidies. But when a shock like the financial crisis hits the system and everyone faces budget problems, redistribution (or bail outs) suddenly becomes problematic and inefficient, with the danger of moral hazard raising its ugly head once more.
Leaving the Euro is not an option for PIGS – their debt is in Euros and this would not doubt trigger another financial crisis. Another option, suggested recently by Charles Goodhart in the FT and long-championed by nef, would be to allow the creation of dual currency systems in these states, following the example of California when it ran in to trouble and in Argentina during the Peso crisis of 2000. An internal Greek IOU currency could be created, to enable teachers and binmen to carry on working and businesses to continue internal trading, at a devalued rate against the Euro, reflecting more accurately Greece’s real exchange rate. It is a radical option but the alternatives don’t look promising – IMF style austerity measures resulting in mass unemployment and violent protest (the Greeks have a record on that) or a bail out which could permanently undermine the integrity of the Euro project.
Jacobs argued in ‘Cities and the Wealth of Nations’ that the City and its hinterland is the true economic unit and the optimum size for a currency in order to ensure efficient feedback and allow effective import substitution effects. We are a long way from that but the financial crisis has revealed the danger of the merciless pursuit of economies of scale – both in terms of the size of financial institutions like banks and now also currencies – at the expense of diversity and increased economic resilience.
Probably not what Gordon was thinking when he declined British responsibility for the Euro mess, but you can bet your bottom ‘dollar’ he’s glad the UK never quite passed those five tests.