by Prof. Rodrigue Tremblay
July 14, 2011
Dr. Rodrigue Tremblay is a
professor of economics (emeritus) at the University of Montreal and
a former Minister of Trade anbd Industry in the Quebec government.
He is the author of “The Code for Global Ethics, Ten Humanist
Please visit the book site at: TheCodeForGlobalEthics.com/
Send contact, comments or commercial reproduction requests (in
English or in French) to: firstname.lastname@example.org
“If you can't explain it simply, you
don't understand it well enough.”
Albert Einstein (1879-1955), German-born
theoretical physicist and professor, Nobel Prize 1921
“It is incumbent on every generation to pay its own debts as it
goes. A principle which if acted on would save one-half the wars
of the world.”
Thomas Jefferson (1743-1826), 3rd President of
the United States (1801-09)
"Having seen the people of all other nations bowed down to the
earth under the wars and prodigalities of their rulers, I have
cherished their opposites, peace, economy, and riddance of
public debt, believing that these were the high road to public
as well as private prosperity and happiness."
Thomas Jefferson (1743-1826), 3rd President of
the United States (1801-09)
On the 4th of July, the credit agency Standard & Poor called
Greece what it is, i.e. a country in de facto financial bankruptcy.
No slight of hand, no obfuscation, no debt
reorganization and no “innovative” bailouts can hide the fact that the
defective rules of the 17-member Eurozone have allowed some of its members
to succumb to the siren calls of excessive and unproductive indebtedness, to
be followed by a default on debt payments accompanied by crushingly higher
Greece (11 million inhabitants), in fact, has abused the credibility that
came with its membership in the Eurozone. In 2004, for instance, the Greek
Government embarked upon a massive spending spree to host the 2004 Summer
Olympic Games, which cost 7 billion Euros ($12.08 billion).
Then, from 2005 to 2008, the same government
decided to go on a spending spree, this time purchasing all types of
armaments that it hardly needed from foreign suppliers. Piling up a gross
foreign debt to the tune of $533 billion (2010) seemed the easy way out. But
sooner or later, the piper has to be paid and the debt burden cannot be
Greece's current financial predicaments (and those of other European
countries such as Spain, Portugal, Ireland and even Italy) are not
dissimilar to the ones Argentina had to go through some ten years ago. In
each case, an unhealthy membership in a monetary union of some sort led to
excessive foreign indebtedness, followed by a capital flight and a crushing
and ruinous debt deflation.
In the case of Argentina, the country had decided to adopt the U.S. dollar
as its currency, even though productivity levels in Argentina were one third
those in the United States.
An artificially pegged exchange rate of one
peso=one U.S. dollar held for close to ten years, before the inevitable
Indeed, membership in a monetary union and the adoption of a common currency
for a group of countries can be a powerful instrument to stimulate economic
and productivity growth, with low inflation, when such monetary unions are
well designed structurally, but they can also turn into an economic
nightmare when they are not.
Unfortunately for many poorer European members of the euro monetary union,
the rules for a viable monetary union were not followed, and its unraveling
in the coming years, although deplorable, should be of no great surprise to
anyone knowledgeable in international finance.
What are these rules for a viable and stable monetary union with a common
First and foremost, member countries
should have economic structures and labor productivity levels that
are comparable, in order for the common currency not to appear
persistently overvalued or persistently undervalued depending on any
particular member economy. An alternative is to have a high degree
of labor mobility between regional economies so that unemployment
levels do not remain unduly high in the least competitive regions.
Secondly, if either one of the two above
conditions is not met (as is usually the case, since real life
monetary unions are rarely “Optimum Currency Areas”), the monetary
union must be headed by a strong political entity, possibly a
federal system of government, that is capable of smoothly
transferring fiscal funds from surplus economies to deficit
economies through some form of centrally managed fiscal equalization
This is to avoid the political strains and uncertainty when the
standards of living rise in surplus regional economies and drop in
regional deficit economies. Indeed, since the regional exchange
rates cannot be adjusted upward or downward to redress each member
country's balance of payments, and since the law of one price
applies all over the monetary zone, this leaves fluctuations in
income levels and employment levels as the main mechanism of
adjustment to external imbalances.
This can turn out to be a harsh
Indeed, such a system of income or quantity adjustment rather than
price adjustment is somewhat reminiscent of the way the 19th century
gold standard used to work, albeit with a deflationary bias, except
that it was expected to have price and income inflation in surplus
countries and price and income deflation in deficit countries,
caused by money supply expansions in surplus economies and money
supply contractions in deficit economies.
In a more or less formal
monetary union, we are left with income inflation and deflation
while the central bank holds the rein on the overall price level.
A third condition for a smoothly
functioning monetary union is to have free movements of financial
and banking capital within the zone. This is to insure that interest
rates are coherent within the monetary zone, adjusted for a risk
factor, and that productive projects have access to finance wherever
they take place.
In the U.S., for instance, the highly liquid federal funds market
allows banks in temporary deficit in check clearing to borrow
short-term funds from banks in a temporary surplus position.
Canada, large national banks have branches in all provinces and can
easily transfer funds from surplus branches to deficit branches
without affecting their credit or lending operations.
A fourth condition is to have a common
central bank that can take account not only of inflation levels but
also of real economic growth and employment levels in its monetary
policy decisions. Such a central bank should be able to act as
lender of last resort, not only to banks, but also to the
governments of the zone.
Unfortunately for the Eurozone, it currently
fails to meet some of the most fundamental conditions for a smoothly
functioning monetary union.
Let's look at them one by one.
First, labor productivity levels
(production per hour worked) vary substantially between the member
states. For example, in 2009, if the index of productivity level in
Germany was 100, it was only 64.4 in Greece, nearly one third lower.
In Portugal and Estonia, for instance, it was even lower at 58 and
47 respectively. What this means is that the euro, as a common
currency, may appear undervalued for Germany but overvalued for many
other members of the Eurozone, stimulating net exports in the first
case but hurting badly the competitiveness of other member
Secondly, and possibly an even more
important requirement, the Eurozone lacks the backing of a strong
and stable political and fiscal union.
This leaves fiscal transfers
between member states to be left to ad hoc political decisions, and
this creates uncertainty. In fact, there are no permanent mechanisms
of equalization payments between strong and weak economies within
For this reason, we can say that there is no permanent
economic solidarity within the Eurozone.
Thirdly, the designers of the Eurozone
elected to limit the European Central Bank to a narrowly defined
monetary role, its central obligation being to maintain price
stability, while denying it any direct responsibility in stabilizing
the overall macroeconomy of the zone and preventing it from lending
directly to governments through money creation, if needs be.
this reason, we can say that there is no statutory financial
solidarity within the Eurozone.
Finally, even though capital and labor
mobility within the Eurozone is fairly high, historically speaking,
it is far less secured, for instance, than it is the case with the
American monetary union.
In retrospect, it seems that the creation of the
Eurozone in 1999 was more a political gamble than a well-thought-out
economic and monetary project.
This is most unfortunate, because once the most
estranged members of the zone begin defaulting on their debts and possibly
revert to their own national currencies, the financial shock will have real
economic consequences, not only in Europe, but around the world.
Many economists think that the best option for Greece and the rest of the EU
should be to engineer an “orderly default” on Greece’s public debt which
would allow Athens to withdraw simultaneously from the Eurozone and to
reintroduce its national currency, the drachma, at a debased rate. This
would avoid a prolonged economic depression in Greece.
Refusing to accept the obvious, i.e. an orderly default, would please
Greece's banking creditors but will badly hurt its economy, its workers and
its citizens. That's what bankruptcy laws are for, i.e. to liberate debtors
from impossible-to-repay debts.
Of course, the most debt-ridden nation on earth is not Greece,
Let me say this as a conclusion:
If American politicians do not stop playing
political games with the economy, a lot of Americans are going to suffer in
the coming months and years, and this will spill over to other countries.
With Europe and the United States both in an economic turmoil, this is very
bad news for the world economy.