E Pluribus Unum?: A Macro Economic Analysis of the Rise and Fall of Euro Zone Currency

Journalist Alen Mattich wrote in the 17 September 2010 edition of Wall Street Journal regarding the economic conundrum facing the Euro Zone with the imminent default of Greece on their national debt. His article, entitled “Trust Greece…to Default,” outlines the failing monetary policy of the Greek government and the quazi-demands for a national bailout made by Finance Minister George Papaconstantinou. If the Greek economy collapses absent perpetuated bailout from other powers, the European universal currency will collapse. The intrinsically diverse European economies, ranging from moderate command-and-control orientation to heavy market influence, defy conglomeration and governance with a single currency. The uniform currency experience has ended in disaster. Because the Euro Zone effort to implement a homogenous monetary policy in a heterogeneous international body is economically untenable, the Euro as a currency will collapse. In 1986, European countries gathered together to initialize the ‘perfectly integrated competitive market economy’, using principles developed by economist Robert Mundell in the 1960s. These concepts emphasize liquidity of physical and financial assets, flexible interest rates, comparable business cycles and asymmetric fiscal policies for use in creating seamless interaction between international bodies within the economic area. This ‘Euro Zone’ exists as the pilot project of sorts for these principles. In 1992, they developed their own uniform currency, predictably named the Euro. Issuance of the Euro marked the beginning of the end for the Euro Zone as an economic power. From the very beginning, the Euro concept suffered from fatal design flaws. Before passing in 2006, economist Milton Friedman ominously warned, “The euro is going to be a big source of problems, not a source of help.” The signing of the Maastricht Treaty of 1992 created the European Central Bank and a laundry list of restrictions and policies for the national governments within the Euro Zone. For example, national budget deficits should not ompose more than three percent of gross domestic product (GDP), and debt should not compose more than 60 percent of GDP. Unfortunately, even at the time of the initiation of these codes, the two biggest economic powers – France and Germany – already stood in violation of the codes and continue to maintain that status today without any fine imposed. At the point where the stabilizing principles necessary for perpetuation of the Euro remain violated without correction from the beginning, the viability of such a currency ought to be questioned. And the worst has not even arrived yet. Participation in the Euro Zone inevitably results in a strict limitation of national economic policies and creates an artifice of financial stability while, in reality, exacerbating the real problem. Variant currencies provide an invaluable reset function to markets during times of international economic flux. Currency values are inextricably linked to the economic status of a given country. Recessionary trends reduce currency exchange rates, while expansion increases those rates. In a recession, the resulting depreciation, while resulting in temporarily decreased real wages, both increases import prices and decreases export prices, stimulating a higher level of exports and boosting real GDP growth. Euro currency differs from other currencies in that it lacks the national flexibility. Being an international level currency, member nations must work their domestic policy within the constraints established by other members. As a result, the recovery process becomes entirely dependent on the domestic workforce. For most of the Euro Zone nations, existing social and labor policies restrict growth and perpetuate high levels of unemployment. This results in a longer lasting recession with devastating effects on the Euro currency. Economist Joerg Radeke writes, “The thing with the eurozone is that, unlike the U.S. or the U.K., there is not one reason why the economic performance is so bad but the reason differs from country to country. And therefore if is more challenging for policy makers to come up with the right action… a one-size-fits-all approach does not work very well.” Reports from the Euro Zone Statistics Office state that the Euro economy depreciated by 1.5 percent in the 4th quarter of 2008, an even greater drop than the US economy’s 1 percent, further confirms the currency conundrum the Euro represents. Business cycle analysis clearly points to the fact that during the expansionary phase, debt accumulated during the recession ought to be able to be paid off. Unfortunately, Euro Zone countries have failed to adhere to this principle, creating a scenario of extreme financial instability. “Stiff, inflexible Euro currency has prolonged the recession, only adding to the declining situation (ref. Appendix, Fig. 1). While the US real GDP is projected to grow by 2.6 percent this year, Euro Zone economies are projected to barely average a 1.7 percent recovery rate. Implications of this fact include higher unemployment for a longer period of time, increased debt levels, skyrocketing deficits and inflation and an overall devastating financial situation. All this initiated by the universal currency applied to the Euro area. Enter Greece. Euro currency and its effects on European economics have been discussed extensively; Greece is the case in point. Greece has accumulated national debt faster than all other members to finance generous social welfare schemes, despite collecting very few taxes due to widespread evasion (Ref. Appendix, Fig. 2). This endemic economic mismanagement has caused Greek goods to increase in cost and decrease in competitiveness, further reducing revenues. This vicious cycle has repeated itself to the point where Greek debt-to-GDP ratio reached 113% and deficit-to-GDP ratio reached 12.7% at the end of 2009 (Ref. Appendix, Fig. 3). Greece has gotten in deep, and its feet are snugly mired in the Euro’s restrictions and dragging the rest of the Euro Zone down with it. If individual currencies existed, Greece could perform serious plastic surgery on its economy, then re-enter the economic community as a new, if weak player, without affecting the other countries. Courtesy of the Euro, however, Germany and France, among other members, have seen the fall of the Euro hurt their domestic economies as well, and they are unable to control the cause of this decline. At the point where one nation’s poor economic management can decimate another nation’s economy, the currency scheme ought to be abandoned entirely; and promptly. Time is of the essence. The Wall Street Journal writes, “even with enormous rescue schemes and preferential interest rates, the Greek debt load is proving impossible to contain. The interest bill on its debt during the first eight months of this year was 7% up on the same period last year,” and concludes by noting that, “Ultimately, [the Greek government] will default.” It is that default that dooms all the other Euro Zone members to a double-dip recession. It is the untenable nature of the Euro currency when placed into an imperfect environment that warrants its discontinuation. One of the first topics learned in study of chemical solutions is that homogenous and heterogeneous solutions are immiscible, that is, they never mix. This principle ought to have been applied to the Euro currency, and is in desperate need of application today. This lack of flexibility, the uniform standards across a non-uniform area, the international tying of one nation’s economy to another’s all prove the immiscible nature of European economies. Greece testifies to the vulnerability of the system to one incident of mismanagement, and serves as strong evidence for abandoning the Euro currency. Greece will collapse, and the Euro with it. The pilot project failed to achieve stability. It has fostered a crisis. It ought to be discontinued.
Works Cited
Mattich, Alen. “Trust Greece…To Default - The Source - WSJ.” Wall Street Journal 17 Sept. 2010. Web. 14 Oct. 2010. “BBC News - GDP growth in 2011 to be slower than thought, says IMF.” BBC News 6 Oct. 2010. Web. 14 Oct. 2010.
Black, Stanley W. “The Eurozone Financial Crisis.” 7 May 2010. Web. 13 Oct. 2010.
Brownback, Sam, and Kevin Brady. “Lessons from the Euro Crisis.” 21 July 2010. Web. 13 Oct. 2010.
“Europe | A forward looking analysis of the global economy..” The World Bank Macro Economics Blog 12 July 2010. Web. 14 Oct. 2010.
Recknagel, Charles. “Euro Loses Strength As Eurozone Recession Deepens - Radio Free Europe / Radio Liberty © 2010.” Radio Free Europe 19 Feb. 2009. Web. 14 Oct. 2010.

Glossary

1. National Debt – The total of all accumulated federal deficits minus surpluses over time, or the total amount of U.S. government bonds outstanding.

2. Monetary Policy – Changes in the quantity of money used to alter interest rates and affect overall spending.

3. Fiscal Policy – Changes in government spending and taxes used to affect overall spending.

4. Bailout – The act of giving capital to an entity that is in danger of failing, in an attempt to save it from bankruptcy and/or total liquidation

5. Command-and-control – An economy in which the government answers all allocative questions, allows no individual ownership of resources and ultimate causes misallocation of recourses.

6. Competitive Market – An economy in which there are many buyers and seller of the same service, none of whom can influence the price at which the good or service is sold.

7. Currency – The paper or coins used for money, specific to the particular country or region

8. Liquidity – The speed at which an asset can be turned into cash without much loss of value

9. Interest rate – The price, calculated as a percentage of the amount borrowed, charged by lenders to borrowers for the use of their savings for one year.

10. Business cycle – The short-run alteration between recessions and expansions, it is a major concern of modern macroeconomic study.

11. Budget Deficit – The difference between tax revenue and government spending when government spending exceeds tax revenue.

12. Gross Domestic Product (GDP) – The total value of all final goods and services produced in the economy during a given year

13. Real wages – The wage rate divided by the current price level.

14. Depreciation – A decrease in price or value.

15. Recession – A period of economic downturn when output and employment levels are falling.

Appendix

Figure 1: Euro Zone economic recovery is consistently slower than that of the USA.

Figure 2: Greek national debt has skyrocketed over any other Euro Zone member, attributable to meager tax income.

Figure 3: Greek debt-to-GDP and deficit-to-GDP ratios have reached historic highs during the past few years, as efforts to stabilize its economy have failed.

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[ 1 ]. Milton Friedman, Nobel Laureate in Economics (July 31, 1912 – November 16, 2006), Interview w/ New Perspectives Quarterly Magazine, 2005.
[ 2 ]. http://www.rferl.org/content/Euro_Loses_Strength_As_Eurozone_Recession_Deepens/1496125.html
[ 3 ]. Ibid.
[ 4 ]. http://www.bbc.co.uk/news/business-11482589
[ 5 ]. http://blogs.wsj.com/source/2010/09/17/trust-greeceto-default/