November 30, 2011

Europe Is Not the United States

Martin Feldstein, writing for Global Public Square:

“European politicians who insisted on introducing the euro in 1999 ignored the warnings of economists who predicted that a single currency for all of Europe would create serious problems.”

Feldstein, who was Chairman of president Ronald Reagan’s Council of Economic Advisors, lays out several reasons why the single currency embraced by seventeen European nations over the last decade or so have led to the impending liquidity crisis. Fiscally conservative countries (those who maintain low deficits and debt, and carry a trade surplus) like Germany are now in the position of having to bail out weaker countries, like Greece and Italy, or see the Euro devalued and crumble.

The Euro is issued by the European Central Bank. What Feldstein doesn’t mention, and it’s not surprising considering his conservative credentials, is the ECB’s lack of monetary discretion. It can’t back the struggling peripheral nations with purchases of a “Eurobond,” because there is no unifying Eurobond. The individual nations must sell their own sovereign debt at market rates. The market is increasingly expressing its doubt about the weaker nation’s ability to service their debt, by requiring unaffordable interest rates.

Contrast that with the US Federal Reserve, which can and does exercise independent monetary authority by purchasing US government debt of varying terms, thereby influencing the interest rate on that debt. That action allows the Federal government to continue funding its operations at reasonable rates, unlike countries like Italy who are at the sole mercy of the worldwide bond market.

What’s more, the Fed can expand its balance sheet (“print money”) in order to extend its ownership of US debt, thereby allowing the Federal government to roll over expiring bonds with new, and equally low interest rate, issues. It can use its monetary authority to purchase toxic assets from illiquid banks, a practice which allowed such banks to clear their own balance sheets and remain solvent during the credit crisis of 2008-2009.

The unified Euro currency was a bad idea from the start, because it required EC members who adopted it to tie their fortunes to all other Euro-adopting countries without the means of tying those countries to a single fiscal (budgetary) policy. Europeans are simply not all on the same financial page.