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The Euro Doomed? No it is mismanaged and misunderstood

by on May 29, 2012

Ever since the Euro crisis it has been claimed that the Euro was doomed from the start. A BBC documentary presented by Robert Preston has made it almost common knowledge that the political construction of the euro is economically doomed because the European economies are dissimilar. I believe this is not true. The Euro can exist in its current form without Eurobonds, German Wage Inflation or ECB tinkering.

Ever since the creation of the Euro it was common knowledge that the European economies were all different. They all signed up to a stable currency in which price stability was crucial. It was common knowledge that rules were set to be adhered to precisely  to create a stable currency.  It was a political mistake not to enforce the rules and a  failure that countries breaking the rules were not punished with higher borrowing costs. It was not politician’s fault that the market miss-calculated and acted as if all European debt was equally risk free. Southern European debt has always been more risky than German debt and those that miss-calculated should now be making this loss. The Euro was and is not doomed. It was first miss-managed and simultaneously miss-understood.

As argued previously in Graduate Times “Why your hairdresser wants a Central Bank with a single mandate” price stability is one of the main reasons why currency is used a medium of exchange. Lowering a currency through inflation makes everybody poorer and lowering the exchange rate only benefits exporters but makes anybody importing less well off. Basically currency manipulation is a subsidy for exporters. The real means of becoming competitive is not devaluing the currency, but increasing productivity through increasing efficiencies and finding new opportunities.

The argument is that Europe is too economically diverse to have a single currency, is flawed too. Economic diversity not that relevant to the currency. Look at any developed individual country inside (or outside) Europe. These individual countries are as economically diverse as Europe. The north German economy is different to the south, the west again is different to the east. The same can be said for France, UK, The Netherlands, Belgium, Italy etc. Germany may be the motor of the European economies but every single individual economy has its own motor but it does not have its own currency. London does not have a separate currency to Newcastle, nor does Naples have a different currency to Milan.

Within a single currency competition is not fought through subsidies, but productivity. Germany has gone through painful decades making it more productive and in the process more competitive. A politically easier option would have been to artificially make it more competitive through increasing inflation or devaluing its currency, but it chose to do it the sustainable (fair) way through wage moderation, labour reforms and budget tightening. Germany should now be reaping its rewards. It will be a painful path to follow and some countries may not be willing and able, but the only road to growth is increasing economic productivity through real economic competition without tax payer and government meddling.

Those who fail, will try to increase their productivity the artificial way.  This was through devaluation, inflation and ultimately tax payers money. This too is painful, especially if one considers the subsequent break down of financial reputation. This reputation will take years if not decades to rebuild.

The lesson: credibility is needed. As for the US in the 1840’s states will signal their own creditworthiness by including balanced budget amendments and signing other agreements such as the stability pact. To stick to these agreements will mean tough love.  It is not the single currency within a diverse economy that is a problem. All currencies operate within diverse economies it is the way the single currency was miss-managed and miss-understood. All that is required is the rule of law and some tough love to signal creditworthiness.

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