The European monetary union is being held together tenuously. After putting €110bn. on the line to save Greece earlier this year, the tab increased by €85bn. as Ireland reluctantly accepted a recent bailout package. While the €750bn. shield brokered by the IMF and EU member states seemed adequate not even one year ago, the outlook grows gloomier by the day. Instead of questioning whether the fund is large enough or has the authority to act quickly enough in an emergency, we should reassess what the original purpose behind it was.
Germany fronted almost €120bn. for the fund, over €1,500 for every German man, woman and child. While it is perhaps not surprising that the EU’s largest economy and population pledged the most support, Germany faces a much starker rationale. The survival of the EU relies on the survival of its periphery. A strong German-centric EU will need help from its core to realize this future. Survival of the periphery, however, may not be in any one individual country’s best interests. So goes the common argument for the maintenance of Europe’s political and monetary unions.
In a recent commentary Mohamed El-Erian points out that the continued support of the periphery is straining Germany’s balance sheet. German government bunds have seen their rates surge over the past weeks, despite the country’s continued dedication to austerity. It shares the same fate as its periphery, without any of the “benefits” of a German funded bailout.
Luckily for the Germans, they largely control a key tool to Europe’s future – the European Central Bank. By continuing to purchase periphery (PIIGS) debt, El-Erian reckons that the ECB can alleviate Germany of this increasingly burdensome role. What he misses are the implicit costs that will result, as well as the promotion of dangerous consequences already in place.
The choice Germany faces is not between straining itself fiscally or inflating its problems away via the ECB. Germany may opt to exit the Eurozone, thus avoiding the bureaucratic costs of its less prudent neighbors. Indeed, after Berlin passed an €80bn. austerity package earlier this year, other Eurozone countries continued their prolific spending programs. The EU’s Treaty of Maastricht “strictly” prohibits member state deficits greater than 3 percent of GDP except for exceptional and temporary circumstances. The Irish deficit could reach 14 percent of GDP this year. Greece is close behind at 13 percent. Although the circumstances affecting these countries do seem exceptional, they are increasingly reckoned as anything but temporary.
Troubled counties such as Ireland would do well to exit the Eurozone to allow their currencies to devalue in an attempt o regain a competitive advantage. Germans will also find their own exit positive.
Continuing to fund bailout packages for less prudent neighbors is not a sustainable nor equitable situation for the Germans to be in. Turning to the ECB to inflate the problems of these periphery countries may be a short-term fix, but at what cost? Germans would be “punished” for not directly bailing out their neighbors with an inflated currency.
While every German man, woman and child has already had to fund the European Financial Stability Facility to the tune of €1,500, an inflated euro would decrease the value of every hard earned euro not already pledged. El-Erian correctly concludes that “The situation this time suggests good economics should play a greater role. Rather than simply doubling up on a faltering liquidity approach, the time has come for Germany to lead a more holistic solution focused on addressing the periphery’s debt overhang and competitiveness problems.”
An exit from the Eurozone and abandonment of the euro would do much to allow individual member states the necessary currency readjustment to regain their competitiveness. Euro membership could be a beautiful thing if it meant that member countries followed the rules – reduce or eliminate deficits and not promote inflationary solutions. Germans, indeed, should quit funding unsustainable situations with bandage solutions, and instead focus on the root problem. The German dilemma between fiscal bailouts and inflation need not necessary cause European-wide problems. A third option exists. Exiting the common currency would do much to remove the root of these problems, both for Germany and the periphery.
