Causes of the Euro Crisis

1. Causes of the Euro Crisis European Network Academy (ENA) of Social Movements Miguel Otero-Iglesias, ATTAC Spain Freiburg, 10 August 2011 (Working Slides)

2. Few Notes on Optimum Currency Areas • The Old Robert Mundell (1961) • Pessimistic view on Currency Unions • The problem of dealing with shifts in demand, so called asymmetric shocks without exchange rate movements • For this you need: • 1) Flexible wages • 2) Mobility of Labour • 3) Insurance mechanisms • A) Centralised Budget (public insurance) • B) Highly developed capital markets (private insurance)

3. Few Notes on Optimum Currency Areas • The New Robert Mundell (1973) • After the collapse of the Bretton Woods System in 1971 • Monetary Union is more efficient to cope with temporary asymmetric shocks than national moneys with exchange rate risk. (The important thing is integrated capital markets). • In the Flexible Dollar System, huge exchange rate movements can actually cause asymmetric shocks, MU acts as protection. • Since the Werner Report (1970), Europe has tried to fixed exchange rates (snake in the tunnel, European exchange rate mechanism (ERM) pegged to the ECU.

4. The Political Side of the Story • 1970s: High inflation and high unemployment (stagflation) • Bundesbank gains great reputation for keeping inflation under control • This despite the ‘dollar weapon’ used by the US • ERM becomes de facto a D-Mark zone, Germany increases its influence and power in the 1980s • Weaker countries try to regain competiveness through devaluations: last experience 1992 devaluations, collapse of the ERM • France accepts German reunification only if Germany agrees to form a monetary union • Germany sees some advantages: more protection against ‘dollar weapon’ and elimination of competitive devaluations

5. Different theoretical approaches on EMU • The ‘Monetarist School’: let’s start with MU and then we will achieve economic converge and OCA (French position) • The ‘Economic School: First we need economic convergence and OCA and then we can create MU (German position) • Introduction of Convergence Criteria: • Inflation needs to be kept under control • Debt levels: 3% budget deficit, 60% gross government debt to GDP • Inclusion in the ERM • Convergence in the interest rates • German position: You cannot have MU without political union, and political union is more than institutions

6. Orthodox understanding of the nature of money • Money has three main functions: • Unit of Account • Medium of Exchange • Store of Value • Ortodhox/metallist view: medium of exchange function is preponderant… (Ex. cigarettes in a concentration camp) • Hetherodox/nominalist view: the unit of account function is crucial (you cannot have money without a political authority behind it) • Bankers/investors favour the first, political economists point to the latter (especially in times of crisis and uncertainty) • History: Constant struggle between bondholders (creditors) and Governments (debtors) • Current EMU gives power to the bondholders and reduces power of the states

7. The Creation of an Orphan Currency “The Euro, probably more than any other currency, represents the mutual confidence at the heart of our community. It is the first currency that has not only severed its link to gold, but also its link to the nation state” Wim Duisenberg, President European Central Bank, 2002 • EMU was created with a fully independent central bank • And on top of this the ECB was not given the lender-of-last resort function (the no bail-out clause) • The idea was to avoid political interference in the managing of the currency • This has created an appreciation bias in the euro

8. Euro-Dollar Exchange Rate

9. European Bond Spreads

10. European Bond Spreads (II)

11. High indebtedness in the Periphery

12. Great Imbalances in the Current Account Balance

13. Public indebtedness has been constant

14. The problem has been mostly private debt

15. House prices rocketed

16. Inflation Levels in the EZ 1999-2007

17. The real exchange rate differs

18. Loss of competiveness in the periphery

19. But this is also the case in the US…

20. The Real Causes of the Crisis • The Appreciation Bias of the Euro = loss of competitiveness in the periphery • Huge imbalances between surplus countries (Germany, Holland, Finland) and deficit countries (Spain, Portugal, Italy) • Real Estate bubbles, especially in Spain and Ireland • Lack of macroeconomic coordination • Lack of supervision in the levels of private debt, and asset bubbles • Lack of a centralised budget to overcome asymmetric shocks • Lack of a pan-European debt market (Eurobonds) • Lack of a lender of last resort • Lack of jurisdiction on derivative markets and credit rating agencies

21. Conclusion • Monetary Union is flawed without political union behind it • There needs to be more macroeconomic cooperation to avoid internal imbalances • Germany needs to stimulate internal demand • EZ periphery needs to be more productive and competitive • The EZ needs to create a ministry of finance • The creation of eurobonds is also necessary • Apart from price stability there needs to be a growth strategy, especially for the periphery • The EZ needs to tackle the appreciation bias of the euro