Problems With The Euro:
Generally, Germany has a strong track record of improving competitiveness, productivity and moderating wage inflation. Germany has been able to grow relatively strongly and seeks above all to maintain it's strong commitment to low inflation. This objective has a large bearing over stance of ECB.
Economies on the periphery of the Eurozone, Spain, Ireland, Portugal, Italy and most dramatically, Greece don't have this same economic track record. The Greek economy has struggled under a burden of rising wages, not met by productivity gains. This is reflected in a large current account deficit and double digit unemployment.
The Southern Euro economies desperately need:
- A depreciation in the exchange rate to boost competitiveness.
- Monetary policy aimed at boosting economic activity and avoiding the threat of deflation and continued mass unemployment.
Quite simply, it is too difficult to use monetary policy for economies as divergent as Greece / Italy / Portugal and Germany. They need separate Monetary policies. To keep them in the same monetary and fiscal straight jacket will satisfy neither. It will only raise political tensions as there is a constant struggle between the conflicting demands of the different Euro Areas
The Problem of Debt.
The government debt problem has only exacerbated the tensions in the Euro. Unsustainable debt mountains in the south have put pressure on the Euro. There is no political appetite for German taxpayers to bailout the South - and who can blame them?
With Greece and others having to make drastic spending cuts, it becomes even more important that they have some recourse to an independent monetary policy.
It is important to bear in mind, that the problem of government debt is much worse when there is a threat of deflation to compound the real value of the debt.
Why Can't the Weak Members Just Leave the Euro?
Greece must wish it had never joined the Euro. But, as I explain here - Why Greece can't leave Euro. It is practically impossible for Greece to leave because it would cause an irreversible currency flight.
What Should Germany Do?
Germany could bite the bullet and promise to pursue European fiscal union. It could try hard to get a bailout of Greece, and anyone else who gets in too much debt.
The other option is for Germany to leave the Euro and have the freedom to pursue its own monetary policy and exchange rate. The D-Mark would be likely to appreciate quite significantly as it looks much more attractive than the Euro dominated by weaker southern states. It would give Germany a certain freedom from the debt problems of other countries.
Would This Solve the problems of the Eurozone?
It would be a mistake to blame for Euro and the common monetary policy for all the economic ills of Europe. The problems of Greece are far more widespread than a lack of independence over monetary policy and exchange rate. Greece would still need to tackle its long term uncompetitiveness, its bloated public sector, its addiction to government borrowing. If Germany left the Euro, all these problems would still remain.
However, the present crisis illumines the inherent difficulties of trying to promote a common monetary policy in an area as a geographically and political diverse as the Eurozone area.
The Eurozone simply doesn't have:
- Sufficient geographical mobility. Spain has unemployment of 20%, but, it is difficult for Spanish workers to move to other countries like UK, Germany to find work.
- Sufficient political will to pursue common fiscal budget.
The ideals of the European Union at promoting harmony amongst nations is admirable. But, the problem is that given the current state of European economies, the Euro will not promote harmony, but only increasing conflict as countries grow exacerbated at the conflicting demands of divergent economies.