The Eurozone crisis has played out like a slow-moving Greek tragedy. The European political elites who created the Euro in the 1990s were warned of problems inherent in their plans, but they ignored these warnings. Once the problems came to a head, European politicians dealt with each new problem in a haphazard way that temporarily postponed the worst, but was not enough to end the overall crisis. Unless this approach changes, the outcome could potentially be disastrous, not only for Europe, but for the world. The United States should intervene in hopes of precluding this dire possibility.
The current crisis is largely the result of two predictable flaws of the Eurozone — one financial, the other relating to exchange rates.
The latter problem is rather straightforward. Prices and wages in peripheral countries like Greece and Spain are high relative to prices and wages in core countries like Germany. As a result, countries like Germany are running large trade surpluses compared to countries like Greece, which is part of the reason that the economic downturn has been far more severe in countries like Spain than countries like Germany.
If Spain and Greece had different currencies than Germany and their exchange rates were flexible, there would be no problem — Spain and Greece’s currencies would fall in value relative to the German currency. This would then increase demand for Spanish and Greek goods, thereby increasing employment in Spain and Greece. However, the existence of the single currency precludes the possibility of devaluation. As a result, peripheral countries like Spain and Greece will probably suffer several more years of deflation and high unemployment.
The Eurozone’s financial problem is more complicated. When you deposit a dollar at the bank, the bank promises to give you that dollar on demand, but the bank does not actually keep that dollar in its safe — instead, the bank only keeps a few cents on hand and lends the rest out. Your deposit at your bank is nothing more than an IOU.
The reason that you consider a bank deposit to be worth as much as the money in your wallet is that the federal government guarantees your deposit. Since the federal government controls the supply of dollars, there is no question about its ability to guarantee bank deposits. In countries that use the Euro, this is not the case. The Irish government guarantees Irish bank deposits, but it does not have control over its own currency. Today, many Irish depositors reasonably wonder whether the Irish government will be able to repay its own debts. If it cannot do so, it will not be able to repay Irish banks’ debts, either.
As a result, banks in countries like Ireland and Greece have been experiencing a slow-motion bank run for over a year now. These countries’ citizens have realized that a bank deposit that is guaranteed by the Greek or Irish government simply is not worth as much as a bank deposit that is guaranteed by the German government. Thus, Greek and Irish citizens have been withdrawing their domestic bank deposits and depositing their money in other European countries instead.
While the Euro should never have been created, it would probably be far too costly to allow a break up now. Given that Greece is insolvent and several other countries will need the backing of their stronger peers in order to avoid contagion, the solution is clear: Greece will have to default in an orderly fashion, and countries like Germany are going to have to put up a lot more money — probably well over 1 trillion Euros — in order to guarantee the debts of countries like Spain and Italy.
If this doesn’t happen, and financial markets lose confidence in the creditworthiness of a government like Italy’s, the ensuing financial crisis would wreak havoc not only in Europe but probably also here in the United States. Perhaps, in a gesture of support, the U.S. federal government should offer to put up some of the money necessary to guarantee European sovereign debt, with the intention of helping convince the German government to finally offer the monetary amount truly needed to prevent the crisis from spreading.
Would it be unfair for American taxpayers to partly be on the hook for a crisis almost entirely of the European political elite’s making? Yes, but the alternative is quite possibly far worse.