A not entirely accurate map Credit - Wik

This is really rather impressive from Phillip Inman in The Guardian. He’s managed to line up all the evidence in a row, to prove how the euro is responsible for varied calamities, then use exactly that evidence to deny that the euro is responsible. If this is how well the national newspapers talk to us about economics then what hope for public policy, eh?

To quote at length so you can grasp the full horror:

A quick look at the financial crisis and its impact on the euro area shows that there were several countries found with their pants down when Lehman Brothers went bust. Ireland, Spain and Portugal were especially hard hit.

Yet none of these countries blamed the euro for their ills. The Irish realised that they had binged on euros – borrowed at rates previously only available to bigger AAA-rated countries – to generate a property boom of extraordinary proportions, pay public sector workers as if they were commercial marketing executives and generally live high on the hog.

When the government of the day pushed through some of the most eye-watering austerity measures anywhere in Europe, the lack of equality in its impact was decided in Dublin, not Brussels.

The Spanish also spent oodles of cheap euros on a property boom and a ludicrous obsession with infrastructure that meant it either built or planned 30-plus international airports, most of which were scrapped or mothballed.

How could Madrid blame others for this frenzied attempt to escape its relatively recent agrarian past and enter the 21st century in supersonic style? These were homegrown decisions.

The Irish and Spanish property disasters were driven by interest rates. Interest rates were determined by euro membership. The two booms – and thus the subsequent busts – were entirely caused by the euro. Spain actually did pretty much everything right except for those interest rates.

To retreat back into basic theory. To have the one currency over a wide area is a good idea as it means that we’ve a common unit of currency to trade over that wide area. This increases efficiency as the ability to divide and specialise depends upon the size of the market. As it turns out this expansion of the euro across a larger area wasn’t all that powerful an effect. The Single Market was – the currency not so much. Both expanded that area across which we could divide and specialise, the currency being such a minimal addition that most studies of the effect find it near or around zero. Nice in theory not so much of an issue in reality.

To have the one currency over a wide area is a bad idea as it also means that we’ve the one risk free interest rate over that area. And the wider the area the more likely it is that there will be asymmetric economic conditions requiring different monetary policy and interest rates. Forcing just the one policy on all of that wider area could be non-optimal.

Which is what gives us optimal currency areas – what’s the area across which that first – and other such – effects produce benefits before we get to an area so large that the dis-beneficial effect predominate and the net effect is to hinder economic growth?

The answer is that the eurozone is very definitely too large to be optimal. Our proof being those Spanish and Irish property booms. For, at euro introduction, the German economy was really rather poorly. So, interest rates across the entire eurozone were pretty low. That’s obviously how it’s going to be as well – even if we weight matters by size of economy we’re going to end up setting -zone interest rates to favour the largest part(s) of our combined -zone. Which is what was done.

Those euro rates were vastly too low for both Ireland and Spain. Which triggered those property booms. Spain even did the right things as well. Raised deposit requirements, increased the capital banks must hold against mortgages and all that. And still the effect of too low interest rates created the mother of all property booms.

The proof of the shiteness of the eurozone is not the crash, it’s those booms before it.

Now note again what Mr. Inman does. Gives us that evidence and then insists that the euro had nothing to do with it. Entirely the opposite of the objective reality. And as I say, if this is what is pumped at us by the national newspapers then what hope decent economic policy?

Do note that even Gordon Bloody Brown managed to get the economics right here, his five tests for euro membership were concentrated on exactly this point. Monetary union demands interest rate union and there’s just no way that economies as divergent as Spain, Germany and the UK are going to be in lockstep as to what interest rates should be. Therefore monetary union is non-optimal.

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  1. You’re still missing a bit, Tim. The UK, USA, Canada are all examples of common currency areas that are too big, with very divergent regional economies and interest rates (and exchange rates) set at levels that in one part feed a bubble while another part is in recession. What makes them work – and is missing in the eurozone – is a mechanism to transfer money from boom parts to bust parts and (maybe stating the bleeding obvious) a political consensus that accepts those transfers and desn’t rumble up into separatist revolt. The second part is important, because not only does the eurozone not have the money-transferring power it would need, it can’t get that mechanism because it’s not politically acceptable in Germany or Holland. So they’re stuck.

    • The second part is important, because not only does the eurozone not have the money-transferring power it would need, it can’t get that mechanism because it’s not politically acceptable in Germany or Holland. So they’re stuck.

      It is this second part that will be the salvation of Europe (although probably not anytime soon), since it creates paralysis and acts as a roadblock to a fully federal Europe (one not supported by the populations in those countries which is why they are not allowed a vote on it).

      I’m a great believer that these very issues will cause either the collapse of the European project or at the very least its retreat back to the initial Western European countries which do share the same fundamentals. There is no way that the Germans will cough up for Spanish or Greek public sector pensions (which is what transfer payments ultimately mean in the EU context), but a smaller EU made up of the Scandies, Germany, Holland, France and Austria might be able to work, although they’d still have to cough up for the inefficient French farmers, that’s been a given since the project started.

      More likely though the EU will go the way of the League of Nations.

    • Well, no, I’m not missing it, I’ve said it often enough. Just didn’t point it out this particular time. Sure, a fiscal transfer union expands the optimal currency area.

      I did actually once point out, at a EU conference style thing, that the only way it would all work was if Germany really was paying Greek pensions. Both the Greek and German reps there were incandescent with rage at it being pointed out.

      • But essentially, the only thing which will enable an expansion of the currency area is transfer payments from the rich areas to the poor areas in the hope that over time a state of equilibrium will be achieved.

        Thus through a process of transformation akin to alchemy the Germans will become more Greek (i.e. consume rather than save) and the Greeks will become more German (i.e. save rather than consume).

        I’m not saying it’s impossible, this being an infinite universe / multiverse, but I find it highly unlikely.

        Equally, politicians seem to rage most about the thing they would secretly like to do but know their own electors would kick them out if they suggested it. Which is exactly why the EU is setup the way it is, so that the difficult and unpopular decisions are made by the unelected bureaucrats / technocrats, rather than the elected ones.

        All seems a bit 1930’s if you know what I mean…

        • I have been reading “transfer payment” and thinking industrialist-to-basement-dweller transfer, rather than Germany-to-Greece transfer. And yet, see my Ecuador counterexample below. A currency union among nations accustomed to sucking the value out of their currencies, requires them to suck at the same rate. It works fine when a nation agrees not to suck at all.

  2. I agree very much with your article, Tim, as well as Hallowed Be and napsjam. And William Hague highlighted it in his “burning building with no exits” analogy. When in discussion with Remoaners, a question such as “What do you consider to be an optimum currency area?” leaves them looking blank, but has to be the basis of the Euro. Brussels blatantly ignored economic evidence (and even EU rules) which were screaming a the not to go ahead, but, well, we know how it turned out, don’t we?

  3. Politics will always trump common sense. Locally we need the main road upgrading to dual carriageway. I’m arguing that yes, it needs to be done up to the point where it splits in two to serve the two towns. Most everybody else is demanding it be twice as long continuing right up to the front door of the town hall.

  4. Tim makes a good case that, after the dynamic effect of removing trade barriers, a common currency is a minor added positive. The problem with the euro is the attempt to use it to create the usual Keynesian roller coaster. Unfortunately, the countries in question have shown that, without the euro, they would suck the value out of their own national currencies with no pretense toward un-inflating in future good times.

    By the way, “infrastructure” is usually a leftie worship word for more federal “work” projects. It’s amusing to see Inman carp about “a ludicrous obsession with infrastructure” in Spain — though the real problem is nearby, at “oodles of cheap euros”. Political interference with interest rates set the price of money wrong and induced millions to make wrong decisions.

    Napsjam writes that the US is an “example[] of common currency areas that are too big” but is wrong on several counts. Our “very divergent regional economies” do trade with each other and this is made easier by a common currency. “Divergent…interest rates” is baloney, as the interest rate is overwhelmingly determined by the Fed’s management of the dollar. That the Northeast is crawling back to life while Galveston is flooded by a hurricane does not call for different units of measurement. And the solution there is that Americans work together, prices mostly are allowed to adjust to account for scarcity, and the permit-granters of the Federal Emergency Management Agency are mostly unable to keep aid from flowing into the disaster area. “What makes them work…is a mechanism to transfer money from boom parts to bust parts and…a political consensus that accepts those transfers.” No, sir, what makes the dollar-zone work is not welfare but the fact that gunpoint wealth transfers are still of lower magnitude than wealth earned by producing it.

  5. Spike, I do know that interest rates are set federally and don’t diverge within the United States. A pedant or just a more careful typist would have put a comma into “very divergent regional economies, and interest rates (and exchange rates) set at levels …” It’s having the single interest rate, and the single foreign exchange rate, that raises the tension that then needs to be solved. I respect your view that the problem is solved by American free spirit and enterprise, and only note that, for example, Mississippi received $7 billion in federal aid in 2014, which must help a little bit (link if needed – and I’m no fan of USA today, it’s just what popped up – https://eu.clarionledger.com/story/news/politics/politicalledger/2017/07/25/mississippi-federal-revenue/509246001/).

    And Tim, apologies. should have said the article doesn’t say rather than you missed…

    • Amount received in federal aid should be set against amount paid in in taxes. The net amount is not dominant in the economy of Mississippi.

      A common currency over a large geographical area is not a call for transfer payments over a large geographical area. Welfarism does not make the dollar possible or even easier, and it induces people to waste resources inventing excuses and lobbying government. In Puerto Rico, which Google, Elon Musk, and the US government are propping up because, a year after a debilitating hurricane, its corrupt government has still not completely restored utilities, the use of the dollar makes things a bit easier than if Puerto Rico used the bolivar. It also precludes theft-by-inflation locally, though enabling it nationally.

      A useful experiment would be the widespread use of an international currency, whose utility as a store of value would be guaranteed by an outside party. (Bitcoin ain’t it, as it offers no good guarantees against hyperinflation or self-dealing.)

      • Not sure what welfarism is, but I’m pretty sure I’m against it. It looks like Mississippi gets $3 from the Feds for every dollar it pays out, so again, it must help smooth things out. I’m certainly not saying transfer payments make everything great, but you can’t run a big currency area without them. Or even a pretty small one – Belgium was too big, the United Kingdom certainly is – maybe you need to be Luxembourg-sized. They of course bring risk, and need to be limited and used with caution, but they have to be there.

        • “you can’t run a big currency area without them” – But the United States did, for over a century, before it saw fit to try to “run” it. The choice of a unit of measurement has nothing to do with the choice of social policy.

          What is the “right size” for the zone employing either English or metric measurement? That’s an equally silly question, but especially because no government asserts the right to define a foot as thirteen inches during an economic depression. If we had guarantees that the government would not use sophistry to rejigger the value of the euro or the peseta — if we followed Milton Friedman and replaced the Fed with an algorithm — a single currency would be suitable for use globally.

          • Sure. Just use gold, accept the pain, and people will adjust. Meanwhile, in the world as it is, Tim’s right. No idea why you think language or measurement are relevant, or who you think asked what the right size currency area is. Not me. I suppose, if i try to think about it, it’s an area where either you don’t need transfer payments or you have the political consensus to make them, and qualifying for either one can change over time.

          • You can’t run a modern social economy in a big currency area without them.

            Sure, if you have no payments from one group to another, but that’s not a modern social economy and it is very difficult to see when it wold be in the future.

          • Napsjam, sorry, but I am in the real world, and there is greater pain with fiat money than with the occasional upheavals in the price of gold. I was not talking about language; let me add a word: “English measurement or metric measurement”. Why is this a good analogy? Because currency is measurement, it is the units by which we reach the right answer to economic questions. So the right size of the area without the need to convert from dollars to pounds is as pointless a question as the right size of the area without the need to convert from feet to meters. It would be somewhat more efficient never to have to convert at all, but other factors are more important, such as the recurring tendency to ruin a currency.

            Sorry if my notion of a world without coerced transfer payments made my post hard for you to grasp, but your original statement that coerced transfers make a large single-currency area work is unconnected to anything but a personal belief that every nation needs them.

            For example, the “dollar zone” includes Panama (by linkage) and Ecuador (entirely). The latter two countries cede the power to inflate the dollar, and tie themselves to any inflating the US might do, without any gain for themselves. The US did not pay them to make this decision, and did not pay them to make it continue to work. Nor did the US charge them for their use of the dollar. The result for them is greater stability than any nation in the region has printing its own currency. That is, it works, even though this “currency zone” is large, noncontiguous, and the countries in it are very different.

  6. “Spain actually did pretty much everything right except for those interest rates.”

    That is a little overgenerous. The local banks in particular (the caja) were corrupt/political to a great degree, and built where building brought votes in return for being allowed to build where building brought profits, regardless of regulations, restrictions and so on. That led to serious trouble for a number of them when the financial crisis hit. The “profits” were often funneled to politicians and others in order to keep the building boom going. Central government did nothing as each party had its own group of cajas that it relied on.

  7. I think you are a little hard on Phillip Inman. There is, after all, no career path in trying to explain economics to Guardian readers. The same is true of readers of The Register, as you will recall.

    As Thomas Sowell almost said, if Guardian readers understood economics, they wouldn’t be Guardian readers.