A (true) European currency Fund is a necessity

The crisis calls for counter policies all of Europe. There would be for many years ahead some countries with structural deficits (‘catching up’ countries) and countries with a structural surplus (the more mature economies). It is difficult to understand that a European Monetary Fund was not established contemporary with the EMU.

Money is, right now, pouring out of public funds in all EU countries.  It is a consequence of the recession that has hit all over Europe.  Both strong and weak economies are experiencing a rise in unemployment.  Fortunately, the automatic stabilizers on the public sector’s budget mitigate some of the social costs experienced by households and businesses affected by the economic crisis. It is therefore entirely 'by the book' that government budgets have gone into deficit in all EU countries. It is precisely in the recognition that the EU Commission has temporarily suspended the Stability Pact's requirement that the deficit of public budgets should not exceed 3 percent  of gross domestic product (GDP). 

 The crisis calls for counter policies all of Europe. A number of countries outside EMU have used monetary and exchange rate policy to put their economies back on track.  This opportunity, the countries within the EMU, does not have.  They must follow the common monetary and currency policy, which creates very unequal opportunities, depending on whether countries have or have not a balance of payments deficit, cf.  Figure 1  The northern European EMU countries have solid surpluses, while the southern European countries have very large deficits which make foreign debt to rise with alarming speed. 

Countries with a balance of payments surplus do not have to worry about their public sector deficit as long as the total public debt has a manageable size. Take for instance Germany. She does not have to reduce her public sector deficit of approx.  5 per cent. more quickly than the overall economic development requires. As long as there is a balance of payments surplus the government can finance its deficit by domestic borrowing – typically from the private pension funds, which have a financial surplus. When employment improves at a later stage the budget will due to the automatic stabilizers improve by itself. As the British economist John Maynard Keynes put it some seventy years ago: ‘Look after employment, then the budget will look after itself. The strong German international competitiveness, inter alia,  reflected in the solid balance of payments surplus will ensure that the German economy inevitably will benefit strongly from the international recovery and sooner or later increase employment and reduce the budget deficit.

Perhaps this explanation sounds too simplistic?  For how should the German government be able so easily to finance the huge deficits it runs while recession is on?  The answer can best be dealt with using some simple accounting principles, based on double-entry bookkeeping.  Here it is an unconditionally accepted principle, that a deficit in one sector, without exception, will be matched by a surplus of similar size in at least one other sector within the entire economic system.  For the German economy it is (like in a number of smaller northern European countries including Netherlands, Austria, Denmark, Sweden and Finland) the case that having a balance of payments surplus, which more than offset the public sector deficit means that private financial savings is at least of equal magnitude.  This means that when money gushes out of the German treasury, an equal amount is pouring at the very same time into the private sector.  The money is in other words kept within the borders of the country, making it possible for German government to decide how money should be retrieved back to the Treasury - through sale of government bonds, or by a taxing (of for instance excess savings). It is a purely domestic issue, which the government can resolve without seeking help from other EU countries or IMF. 

The situation in the South - as the figure shows – is, however, fundamentally different.  Here money is also gushing out of the treasury, but because of the large external current account deficit, money is pouring out of the country.  Although a substantial proportion of the Greek budget deficit probably is due to previous governments overspending, the new Greek government has to realise that the huge balance of payments deficit is mainly caused by a substantial deterioration of the Greek international competitive position. Greece, like the other southern European countries, could not match the German low cost development within the last 10 years. This weakening economic development has gone on for more than ten years and had caused Greece’s foreign debt to explode. In this case it does not matter, that the foreign debt is denominated in euro, because Greek citizens (or the government) have to pay interest on the debt to foreigners who are not taxable by the Greek government. Foreign companies and banks now stand as the owners of a significant part of Greek national wealth.  Today, the Greek Government (and companies) must pay a considerable extra rate of interest of 3-4 percent just to cover the balance of payments deficit.  The above mentioned extra rate is not unique to Greece.  Spain and Portugal are met with the same financial requirements, because they have also for years had a balance of payments deficit in the amount 10 per cent. of GDP.  The high interest rates and the growing indebtedness to foreign countries make it harder for these countries to wriggle out of the employment crisis, because they have less money available. 

Why has it gone so wrong in the South? For two reasons: Firstly, they have had a higher real growth rate (Greece and Spain) than the EMU-average. Secondly, and more important, the unit labour cost has grown 2-3 per cent more quickly than the EMU-average for more than 10 years.  This means that competitiveness over the past 10 years has been weakened by 20-30 per cent.

This is the real Achilles’ heel of EMU. The participating countries are steadily moving away from each other. There is not the convergence in economic development as a common currency has as an indispensible precondition. Competitiveness in Southern Europe is now so weakened that even a prolonged recession to correct the faults of the past would hardly do the trick. Some of the EMU-countries have accumulated such a large external debt and their international competitiveness has been so markedly deteriorated, that they seems to have fallen into the debt trap. They cannot get free by their own (economic) forces. They need support from the surplus countries; but they have no strong incentive from a national point of view to support deficit countries. They fear that a more expansionary policy would endanger their international competitiveness inside and outside the EMU-area. 

This is the essence of the so-called ‘Greek Tragedy’ that the single European currency was not a 'free pass' to unlimited foreign credit.  The balance of payments still remains for every sovereign country an Achilles' heel.  That was the lesson which for stance the Danes and Swedes was taught in the late 1980s and early 1990s when a prolonged and self-imposed recession sent unemployment up sharply. The question is whether the southern European countries today would accept such a drastic cure, all the while that surpluses are piling up in Germany and other northern European states.   From this point of view it is difficult to understand that a European Monetary Fund was not established contemporary with the EMU. Because already at that time it was obvious that countries would not be really convergent. There would be for many years ahead some countries with structural deficits (‘catching up’ countries) and countries with a structural surplus (the more mature economies). Catching up countries would need support occasionally, which could be loans with a low rate of interest 'mitigating the air' for the countries that struggle to keep up with the German efficiency.  The growing EMU imbalances are not just a southern European problem. A single currency requires common ground between all participating countries.  Here, Germany has an equally important responsibility to reduce the EMU imbalances.  This could happen through an expansion of domestic demand that will increase exports from the poorer southern countries and by that limit the increase in unemployment.

On the other hand, if the EMU-countries continue to grow apart the Greek tragedy could easily develop into a Euro Tragedy with growing instability and an increasing risk of the EMU breaking up as a longer term consequence. It is a historically well established fact, that no monetary union has lasted without a political superstructure. Something has to give in, because the institutional setting around the EMU is destabilizing and growth preventing. 

Jesper Jespersen

Jesper Jespersen is professor of economics at Roskilde University.(jesperj@ruc.dk).
Member of the EMU committee appointed by the Council for European policy,2000, He has contributed at several Parliamentary hearings on EMU respectively in Januar 2009 and Februar 2012. Together with Dr. Bruno Amoroso published L’Europa oltre l’Euro, by RX-CastelVecchi, Roma, Settembre 2012, info@castelvecchieditore.com