I’ve never been a huge fan of the Eurozone, as longtime readers know, and as this old piece indicates. When times are volatile simplicity is rewarded and complexity punished. Hard guarantees are favored over softer implied commitments. Simple funding structures are favored when times get tough. What then, to make of the humongous bailout plan proposed by the Eurozone, and aid proffered by the ECB?
First, it is by no means certain that all of the Eurozone governments will cooperate with the agreement. It is not in the interest of most Eurozone countries to agree with the aid package. Better to use the money at home and support debtors and banks at risk of failure, than support those that do not elect you. With some countries, lending money to Greece on these terms may prove unconstitutional.
Second, providing liquidity to profligate nations does not tend to ease them onto “the straight and narrow,” but rather delays or prevents their adjustment to orthodox finance. They accept the liquidity easily, but don’t easily return it. The debt problem gets bigger through a rescue/bailout, leading to a bigger problem to solve later.
Third, multiparty agreements or multiple bilateral agreements are inherently less stable than simple bilateral agreements. The more agreements that need to be upheld, the greater the probability of failure.
Fourth, making the ECB buy Eurozone government debt means that the Euro is only as hard as the debt that they buy. Given the political pressure, it is more likely that they buy Spanish debt than German debt, and Greek debt than Dutch debt.
Fifth, it sends the wrong message other profligate nations, saying that there is someone to catch them if they fall. Far better to kick one nation out of the Eurozone, and make the others take notice. Is there something about being in the Eurozone that prevents intelligent judgment from taking place?
Sixth, it does not solve the problem that banks are increasingly less willing to lend across national boundaries. No surprise; they see the same things that I am seeing, and are demanding a high risk premium to lend to other nations that may eventually default.
Seventh, it does not affect the ability of Eurozone governments to run large deficits in any significant way. Yes, hey may make promises today, but what if they face domestic political issues later. Who will they listen to, the Eurozone, or the local electorate?
Eighth, the ability of governments to modify pension and other entitlement promises is limited, which limits their willingness to comply with fiscal restraints.
Ninth, so you want to defend the Euro? Go ahead. Sell dollar-denominated debt and buy Euro-denominated debt.
Tenth, so where is the enforcement mechanism? What will keep Eurozone governments from breaking the agreement? Whether borrower or lender, the call from the local electorate is stronger than that of European unity. Those calls head in opposite directions.
David:
I don’t understand why they are in such a hurry to defend the Euro. Wages in the EU have been growing faster than the aggregate economy for years, which tells me that unit labour costs are higher than desirable. This is their opportunity to become more competitive (and this is really important, given the intrinsic rigidity of the labour force in Europe compared to the United States and east Asia).
Breaking Greece out of the Eurozone would be better for everyone. The main Euro countries could enjoy a currency more closely aligned with their fundamentals and the basket cases could create their own currency and become Zimbabwes.
@matt: Defending the euro was a big talking point, but I don’t think it was the primary impetus for the emergency actions. The emergency was in the banks. As the Greek example caused investors to shift out of Spanish and Portuguese bonds, the losses to banks holding the debt of those countries was looking scary. Last week the banks all got together and begged the authorities to do something. And as an illustration of one of David’s main messages, Sarkozy and Merkel were much more willing to take care of their own banks than they were to take care for the EU. Once the decision was made, it was more politically palatable to talk about defense against speculators than to talk about once more rescuing banks that had made stupid investments.