The underlying problem is the rule for printing money: in the
eurozone, any government can finance itself by issuing bonds directly
(or indirectly) to commercial banks, and then having those banks
“repo” them (i.e., borrow using these bonds as collateral) at the ECB
in return for fresh euros. The commercial banks make a profit because
the ECB charges them very little for those loans, while the
governments get the money – and can thus finance larger budget
deficits. The problem is that eventually that government has to pay
back its debt or, more modestly, at least stabilize its public debt
levels.
This same structure directly distorts the incentives of commercial
banks: they have a backstop at the ECB, which is the “lender of last
resort”; and the ECB and European Union (EU) put a great deal of
pressure on each nation to bail out commercial banks in trouble. When
a country joins the eurozone, its banks win access to a large amount
of cheap financing, along with the expectation they will be bailed out
when they make mistakes. This, in turn, enables the banks to greatly
expand their balance sheets, ploughing into domestic real estate,
overseas expansion, or crazy junk products issued by Goldman Sachs.
Just think of Ireland and Spain, where the banks took on massive loans
that are now sinking the country. http://baselinescenario.com/2010/04/29/to-save-the-eurozone-1-trillion-european-central-bank-reform-and-a-new-head-for-the-imf
Vs.
The current system, in which fiscal authority is concentrated in Madrid and monetary policy is determined by the needs of the euro, will create insurmountable political opposition as many years of high unemployment turn the population to more radical solutions.
Spain will almost certainly have to choose. Either it gives up fiscal sovereignty – including, most importantly, taxation authority – to Brussels, or it gives up the euro. The alternative, several years of difficult adjustment borne mostly by workers, is politically unlikely.
Can Spain give up fiscal sovereignty? Actually that might be easier than many people think. Already there are strong separatist movements in many parts of Spain, and a number of regional governments might be happy to reassign sovereignty from Madrid to Brussels in exchange for real relief from the burden of adjustment. I would imagine that Catalunya and Euskadi (the Basque provinces) would not find it so difficult if economic conditions deteriorated. Other regions are also likely to consider it a viable prospect.
The problem with this strategy might actually be Germany. Although one can posit a scenario in which regions in Spain and other southern economies (for example Italy, with its own regionalist movements, especially in the north) reassign sovereignty to Brussels, unless Germany does the same the viability of a United States of Europe would be doubtful. It is hard for me to imagine, however, a situation in which Germany assigns fiscal sovereignty to Brussels. In that case the only real European entity with any chance of viability might be the United States of Germany.
Could this happen, and European regions assign sovereignty to Berlin? Maybe, but aside from the near impossibility of imagining France agreeing to a United States of Germany, if I am right about rising anti-German feeling in many parts of Europe, this will make it tough even for the smaller countries to swallow the prospect.
So these are the options as I see them. Spain might choose closer integration into Europe, including giving up fiscal and tax sovereignty, although it is not clear which European entity this would entail. Spain might choose to disenfranchise the working class, but the probability of this is close to zero, I think, and would be morally unthinkable. Or Spain might choose to give up the euro. This is just another restatement of Dani Rodrik’s “inescapable trilemma of the world economy”, by the way.
If you do decide to follow my advice, I told my Spanish friend, I wouldn’t bet too heavily on the first two outcomes.
http://mpettis.com/2010/05/are-you-ready-for-the-united-states-of-germany/
Vs.
I think what is needed is for every deficit-plagued government to
lower public sector salaries [including pensions] by ten percent until the crisis blows
over.
The worst thing that could happen is that cutting wages could reduce
aggregate demand through Keynesian channels. But gosh, look at some of
the alternatives: sovereign defaults, bank runs, cuts in public sector
jobs? A cut in public sector pay is probably the least unpalatable
option.” http://econlog.econlib.org/archives/2010/04/the_best_policy_1.html
