2011 November 26 Saturday
Tyler Cowen Asks If Euro End Is Near

The euro zone debt crisis continues to grow. Tyler Cowen opines on lack of good options as the markets start to price more southern European debt into default territory. The architects of the EU and the euro currency have created the conditions for a very big financial train wreck. Will the EU be discredited as a result?

I am seeing reports of 7.7 on the Italian ten-year bond, over eight percent on the two-year bond, 6.5 percent on the six-month note, and so on.  Here is one account.

Maybe these markets simply will shut down soon.  There is so much talk about what the Germans should do, but I don’t see the viable options.  With Germany’s own credit status now in doubt, eighty percent debt to gdp ratio, massive welfare state, and unfavorable demographics, are they supposed to endorse — going to endorse — ten or fifteen percent price inflation for a few years’ time, all with no guarantee of reforms in the economically weaker countries?  And is that inflation then followed by a subsequent deflation?  Or does it continue forever?  And would Germany have to move to a regime of wage flexibility for the professions too?  How politically feasible is that?  I don’t see how the Germans benefit from going down this road, even if you think, as I do, that the alternatives are quite dire.

7.7% is not a stable interest rate for any of the southern European countries. They either have to default or get bailed out. Since the bail-out option seems unlikely default seems more likely. But default means bankruptcy of many banks that hold sovereign debt. That drives already poor governments to try to bail out their banks. That, in turn, drives these governments to want to leave the Euro and regain their own currency with their own central bank to bail out the banks

You can find lots of commentary on why Germany should save the euro in its present form with all current members. But such a move would be incredibly expensive and just kick the ball down the road into an even bigger crisis. Why? A root cause: Spain Labor Market Incompatible With Euro. Read that. As long as southern European labor markets basically require periodic bouts of inflation the northern and southern European countries should not be in the same currency zone.

Jeremy Warner sees the markets have started to price in a major break in the euro. My guess is we will end up with a much smaller euro zone including Germany, some Nordic countries, Austria, and probably France.

No, what this is about is the markets starting to bet on what was previously a minority view - a complete collapse, or break-up, of the euro. Up until the past few days, it has remained just about possible to go along with the idea that ultimately Germany would bow to pressure and do whatever might be required to save the single currency.

The EU dream is looking pretty tattered. Is this a dying brand? Or will it bottom out and then experience a resurgence? Will crisis enable Eurocrats to make it stronger? Niall Ferguson says it is legally easier for a country to leave the European Union than the euro currency zone.

Many people assume that the tipping point will come when one country — most likely Greece — leaves or is ejected from Europe’s monetary union. But the scenario that worries Eurocrats is different. They fear that a country could leave the European Union itself.

This is by no means an irrational anxiety. Under E.U. law, it would be much easier for Britain to leave the European Union than for Greece to leave the euro zone.

Ferguson sees Britain's exit from the EU as more probable than southern European countries leaving the euro currency zone. I'm not persuaded. Even if the Germans give large sums of money to the southern European countries and agree to a monetary policy that causes sustained inflation to inflate away some of the debt what happens 5 years hence? Mechanisms in the labor markets and politics of southern European countries will gradually cause them to become uncompetitive again.

Share |      By Randall Parker at 2011 November 26 11:10 AM  Europe Monetary Union

Stephen said at November 26, 2011 6:17 PM:

I can't see why Britain would ever leave the EU. There's zero upside for a liberal democracy to raise trade barriers.

A.Prole said at November 27, 2011 1:30 AM:

Britain had higher economic growth rates before it entered the EU than after entry.
Besides, the EU is really about 'free trade' (by definition an entity that forms a 'trade bloc' within itself, discriminating against the rest of the world outside the bloc, is not practising 'free trade'), no, the EU has always been about destroying national independence and sovereignty to meld a federalist superstate, 'the United States of Europe' and the Euro was merely a lever to do this.
Anyhow. 'free trade' has proved disasterous for Britain.Britain has racked up a massive, insoluble and persistent trade deficit for decades now - it is the real source of Britain's economic difficulties.

Randall Parker said at December 4, 2011 5:13 PM:


Yes, I haven't come across any arguments about how the EU raised the rate of growth of average GDP in Europe. Maybe their economies would have done even worse without the EU. But if the EU delivered a big benefit why no statistical studies trumpeting this?

The EU raised the average level of regulation while decreasing internal trade barriers and raising some external trade barriers. It also imposed a currency that was either undervalued or overvalued depending on the member state. What was the net effect?

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