segunda-feira, maio 31, 2010

Rebalancing the EuroZone

Any talk of some indebted countries exiting the EURO (just to apply a 30% devaluation?) is pure mirage, the worst kind of illusion.

Would the old currency increase productivity,reduce the diseconomies of scale of small markets,remove the Eastern European and Asian competitors? Would it increase labour productivity, would it make the labour market more flexible and efficient, would it sort out the (in)justice system, would it make easier to pay for pensions and pensioner health costs?

Why not re-introduce intra-EU import tariffs temporarily, that would certainly be less disruptive and more easily reversed. In effect, austerity measures and cutting consumer credit will have the very effect of reducing Club Med demand for German cars, etc.

We can recall from customs union theory that trade diversion and the deteriorating terms of trade for the American south were some of the causes of the US Civil War. The growing pains in customs unions are well documented in history.

A 30% weaker Euro, lower consumption and higher savings in the Club Med countries, sharp reductions in intra-EU trade imbalances and orderly restructuring of existing debt, a proper rebalancing of the EU budget,  and new debt subject to IMF conditions, these are more likely to produce the desired results. Temporary and partial assistance in coping with the permanently higher interest rate differentials will also be necessary.

Creditor and borrower countries are both showing a rermarkable little foresight, prudence and responsability. Hence the acute market volatility, playing with fire.

Exiting the single currency may follow orthodox economic theory but it is not convincing in reality. The market would resist redenominating contracts to the new-old but devaluing, currency, which would become a pariah currency. Just try to get a rental contract, or even a hotel bill, in local currency in Luanda or Buenos Aires. The country would become “euro-ized”, like many dollarized emerging markets.

The pressures to compensate workers and pensioners for the loss of purchasing power would lead to higher inflation and continuing deficits.

The source of the problem is not in the single currency, and the diverging bond yield differentials, butin the single market and in the persistent bilateral trade imbalances.

Tax imports and subsidize exports, if necessary. Reintroduce import tariffs, suspend the customs union until trade flows are rebalanced, but keep the single currency.

There are no optimum currency zones, not in the real world.

As there are no free exports.
Trade surplus have to be financed, usually by the exporting country, and paid for eventually by the importing country, IF the imports contribute to local productivity and competitiveness.

Portugal has a large and persistent trade deficit with Germany, €2,6 billion in 2009. Other bilateral trade imbalances in the EuroZone are even larger.

The politicians who created the EURO knew that this was a risk, particularly given the overvalued conversion rates, that’s why they provided for it with Structural and Cohesion Funds.

But the total debt problem turned out to be even greater than expected, due to stimulus provided by the conversion of the interest rates (from 17% to 1,7% in 20 years), and mostly, by the excessive leveraging up of the Club Med countries, given the easy credit globally. Fragmenting the EuroZone would resolve none of these problems. a

PPP Lusofonia