Saving the Euro

There is an excellent long article by Paul Krugman in the New York Times about the origins and the future of the Euro. He outlines the reasons for the formation of the Euro: to make doing business in Europe easier as you wouldn't need to change currencies as you travel to other European countries and a removal of uncertainty for importers about the cost of a contract due to currency movements.

Krugman also outlines the case against the Euro. Lack of monetary authority. No fiscal union to accompany the monetary one. Although labour mobility is legally uninhibited in the Euro area, cultural and language differences make labour mobility restricted.

Krugman also outlines how the lack of flexibility that being part of the Euro means for the peripheral countries, like Ireland, where deflation and wage reductions are present. This means our wages are falling but our debts are not, which means debtor must meet their obligations with less income, which means they must consume less, thus worsening the economic slump. In this case, allowing your currency to depreciate is a viable way to keep away this deflationary cycle.

He outlines four possible paths for Europe to take:

1. Tough it out: This is the current situation where the peripheral countries will push out with their current paths of fiscal consolidation, repaying their debts in full, with the aid of EU/IMF emergency loans.
2. Debt restructuring: Peripheral countries would undergo a structured default on their debts.
3. Default and Devalue: Same as path 2 but with a currency default. This would mean some countries dropping out from the Euro and devaluing their new currencies.
4. A more Fiscal Union: This is where the Euro becomes a fiscal union to go with the monetary union. Krugman acknowledges that this is practically politically impossible as the Germans, in particular, don't want the Euro to become and transfer union. This would make the Euro work and is Krugman's preferred option, but he allows that it is, at the moment, unattainable.

My preference is for path 2, which is outlined in the leader in this weeks Economist. It outlines that the best option for the Euro is for a debt restructuring of the clearly insolvent peripheral countries, namely Ireland, Greece and Portugal. The Economist argues that the only long-term alternative to debt restructuring is path 4 outlined above but recognises that it is political non-starter. It also argues that now is the opportune time as the dangers from debt restructuring have diminished as the European economy is in better shape now than it was when the EU/IMF deal was sorted out for Greece and that buying more time with emergency loans is imposing a greater burden on the countries that have been rescued.

Therefore, the case is for an orderly debt restructuring of the insolvent peripheral countries, with some of Ireland's restructuring coming from a write down of its bank debt.