Tuesday, 16 July 2013

On the PIIGS back - time to dump the Euro

It’s a life time since the Great Depression but the events on the twenties and thirties maintain a strong hold on our economic and political psyche.  During the intervening years the gold standard has figured prominently as the boogieman that deprived countries of the policy options required to combat the deepening slump. Firm evidence for the overly restrictive nature of the standard is provided by the economic rebound enjoyed by most countries choosing to exit the system, Britain being foremost in this regard.  What’s puzzling us today is why countries stayed wedded to the gold standard for so long.  The relative merits of the gold standard depended on the valuation on joining;  France joined as an under-valued currency whereas Britain re-joined in 1925 as an over-valued currency, this meant that when recession struck Britain was at a significant disadvantage to France and other competitive economies.  Without room to manoeuvre (easing monetary policy and lowering interest rates)  Britain ended up in economic and political turmoil, with an unemployment rate of  25% and the collapse of the Labour government who did not return to power until 1945.
Today most Eurozone countries are going through the same pain that we went through in 1929 – 1931; sharply rising unemployment, uncertainty about the banks and burgeoning public sector debts.  Although the gold standard had no Central Bank and it did not float against other global currencies there are many similarities between the Eurozone construct and the old gold standard.
The first similarity is the constraint the single currency puts on currency values.  Within the gold standard there was no ability to flex exchange rates to help improve competitiveness and drive exports.  In the same way the Eurozone all economies are pegged to an exchange rate that was set when they joined; what we can now see is that Germany had a grossly undervalued currency in 1999 when the Euro was founded, a function of reunification, and many other countries have very overvalued currencies – the PIIGS economies for sure!   The net result has been that German exports have thrived whilst other economies have been unable to compete.
The second similarity is the inability to set real interest rates at sensible levels.  Whilst in the gold standard Britain had to maintain high interest rates to arrest outflows of gold to the US and other economies, this did untold damage to our industrial base and forced up unemployment unnecessarily.  Prior to the credit crunch the ECB set low interest rates, which encouraged personal indebtedness and fueled an unsustainable property boom  in many parts of Europe - the prime cause of the banking melt down.  Now when stagnant economies need low real interest rates the ECB can’t deliver this as credit worthiness is negatively impacting base rates; this means that although interest rates are set at 0.5% by the ECB real interest rates in Italy and Spain and elsewhere are well above 5%, whilst Germany has a the advantage of ultra low rates .  This inability of domestic government to set appropriate interest rates  is doing untold damage to the small business community in  the PIIGS (Portugal, Ireland, Italy, Greece and Spain).  The end result is that the rich countries get richer and the poor get poorer, no wonder the Germans and the Dutch want to keep the Euro, they are on the PIIGS back!

The final similarity is the impact this economic straitjacket have and will have on the politics of Europe.  The final period of Britain’s participation in the gold standard saw the employment levels drop by 3 million following the Wall Street crash and similar level of unemployment are now being seen in Europe with all the hardship this entails.  These levels of unemployment forced us out of the gold standard and also forced the labour government to fold.  It’s quite likely that a similar pattern will follow in the Eurozone as the politics become unmanageable for a number of left of centre governments.  Once employment levels drop below 80% for any period of time there will be political change, this is an immutable fact; we have seen the first signs of this in Portugal last week and we can expect to see more of the same as austerity turns to despair.

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