Global Crisis Blog

Martin Wolf Lifts the Fog:    What in the World is Going On in Europe

 

Martin Wolf

By Shlomo Maital

    Among the columnists I follow closely is FT columnist Martin Wolf.  Born in 1946, Wolf had a career with the World Bank before joining a research institute, then the Financial Times. He is regarded as a leading business columnist, whose analysis is as deep as it is clear. On Nov. 30, his article “Why the Irish crisis is such a huge test for the Eurozone” is worth careful reading.  Let’s go through it step by step together.

1. “A currency union (i.e. the euro) causes crises”.  Some countries (Germany) in the union control wages, others (Portugal, Ireland, Spain) do not.  So they become less competitive, and their economies weaken.  Governments then engage in deficit spending to sustain employment, when other countries use exports.  This creates confidence crises in their bonds, a la Greece.

2.  “A currency union has a common interest rate”.  Interest rates are everywhere the same. But different countries have different risks.  So in some countries, the common interest rate will seem excessively low, leading to credit booms and asset bubbles.  The result is a huge credit crisis.  If exchange rates could change,  the Irish punt and the Greek drachma could fall, stimulating exports. But they no longer exist. So a currency crisis becomes, instead, a credit crisis, as lenders stop buying sovereign bonds.  If Ireland, for instance, still had its pound linked to the British pound, it would have fallen, helping Ireland’s economy.  That is no longer the case.

3.  Facing the crisis, governments offer such high interest rates on their bonds (they have to, all governments need to roll over their debt), that they destroy their credibility, rather than strengthen it. (A high and rising risk premium on Irish bonds drives investors away).   Ireland erred. Instead of letting Allied Irish Bank creditors take a ‘hit’, wiping out part of the debt, the Irish government assumed that debt, saddling Irish people with billions of euros in debt for a whole future generation. 

4.  Will the euro zone survive?  Possibly not.  German reluctance to continue to bail out irresponsible deadbeat countries may force peripheral weak countries to return to their own currencies. This too is not viable. When Ireland re-adopts its punt, money will flee and Irish government debts will soar disastrously.  The key issue is Spain. Spain has to roll over some 250 billion euros in debt alone this year, and its PM Zapatero, a Socialist, blames everyone but his own government’s mismanagement. 

5.  Survival of the euro zone is a political, not economic, issue.  Countries in Europe, including Italy, used to have currency crises.  Today, in the euro, they have credit crises.  These crises have forced them to swallow enormous debts created by private-sector banks and impose austerity that increases unemployment and reduces welfare spending.  Countries will make the following calculation:  which is worse, a currency crisis or a credit crisis, in which the EU itself does not come to their aid?  If the answer is ‘currency crisis’ – bye bye Euro.