Don’t blame the euro

By: Heleen Mees

With all the turbulence rocking the financial markets and the sharp drop in the euro’s exchange rate, you could almost forget that the single European currency has been quite a success. One of the main reasons for its introduction was to enable the eurozone countries to benefit from the low interest rates associated with the status of reserve currency. For decades the US dollar was the world’s sole reserve currency, which meant that interest rates in the United States were permanently lower than those elsewhere. Those lower interest rates boosted US investment, employment and economic growth. This “exorbitant privilege”, as former French President Valéry Giscard d’ Estaing once described it, enabled Americans to live beyond their means for many years. They spent more than they earned and used their homes as their own personal ATMs.

 

Since the eurozone was established, the countries that adopted the single currency have enjoyed a similar privilege. By increasing the size and liquidity of the financial markets, the single currency resulted in lower real interest rates, not just on government bonds, but also on corporate bonds, mortgage loans and consumer credit. The fall in interest rates was most pronounced at the periphery of the eurozone. Until the crisis, Spain, Ireland and Greece had been achieving above-average economic growth of about 5 per cent annually. Cohesion became a reality, as the per capita incomes of the various eurozone countries began to grow closer. This development also benefited countries such as Germany and the Netherlands – their export markets expanded, since a major portion of their exports go to other EU countries.

 

It’s ridiculous to brand Spain, Portugal and Ireland as “overspending, unreliable partners”, as some commentators do. Until the economic crisis erupted, their national budgets were almost as well managed as those of Germany and the Netherlands. The same cannot be said of Greece, but it would be wrong and short-sighted to lump all the peripheral countries together.

 

It was the banks and other financial institutions (e.g. pension funds, insurance companies) that facilitated the boom at the periphery of the eurozone by lending huge sums to Spain, Greece, Ireland and Portugal under virtually the same conditions as those applicable to Germany and the Netherlands. In doing so they failed to charge a realistic risk margin. One of the consequences was that European leaders were lulled into a false sense of security. After all, if the financial markets didn’t envisage any problems, why would Europe’s leaders – themselves mere mortals – be troubled? Surely the markets are always right?

 

The extensive package of measures presented by the eurozone countries, the International Monetary Fund (IMF) and the European Central Bank (ECB) may not be enough to solve the crisis afflicting the euro. After all, it’s not simply a liquidity crisis but a solvency crisis as well, at least as far as Greece is concerned. Without the rescue package it is unlikely that the country could both service its debt and reduce the budget deficit. The banks and other financial institutions that lent money to Greece therefore should accept “haircut”: a restructuring of the excessive debt burden in the form of a partial write-down of claims against. The greatest risk of moral hazard does not apply, as is often argued, to politicians, but instead to financiers.

 

In the US, the banks have seen their profits rocket back up to record levels. These are the same institutions that needed many billions of dollars in government aid to prop them up back in 2008. Now, for the first time in history, the trading desks of the four largest Wall Street banks have experienced a quarter in which they turned in a profit every single day. In the first 65 trading days of 2010, Goldman Sachs, JP Morgan, Bank of America and Citi Group each allegedly made about a hundred million dollars. So while their 2008 losses were shouldered by tax payers, their profits are now once again falling into the hands of a select group of financiers, traders and bank directors. It’s like a lottery in which they can never lose.

 

Globalisation has brought instability to the global economy. Banks and other financial institutions have played a key role in this respect by taking massive risks without pricing them properly. They must not be allowed to emerge from the carnage unscathed.

 

Heleen Mees is researcher at the Erasmus University in Rotterdam. In May 2009 her book “Between Greed and Desire – The World between Main Street and Wall Street” was published in the Netherlands.

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