This articles reviews the theory behind Optimum Currency Areas and the lack of willingness in the European Union and particularly of Germany to lead the process of political and fiscal unions. With Britain maintaining its euro-skeptical status and France and Italy immersed in political crisis, there remains little hope that the Eurozone will ever become what Professor Robert A. Mundell once defined as an Optimum Currency Area.
You do not need to be a rocket scientist to know that Columbia University Emeritus Professor Robert A. Mundell won the 1999 Nobel Prize in Economics for his seminal work on Optimum Currency Areas explained in his 1961 paper “A Theory of Optimum Currency Areas” (American Economic Review, Vol. 51, No. 4 (Sep., 1961), pp. 657-665). Prof. Mundell won the Nobel Prize before the European Union launched the Euro on January 1st, 2002. Prof. Mundell created the Eurozone and he did so in 1961, only four years after the Treaty of Rome was signed by the six founding members of the European Union (then European Economic Community) in 1957.
You do not have to be a Nobel Prize Laureate to know that Prof. Mundell’s theoretical conditions need to apply in order for an Optimum Currency Area (the Eurozone) to work properly. The fact of the matter is that because of the current political leadership in Germany and the European Commission at large, only a handful of these theoretical conditions have been accomplished. The ones which remain to be implemented are the fiscal and the political unions, which I reviewed as a student of the MPA Program in Economic Policy Management at Columbia University in 2007-2008.
There is no fiscal union in the Eurozone. This condition is implicitly known as fiscal federalism. It is here where the Eurobonds controversy steps in. A northern axis of countries including Austria, Finland, Germany and the Netherlands seem to oppose the idea of debt mutualization of up to 60% of a country’s public debt. The spread on the Eurobonds is likely to be higher than that on the Deutsche Bund but significantly lower than spreads on Greek, Italian, Portuguese or Spanish Debt. This move forward would allow southern Europe to breathe normally and focus more of the attention on fixing the house which is indeed a disaster (remember Tom Hanks’ 1986 Movie “The Money Pit”). In the absence of Eurobonds the financial markets have put a severe burden on the highly-indebted countries whose debt is skyrocketing under no control whatsoever. Public debt has already reached unsustainable levels in Greece, Italy, Portugal and Spain. Spain’s debt coupled with its terrible job market does not leave a lot of room for maneuver.
In a recent conversation, a former Deputy Finance Minister of Spain pointed out that spending three percent of GDP servicing the debt interest and three percent of GDP on unemployment benefits (“el paro”) for the jobless, leaves very little room to pull Spain out of the ditch, from where the country continues to fight a war against itself and against the financial markets.
There is no political union in the Eurozone, although the Members of the European Parliament based in Strasbourg may think otherwise. Prof. Mundell explains (page 661) that “In Western Europe the creation of the Common Market is regarded by many as an important step toward eventual political union, and the subject of a common currency for the six countries has been much discussed”. Prof. Mundell adds:
In the real world, of course, currencies are mainly an expression of national sovereignty, so that actual currency reorganization would be feasible only if it were accompanied by profound political changes.
When have the profound political changes been accomplished in the Eurozone? The Eurozone and more in particular the European Union remains a club of “rich” nations (perhaps this term should not apply to some of the latest incorporations in Eastern Europe) with a governance at the nation level which is much stronger than the weak governance of Brussels and the European Commission and Parliament. This is why the European Central Bank is particularly commanded by Germany, reason why the French are particularly “méfiant” and always try to interfere with the apparently independent monetary policy of the European Central Bank, too focused on inflation control applying the old manual of the Bundesbank.
European countries are unlikely to give up their dreams of grandeur for the sake of the continent’s emergence as the World’s leading force. Almost every country in Europe has been an Empire: Austria, Britain, France, Portugal, Spain. In the absence of a common agenda Europe –the aggregation of past World Empires- is condemned to irrelevance. Who cares about Europe any longer? We will fall in the trap that Japan has already fallen into. Priorities at the nation-state continue to dominate continental priorities. Member states of the European Union continue to insist that certain areas no limited to monetary policy and including defence and foreign policy remain sovereign.
Usury with the Greek has reached a point in which we must say “enough is enough”. Germany must stop the episode of arrogance or we might reach a point in which history shall be repeated. Some say, anyhow, that an (economic) war has already begun. No further cooperation seems possible, we have reached a plateau from which who knows what trigger might help us move forward.
Greece’s GDP is about 5% of Germany’s, which means that bailing out Greece’s 100% of GDP would have represented issuing Eurobonds equivalent to 5% of Germany’s GDP. In the meantime Greece’s public debt-to-GDP ratio continues to increase reaching a point of no return with spread levels in the two digit space for the Greek debt.
The Germans are perfectly able to disseminate their euphoria and enthusiasm on top of their rigor and discipline. A New Europe shall then be born. Perhaps southern Europe can contribute with its creativity and improvisation which the Germans most often lack.
Perhaps only the World’s best surrealist painters would have been to depict the ongoing lack of vision among our political elites in Berlin and Brussels. We all know and know very well the recipe to get out of this mess. Why don’t we move forward faster then? Europe’s twentieth-century history (the two World Wars) represents an obstacle on our way forward to the best World we could have ever imagined.