Paul Krugman: The Road to Economic Crisis Is Paved With Euros
PK:
The Road to Economic Crisis Is Paved With Euros: In Greece the story is straightforward: the government behaved irresponsibly, lied about it and got caught. During the years of easy borrowing, Greece’s conservative government ran up a lot of debt — more than it admitted. When the government changed hands in 2009, the accounting fictions came to light; suddenly it was revealed that Greece had both a much bigger deficit and substantially more debt than anyone had realized. Investors, understandably, took flight.
But Greece is actually an unrepresentative case. Just a few years ago Spain, by far the largest of the crisis economies, was a model European citizen, with a balanced budget and public debt only about half as large, as a percentage of G.D.P., as that of Germany. The same was true for Ireland. So what went wrong?... [A] large direct fiscal hit from the slump... the costs of financial clean-up.... [O]ther nations — in particular, both the United States and Britain — that have been running deficits that, as a percentage of G.D.P., are comparable to the deficits in Spain and Ireland. Yet they haven’t suffered a comparable loss of lender confidence. What is different about the euro countries?
One possible answer is “nothing”: maybe one of these days we’ll wake up and find that the markets are shunning America.... But the real answer is probably... it’s the euro itself that makes Spain and Ireland so vulnerable. For membership in the euro means that these countries have to deflate their way back to competitiveness, with all the pain that implies. The trouble with deflation isn’t just the coordination problem.... Even when countries successfully drive down wages, which is now happening in all the euro-crisis countries, they run into another problem: incomes are falling, but debt is not. As the American economist Irving Fisher pointed out almost 80 years ago, the collision between deflating incomes and unchanged debt can greatly worsen economic downturns....
Some economists, myself included, look at Europe’s woes and have the feeling that we’ve seen this movie before, a decade ago on another continent — specifically, in Argentina.... As I see it, there are four ways the European crisis could play out (and it may play out differently in different countries). Call them toughing it out; debt restructuring; full Argentina; and revived Europeanism.
Toughing it out: Troubled European economies could, conceivably, reassure creditors by showing sufficient willingness to endure pain.... The role models here are the Baltic nations: Estonia, Lithuania and Latvia.... Have these policies been successful?... The Baltic nations have, to some extent, succeeded in reassuring markets.... All of this has, however, come at immense cost.... It says something about the current state of Europe that many officials regard the Baltics as a success story....
Debt restructuring.... I find it hard to see how Greece can avoid a debt restructuring, and Ireland isn’t much better. The real question is whether such restructurings will spread to Spain and — the truly frightening prospect — to Belgium and Italy, which are heavily indebted but have so far managed to avoid a serious crisis of confidence.
Full Argentina: Argentina didn’t simply default on its foreign debt; it also abandoned its link to the dollar, allowing the peso’s value to fall by more than two-thirds. And this devaluation worked: from 2003 onward, Argentina experienced a rapid export-led economic rebound. The European country that has come closest to doing an Argentina is Iceland.... Iceland took advantage of the fact that it had not joined the euro and still had its own currency.... The combination of default and devaluation has helped Iceland limit the damage from its banking disaster. In fact, in terms of employment and output, Iceland has done somewhat better than Ireland and much better than the Baltic nations....
Revived Europeanism: The preceding three scenarios were grim. Is there any hope of an outcome less grim? To the extent that there is, it would have to involve taking further major steps toward that “European federation” Robert Schuman wanted 60 years ago.... [A]s the earlier Ireland-Nevada comparison shows, the United States works as a currency union in large part precisely because it is also a transfer union, in which states that haven’t gone bust support those that have. And it’s hard to see how the euro can work unless Europe finds a way to accomplish something similar. Nobody is yet proposing that Europe move to anything resembling U.S. fiscal integration; the Juncker-Tremonti plan would be at best a small step in that direction. But Europe doesn’t seem ready to take even that modest step....
For now, the plan in Europe is to have everyone tough it out...
