Crashing Visions, Euro Version

Big changes are hard to bring about and, when they do happen, usually have very serious costs. The world isn't the way it is for no reason at all, and big changes usually hurt somebody a lot.

This is the lesson I draw from the European economic situation. All the smart economists seem to think that the real problem in Greece, Italy and Spain isn't excessive spending or debt, but the Euro. The vision of one currency for Europe was appealing for a lot of reasons: it would encourage trade and investment, make it much easier for Europeans to travel, and symbolize the increasing political unity of the continent. Skeptics said it would never work, because the countries involved were too different from each other. Now it looks like the skeptics were right. If the Euro survives, it will be because politicians in southern Europe decide to accept a decade of economic pain as the price for remaining in the Euro club. I'll let Paul Krugman explain:

The fact is that three years ago none of the countries now in or near crisis seemed to be in deep fiscal trouble. Even Greece’s 2007 budget deficit was no higher, as a share of G.D.P., than the deficits the United States ran in the mid-1980s (morning in America!), while Spain actually ran a surplus. And all of the countries were attracting large inflows of foreign capital, largely because markets believed that membership in the euro zone made Greek, Portuguese and Spanish bonds safe investments.

Then came the global financial crisis. Those inflows of capital dried up; revenues plunged and deficits soared; and membership in the euro, which had encouraged markets to love the crisis countries not wisely but too well, turned into a trap.

What’s the nature of the trap? During the years of easy money, wages and prices in the crisis countries rose much faster than in the rest of Europe. Now that the money is no longer rolling in, those countries need to get costs back in line.

But that’s a much harder thing to do now than it was when each European nation had its own currency. Back then, costs could be brought in line by adjusting exchange rates — e.g., Greece could cut its wages relative to German wages simply by reducing the value of the drachma in terms of Deutsche marks. Now that Greece and Germany share the same currency, however, the only way to reduce Greek relative costs is through some combination of German inflation and Greek deflation. And since Germany won’t accept inflation, deflation it is.

The problem is that deflation — falling wages and prices — is always and everywhere a deeply painful process. It invariably involves a prolonged slump with high unemployment. And it also aggravates debt problems, both public and private, because incomes fall while the debt burden doesn’t.

I won't make any predictions. I merely point out that choices have consequences, and that most of the important ones lead to pain of one kind or another.

Oh, I have one more thought: as we move toward a cashless economy, in which you can buy almost anything with a debit card, does having a single currency matter that much? If people don't actually have to change money and worry about using up all the francs or lire in their pockets before they go home, will they care so much about the Euro?