Wednesday, April 28, 2010

Europe in Crisis

One of the better articles explaining the current situation in Greece and Europe and why it matters.
...The internal problem stems from the fact that the euro, widely hailed as Europe’s greatest initiative, is starting to look like a strategic mistake. Europe’s countries and cultures may be too different to live under the same set of economic policies. While none of the European countries wants American-style capitalism, some are much better than others at managing their economic affairs in an orderly fashion. Germany and the Scandinavian countries plus the Netherlands in particular seem to have a gift for good economic management. Spain, Portugal, Italy and Greece don’t manage things as well, by and large. (France stands uneasily in the middle; more competent than its southern neighbors, but less effective than the Germans.)

Historically, the Latin countries and Greece have used currency depreciation to ease the strain when poor economic decision making has caused debt to rise too quickly. As has often been the case in Latin America, inflating bad debts away has been a traditional resort of political elites.

In Germany, inflation is associated with the two great catastrophes of the twentieth century. The runaway Weimar inflation brought the consequences of Germany’s devastating World War One defeat to every home in the country; after World War Two the German currency similarly became worthless. Whole generations lost their savings and inflation for Germans even today remains associated with the worst kind of irresponsibility and disaster.

The euro was a glorious fudge. The Latin countries plus Greece could enjoy the benefits of German discipline and virtue while carrying on with traditionally unsustainable public and private sector policies. In the old, pre-euro days, the southern economies had to pay high interest rates on their debt; wary investors knew that inflation and devaluation were likely and so demanded interest rates that would compensate them for the risk. The lira, the drachma: everyone knew they would lose value over time against the Deutsche mark and even the dollar, and interest rates reflected this understanding. But as the southern countries moved into the euro, calculations changed. For the last twenty years, countries like Greece and Italy were able to borrow money at essentially the same rate that Germany could.

Typically, they decided to spend rather than save this windfall. Greece in particular decided that since the costs of servicing its debt were so low, it made sense to run up more debt. Lousy leaders gave greedy civil servants fat raises; promises were cheap and the government scattered them far and wide. In Italy as well, once the national debt was less painful to carry, there was less pressure to reduce the national debt.
Read the rest here.
Hat tip T-19

No comments: