Monday, 15 September 2014

Shifts and shocks

At last the book I always dreamed of writing but lacked the skills to do so has been written.

What a joy to read Martin Wolf's ( Financial Times Chief Economics Commentator at The Financial Times) new publication :

'THE SHIFTS AND THE SHOCKS: What we've learned - and still have to learn- from the financial crisis'

This has many of ideas that I have been sharing in my writings.  It has a clear warning that those who think that the sustainability of the Euro Monetary Union is now safe, because the crisis has abated from the intensity of 2012, are unrealistic optimists.

In spite of the valiant efforts of the ECB the Euro is still a slow motion train wreck.   I had written this on 23rd May 2012 in a piece entitled:

"Can this slow motion train wreck be avoided?"

Martin Wolf makes an important point that is worth emphasizing and reflecting upon. Whilst the Euro rules makes a lot on stringent conditions about budget deficit and debt levels it makes no provisions about Balance of Payments imbalances.   This is wrong!  Outside a monetary union balance of payment imbalances are self-correcting through the rate of exchange mechanism.   But in a monetary union the rate of exchange mechanism does not work for one particular country but for the union as a whole.    So within a monetary union countries having a balance of payments surplus are having a free ride on the back of countries with payments deficits.    

If Germany still had their Deutsche Mark its exchange value would have shot up as part of self-adjusting mechanism to restore equilibrium.   But because of the Euro, Germany can continue to enjoy their export competitiveness at the the expense of deficit countries like France, Spain and Italy as the Euro exchange rate does not fall enough to reflect their deficits.

In the absence of such balance of payments conditionality to restore equilibrium as rigidly as applicable for fiscal deficits, the Euro monetary union remains at risk.   So far countries have accepted adjustment through austerity and high unemployment as a choice of a lesser evil.   Germany imposed government changes in Italy and Greece when its leaders were unwilling to go along with their austerity recipes.

Just imagine what would happen when sooner or latter in a big country like France, Italy or Spain, the electorate, weary of never ending recession cum austerity poison chalice, democratically elect demagogues from the extreme right or left which make Euro abandonment or re-design as their main policy platform.

More controversial food for thought!!!   Should Malta make contingency plans for either of these two alternatives, of which, one will have to prevail in the longer term:

  • Break up of the Euro monetary system
  • Fiscal union ( jeopardizing our tax competitiveness) and shared debt responsibility as the ultimate required medicine to avoid Euro break up.

Worth bearing in mind.

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