Constantin Gurdgiev is head of research with St. Columbanus IA and lecturer in finance at Trinity College, Dublin
Last month, research from the Kaufman Foundation provided an interesting insight into the views economists hold of the future prospects for the euro.
Kauffman Economic Outlook: A Quarterly Survey of leading economics Bloggers published by the Kaufman Foundation asked the panel of economics bloggers the following question: “Should the euro zone become:
1) a currency union without fiscal union, allowing sovereign default;
2) a currency union with strong fiscal union; or
3) Broken up (no euro) into national currencies or smaller units?”
The results were only slightly surprising. Number 1 was supported by 22 per cent of the respondents; No. 2 was picked by 27 per cent of respondents; while No. 3 was favoured by 51 per cent.
Significantly, the question posited the operative verb “should”. In other words, the responses did not relate to the politically feasible or probabilistically likely predictions of the final outcome for the euro. Instead, they reveal economists preferences as to the specific choices of outcomes. Which brings us to the ‘surprise’ element of the results: More than one-quarter of the respondents (27 per cent) support for the general policy direction adopted by the euro area leaders - the path of closer political and fiscal integration.
Now, put the above fact alongside the current news flow from Europe. Since May, 2010 – the moment the timeline for the Fiscal Compact Treaty started amidst the first Greek crisis blowout – Europe has managed to produce nothing beyond a large amount of rhetoric about political integration. The Fiscal Compact released last week is nothing more than a re-iteration of the 1992 Maastricht Treaty with an addition of an economically illiterate target of the structural deficit. It’s worth noting that the latest target is set at 0.5 per cent structural deficit as measured against the current nominal GDP. This, of course, is the macroeconomic equivalent of a gobbledygook. Even Economics 101 students would know that structural deficits are usually measured against potential GDP and that the entire concept is not suited for hard policy targeting, since there are no precise unified measures of potential GDP.
So, the EU’s capacity to progress along the path of the fiscal unification can be described by its speed -- 21 months of work, one poorly constructed target.
In other words, we can safely assign the 27 per cent of the votes in favour of the euro survival under the constraints of fiscal policy unification to the category of purely speculative scenarios.
The other two scenarios -- the continuation of the euro with explicit allowance for sovereign insolvency and the dissolution of the euro – offer the only viable alternatives for medium-term consideration. However, of these, only one represents a stable outcome – the scenario of euro disintegration. Here’s why: Sustaining the euro area in its current composition, while allowing for sovereign defaults requires creation of automatic instruments for fiscal and monetary policies responses to such defaults. Automatic fiscal transfers to cover the excessive deficits and post-default debt financing must be put in place before the sovereign defaults mechanisms are enshrined in the new treaties governing the euro. Monetary policy will have to be reformed as well, since one state default will risk creating severe misalignments in the euro area. Monetary conditions, banking system stability, interest rates and inflation will impact each country differently.
This option would be as legislatively burdensome for the EU to implement as the option of fiscal unification.
But wait, there is more. The option of sustaining the euro by allowing sovereign defaults is simply a medium-term stop-gap measure on the road to dissolution of the euro. Persistent fiscal transfers from the surplus states to the defaulting states will spin out of control over time, pushing the solvent states into either insolvency or toward exiting the currency union. Currently, only Germany, Finland, Luxembourg and the Netherlands can be expected to provide net contributions to such transfers. Taken over the period of 1990-2008, the list of countries that have sustained aggregate surpluses on the current and government accounts is even smaller -- Luxembourg.
So in the end, the first option explored by the Kaufman Foundation survey respondents is just a transitory one toward the ultimate dissolution of the euro. The second option for preserving the euro is simply infeasible. Leaving us with nothing but the third scenario, in which the euro is dead.
Which explains why the entire Fiscal Compact signed this has more in common with the Grunthos The Flatulent’s poetry than with a treaty to save the euro.
