Why would any nation want to join the Eurozone?

The Wall Street Journal carried an article on Wednesday (September 12, 2012) – Latvia Remains Keen on Euro – which reported that the queue to enter the Eurozone remains healthy. I immediately asked why? There is a queue of nations (east and Baltic) who desire to join the Eurozone. The public debate in those countries must be so distorted by the elites for the public to go along with that. The very small gains that a nation might enjoy by joining the common currency (for example, lower transaction costs) will be dwarfed by the economic damage that membership will bring. Nations that join the Eurozone in its present structure are effectively signing a death warrant. The speed of the death will be a direct function of how competitive they are in relation to Germany. There is no case to be made for Latvia or any other nation to enter a monetary system that is incapable of effective functioning. Major changes would need to be made to the basic design of the system for it to be viable. I sense that there is no will in Europe to make the necessary changes and the zone will continue its slide down into further malaise. Why would any nation want to join the Eurozone?

The article said that:

Latvia is undeterred by the euro zone’s sovereign-debt crisis and intends to adopt the common currency in a little over a year …

As reported last week (see blog – Off to the Land of Austerity), Bulgaria, the poorest member of the EU (GDP per capita) abandoned its long-held desire to join the Eurozone. It decided that it would become much poorer if it joined the monetary union.

Unfortunately, it didn’t announce that it would also abandon its currency peg with the Euro, which has required the Government to run restrictive fiscal policies and suppress growth and undermine prosperity for its beleaguered citizens. They might realise that the peg has to go as well in due course. But their decision not to press for entry is a step in the right direction.

The Bulgarian Prime Minister was reported in the WSJ article as saying “he didn’t see ‘any benefits’ from joining”. A wise assessment.

Latvia is not alone however. Other known candidates include the Czech Republic, Lithuania, Poland, Hungary, Romania and Sweden – which is a real hotch potch of nations in terms of similarity with the Euro powerhouse of Germany.

All of these nations will undermine their prosperity if they are foolish enough to join the common currency.

The challenge of the currency zone is not to expand but to integrate. By that I mean it has to address its basic flaws which include a disparate banking sector which member states cannot guarantee, significantly different levels of competitiveness and the absence of a federal fiscal capacity that can easily distribute spending when there are asymmetric demand shocks across the regions comprising the monetary union.

Not only does the Eurozone have to achieve that degree of integration but it also has to also has to abandon its restrictive fiscal rules, which make it difficult to run counter-cyclical fiscal responses. At present, with the Stability and Growth Pact, nations fall foul of the budget deficit limits easily during a major recession.

Even the automatic stabilisers (the cyclical changes in tax revenue and welfare payments) have in some cases been of such a magnitude during the current crisis that the fiscal limits have been breached.

Spain was operating with fiscal surpluses as it entered the crisis and that didn’t help them at all. It is now one of the worst hit nations in the Eurozone.

Short-term crisis management solutions – such as the EFSF or the ESM (bail-out funds) – do not negate the need for a coordinated fiscal capacity to ensure the spatial pattern of aggregate demand is sufficient to avoid recession in all member states.

While the European leaders are now talking about fiscal integration they are doing so within a culture of austerity and very deep hostility from Germany and other richer northern nations such as the Netherlands.

The questions that have to be answered include:

1. Are the Germans willing to become part of a true fiscal federation where it becomes a “state” that is subjugated to the welfare needs of the union? For example, in nations such as Australia which is a true fiscal federation, no one would tolerate one state not being able to access basic health care while another had more than enough.

We would demand our federal government make sure all citizens had more or less similar access to essentials. That sort of cultural approach is totally absent in Europe at present. The Germans and Dutch hate the fact that they might have to pay out to assist the Greeks.

The federal fiscal capacity should not be driven by rules such as the proposed “Six-Pack”. I considered that recent Euro “solution” (every month or so a new solution is proposed) in this blog – The left – entranced by the fiscal austerity mantra sold to them by the conservatives.

The “Six-Pack” refers to the new so-called “reinforced Stability and Growth Pact (SGP)”, which was agreed upon on December 13, 2011. In the Official Memorandum we read that the “Six-Pack” is “made of five regulations and one directive” and according to the EU elite spin:

… represents the most comprehensive reinforcement of economic governance in the EU and the euro area since the launch of the Economic Monetary Union almost 20 years ago … [and] … brings a concrete and decisive step towards ensuring fiscal discipline, helping to stabilise the EU economy and preventing a new crisis in the EU.

In fact, the Six-Pack annoucement further de-stabilised the EU economy. The Six-Pack recognised that “23 out of the 27 Member States are in the so-called “excessive deficit procedure” (EDP), a mechanism established in the EU Treaties obliging countries to keep their budget deficits below 3% of GDP and government debt below (or sufficiently declining towards) 60% of GDP”.

These 23 have to undergo formal reviews and “must comply with the recommendations and deadlines decided by the EU Council to correct their excessive deficit”.

The components of the Six-Pack are that more rigourous imposition of financial sanctions will be followed if a nation fails to “comply with the specific recommendations” to get their deficits below 3 per cent of GDP. Further, if the “60% reference for the debt-to-GDP ratio is not respected” then the EDP will begin “even if its deficit is below 3%” and the nation will have to reduce “gap between its debt level and the 60% reference … by 1/20th annually (on average over 3 years).”

There will be “expenditure benchmarks” which will enforce “a cap on the annual growth of public expenditure according to a medium-term rate of growth”.

And a series of interventions under the so-called “Excessive Imbalances Procedure (EIP)” which aims to reduce macroeconomic imbalances (particularly unit costs etc) and will force nations to submit “a clear roadmap and deadlines for implementing corrective action”. The whole system will be subjected to a huge surveillance operation (EU monitoring) with “rigorous enforcement” (fines equal to 0.1 per cent of GDP) and central intervention in a nation’s budgetary process.

It all reeks of a nasty controlling, big brother sort of world where the worker in the village in Greece or the Netherlands will basically be casting a vote in futility if their respective governments stay in the Eurozone – because at any time an EU official will be able to intervene and coerce the elected government into following EU dictates rather than their elected mandate.

It seems from the recent political events in Europe that the people are getting wind of this abrogation of their democratic rights and are voting accordingly. But the choices now as so poor.

Today (Wednesday as I type) the Dutch national election is being held and the likely winners of the most seats will be the Labour Party and current governing conservatives. Both are pro-Euro and pro-austerity. There are differences around the edges but there is no hope for change here. They are likely, if the polls are correct to form a solidarity government. Austerity will rule. Madness prevails in a climate where political choice has almost vanished.

Budget outcomes should not be evaluated against meaningless fiscal rules, which are impossible to meet when a crisis is being experienced. As we have seen, in the attempt to drive fiscal policy decisions on the basis of these rule, the governments of Europe are making the situation worse.

Nothing was more predictable than that outcome, yet the debate here is how to strengthen the rules (make them more unworkable) and what frameworks can be agreed to impose punitive sanctions on nations that dare to deviate.

It is totally overlooked that the deviations in budget outcomes against the rules are in most cases totally out of the control of the member-state government. In bad times, budget deficits will rise. That is not a signal to impose pro-cyclical fiscal austerity.

It is a signal to attack the collapse in aggregate demand with all the fiscal spending tools that a government has, supported by a growth-oriented central bank (which in this particular monetary system can keep the private bond markets at bay).

The debate in Europe fails to recognise any or most of this. They think the problem is some numbers that Eurostat report from time to time telling us what the budget outcomes have been. They think the solution is to attack spending and/or increase taxation to directly reduce these budget outcomes.

They fail to realise that this strategy is counter-productive and doomed to fail.

In economic terms the SGP and the proposed amendments describe a set of rules that even in good times will present difficulties but in bad times will be simply unworkable. They will be handing out fines and penalties to every nation.

2. How integrated should banks and the laws pertaining to them be? At present they are a member-state responsibility but each member state, by dint of the fact they do not issue their own currency, ultimately cannot guarantee the stability of those banks – and hence the financial system in general.

So it comes down to the role of the central bank. The problem is that the ECB has all the capacity that it needs to ensure the financial system is stable but seems intent on getting its pound of flesh in return for using it.

As I wrote on Tuesday in the blog – The ECB plan will fail because it fails to address the problem – it is not a productive strategy to offer unlimited bond purchasing to the member states if at the same time the conditions under which they can be freed from the tyranny of the private bond markets is that they go further into depression.

In a truly functioning federal monetary system the central bank should not deliberately undermine growth and then turn around and offer assistance for the damage they have generated while at the same time causing more damage as a condition for that assistance. It is hard to take this approach seriously really.

What the Eurozone needs is to understand that the only purpose of banks should be to facilitate a payments system and provide loans to credit-worthy customers. Attention should always be focused on what is a reasonable credit risk. In that regard, the banks should be tightly regulated.

They should only be permitted to lend directly to borrowers. All loans would have to be shown and kept on their balance sheets. This would stop all third-party commission deals which might involve banks acting as “brokers” and on-selling loans or other financial assets for profit. It is in this area of banking that the current financial crisis has emerged and it is costly and difficult to regulate. Banks should go back to what they were.

Banks should not be allowed to accept any financial asset as collateral to support loans. The collateral should be the estimated value of the income stream on the asset for which the loan is being advanced. This will force banks to appraise the credit risk more fully.

Banks should be prevented from having “off-balance sheet” assets, such as finance company arms which can evade regulation.

Banks should never be allowed to trade in credit default insurance. This is related to whom should price risk.

Banks should be restricted to the facilitation of loans and not engage in any other commercial activity.

There is no public sense in them being allowed to do anything more than the activities noted above. The ECB can then reasonably play the role as lender of last resort in the case of a crisis.

I sense that the European debate is a long way from that sort of model of banking and so will continue to support a flawed approach just waiting to collapse.

3. How do you deal with different levels of competitiveness when exchange rates are fixed between member states? There are major differences in unit labour costs and productivity growth across the current Eurozone. The new nations seeking to join are also mostly uncompetitive when considered against the German benchmark.

As I have written in the past, the Germans knew better than most that by signing up to the EMU they would have to change the way they pursued their mercantilist ambitions.

Previously, the Bundesbank had manipulated the Deutsch mark parity to ensure the German export sector remained very competitive. That is one of the reasons they became an export powerhouse. It is the same strategy that the Chinese are now following and being criticised for by the Europeans and others.

Once the Germans lost control of the exchange rate by signing up to the EMU they had to manipulate other “cost” variables to remain competitive. So the Germans were aggressive in implementing their so-called “Hartz package of welfare reforms”. A few years ago we did a detailed study of the so-called Hartz reforms in the German labour market. One publicly available Working Paper is available describing some of that research.

The Hartz reforms were the exemplar of the neo-liberal approach to labour market deregulation. They were an integral part of the German government’s “Agenda 2010″. They are a set of recommendations into the German labour market resulting from a 2002 commission, presided by and named after Peter Hartz, a key executive from German car manufacturer Volkswagen.

The recommendations were fully endorsed by the Schroeder government and introduced in four trenches: Hartz I to IV. The reforms of Hartz I to Hartz III, took place in January 2003-2004, while Hartz IV began in January 2005. The reforms represent extremely far reaching in terms of the labour market policy that had been stable for several decades.

The Hartz process was broadly inline with reforms that have been pursued in other industrialised countries, following the OECD’s job study in 1994; a focus on supply side measures and privatisation of public employment agencies to reduce unemployment. The underlying claim was that unemployment was a supply-side problem rather than a systemic failure of the economy to produce enough jobs.

The reforms accelerated the casualisation of the labour market (so-called mini/midi jobs) and there was a sharp fall in regular employment after the introduction of the Hartz reforms.

The German approach had overtones of the old canard of a federal system – “smokestack chasing”. One of the problems that federal systems can encounter is disparate regional development (in states or sub-state regions). A typical issue that arose as countries engaged in the strong growth period after World War 2 was the tax and other concession that states in various countries offered business firms in return for location.

There is a large literature which shows how this practice not only undermines the welfare of other regions in the federal system but also compromise the position of the state doing the “chasing”.

But in the context of the EMU, the way in which the Germans pursued the Hartz reforms not only meant that they were undermining the welfare of the other EMU nations but also droving the living standards of German workers down.

And then the crisis emerged amidst all this.

Please read my blog – The German model is not workable for the Eurozone – for more discussion on this point.

The response of the Troika has been to point the finger at the less competitive nations such as Greece, Spain, Portugal and Italy and accuse them of living beyond their means.

What has followed has been harsh attacks on the basic living standards of workers and the poor in these nations. The Euro leaders, sitting in their salubrious bunkers in Brussels are oblivious to the suffering their policies are causing in the peripheral countries.

The European Parliament head, Martin Schultz accused the main Eurozone decision-makers last week at the Brussels conference I attended of not getting out enough and seeing the devastation the fiscal rectitude is causing.

For those that missed the picture, this photo was taken in June 2012 and shows “a tray full of chilled champagne at the Eurozone Finance Ministers meeting” that was staged in Luxembourg (Source).

I reported last week from Brussels that the delegates – mostly high-level officials from various parts of Europe – didn’t do it hard by way of wine and food during lunches and the dinner.

But while the Germans can accuse the Greeks etc of “living beyond their means” it could easily be said that the German government courtesy of the Hartz attacks on living standard in Germany has forced its workers and families to “live below their means”. In other words, the problem is better presented as the Germans deliberately depressing their domestic demand and relying on exports to drive growth which in a currency union with such disparate levels of productivity growth is unsustainable.

So my view is that if the Eurozone is to survive, Germany has to radically alter its approach to its own economic structure. It has to start paying its own workers more to ensure that real wages keep pace with productivity growth, which would serve to stimulate domestic domestic demand the demand for imports.

More Germans have to be given access to the resources necessary for them to enjoy lovely sunny vacations down in the Greek isles.

That shift in mentality would go some way, within a truly federal system, to resolving the so-called imbalances that arise from the nations having fixed exchange rates.

The very fact that we talk about “fixed exchange rates” is indicative of the fact that we do not consider Italy, Greece, Germany and the rest of them as member states united by a sense of “one country”. In Australia, we never think about trade imbalances between the states.

I sense in the current European debate that such a shift is not being considered and will not be possible given the diversity of European culture and politics.


An essential requirement for an effective monetary system is that the citizens have to be tolerant of intra-regional transfers of government spending and not insist on proportional participation in that spending. The other side of this coin is that a particular region might enjoy less of the income they produce so that other regions can enjoy more income than they produce.

To achieve that tolerance there has to be a shared history which leads to a common culture. Language is an aspect of this but not necessarily intrinsic.

That shared culture etc also has exist within a fully integrated fiscal and financial system. An effective federal system has to share common elements to ensure that the macroeconomics of the monetary system dominate more regional concerns. That capacity is non-existent in the Eurozone.

Tomorrow (Thursday) I am off to Austerity Zone II – Britain. I will report how it feels on the ground there as the Olympic smokescreen gives way to the reality that their government is deliberately trashing their economy.

That is enough for today!

(c) Copyright 2012 Bill Mitchell. All Rights Reserved.

This Post Has 14 Comments

  1. Well, I guess it’s fun to be vendor financed until the repo-man comes.

    It’s strange that none of those countries have the wisdom to come up with their own stable money solutions or at least try to. And who can even say the Euro is stable?

  2. I guess its not good to generalise but its been my experience during the Irish Boom that Baltic people generally remain extremely detached from any form of economic politics – they are strangely atomised units of Labour / consumption , much like the Irish post 1987 but far more extremely zombified.
    It was their History I guess.

    Bill , Ireland does not exist anymore – France is gone ,Spain wrecked , I could go on……………
    These are no longer political units – they are simply loose jurisdictions , they are merely geographical locations really where capital flows in , labour follows , capital subsequently flows out , the malinvestment is socialised as capital is allowed to move out to the next rich hunting ground , the country where the malinvestment occurred must export to the country where malinvestment is currently occurring so as to pay for the malinvested debt – eventually capital will flow out of this currently booming export market , it will flow back into the degraded country it has left for dead , turning the cycle into a strangely dark but funny Punch and Judy show as entropy becomes the most efficient physical law for what appears to be non sentient automans.
    Of course eventually the Buffalo will disappear from the plains but thats not important right now……….
    Only Yield on the declining capital stock is important…….for then moment.

    The market state has won…….Irish people are no longer self aware , the various European peoples are much the same really.
    The market state will collapse of course – but only when we get a larger breakdown crisis.
    People rationally no longer accept the political song and dance and become even more detached , however they continue to ask the wrong questions which is very strange given whats happened.
    The universities are a Joke of course.
    Surprisingly most people seem quite happy with becoming limited credit consumption sinks , Conduits -although it makes sense as rational discourse serves no function in this lukewarm fish tank….as people seem to forget everything when they swim just once around the tank and accuse others who say we will become fish meal soon as radical non fish like people…

  3. I’ve seen this pointed out for some time, but it seems to be underappreciated that a major problem is not that the Germans were selling too much but that they were buying too little. They ARE more productive and sell very high value-added products, so they should reap the benefits. And, in the meantime not run unsustainable trade surpluses. A win all around.

  4. Thank you for an informative post.

    A comment on Sweden and the euro. Sweden will not join, Sweden had a referendum when the euro was introduced and that one delivered a clear ‘NO’. In light of developments the latest polls give the no side 77%, while the yes get 14%. Trying to join without a referendum would be political suicide and is extremely unlikely.

    Technically Sweden remains a candidate, as contrary to Denmark and the UK, Sweden has no formal exception and is thus (as all EU states without a formal exception) formally expected to join once Sweden manages to fulfill the EMU entry criterias. Sweden has fulfilled all but one, to peg the krona to the euro for a long enough time. To keep up the formal charade Sweden fails to peg the krona. Everybody knows that this is a charade, but the Commission will not drag Sweden to court over it, though they have signalled that they will not be so lenient if anyone else try to do the same. But that was back before the crisis, doubt they will now try to drag Bulgaria in kicking and screaming.

  5. Having travelled (briefly) in the Baltics and gone to the ‘Latvian Museum of Occupation’, I think that the desire for the eurozone has much more of a political than economic motivation. The sense that I have (which is based on very limited knowledge, admittedly) is that they want stronger ties with Western Europe to prevent a return to Russian dominance. For the native Latvian speakers, especially as so many ‘Latvians’ are Russian speakers who consider themselves Russians, there is real fear of this.

  6. For Eurozone to grow its governments need to emit enough financial assets relative to saving desires of the population. Warren Mosler calls attention to demand leakages, for example government mandated or tax advantaged savings schemes, that increase ‘saving desires’ of population: http://www.huffingtonpost.com/warren-mosler/demand-leakages-the-800lb_b_1646916.html

    Thats the other part of the equation, government spending financial assets into the economy and saving desires for them. It is safe to say that population aging in europe increases ‘saving desires’ of population for retirement days. If government also constructs some pre-saving plan instead of pay as you go arrangement, need for financial assets that can be saved during the accumulation period can become quite large. Economic mainstream seems to think that money grows on trees.

    This is not a question of competitiveness, which is, by the way, a zero sum game for Eurozone nations. Trade suprluses of surplus countries are caused by trade deficits of deficit countries, because EZ external accounts are (roughly) in balance. I wonder why this fact that anyone can check out from statistical services almost never gets mentioned. Germany does not run trade surpluses with China and India. All internal trade imbalances in the Eurozone are offset by other trade imbalances of equal maginitude in opposite direction.

  7. Economists don’t know how to measure the true rate of economic growth, because they can’t model the consumer’s perspective on technological advancement. Alex Gheg has released a new framework that can solve this problem. The hidden thoughts and feelings of people can be indirectly measured using the very accurate internal body clock, that we all have. Pleasure contracts time in the human mind, and we can see how this changes our daily circadian rhythms. See some facts and be amazed. Quantity, quality, variety and convenience in one equation. http://www.youtube.com/watch?v=u6tFLGpcOpE

  8. Now what would you expect from Cork,the breeding ground of rebellions? More power to you,Dork.

  9. only Denmark and UK have a treaty with EU that give them exception from the Euro. All other member states are obliged to adopt the Euro and do what they can to fulfill the requirements. It’s explicit in the Lisbon treaty. Swedish referendums is only advisory, anyhow Sweden’s parliament did sign the Lisbon treaty with about 80% for. To require a exemption  wasent even an issue.  The loophole to avoid anslusch is that joining ERM 2 is voluntarily. ECB now and then remind Sweden that the Euro is mandatory for EU mebers. 

  10. Welcome to the Chinese Century and perhaps even the Chinese millenium! China achieved its first unification in 221 BC. China has suffered periods of disunity and (partial) conquest since then but essentially China has existed as a unified state or an incipient/re-emerging unified state for about 2,000 years. Here we are in the year 2012 and the Europeans still cannot achieve unity. At the same time, the US is crumbling. Absurd, ossified, neocon ideology dominates the West as it crumbles away and loses all its comparative advantages. Meanwhile, the pragmatic Chinese just get on with whatever works.

    China’s plan of moving all world manufacture to China proceeds apace. When China makes just about everything and the rest of the world makes practically nothing, what then?

  11. Bill, if you really wanted to be up with the curve you would be studying China. The important thing to study now is why China is succeeding and why the E.U. and U.S. are in terminal decline.

  12. Recently I red a Paul Krugman’s interview given to the one Croatian daily newspaper. Croatia is going to be a formal EU member from 1st July 2013. Briefly he said:

    – adopting the Euro was a mistake for EU countries (I agree)
    – the Euro makes this crisis harder to overcome (I agree)
    – the cost of abandonment of Euro would be insupportable, so go ahead with it
    – thw only way to end up the crisis is spnding, spending, spending (I agree but impossible within Euro system)
    – for such a small country as Croatia in the meddle of the EZ would be non sense to keep their own currency because of huge transaction costs(?) and it may be considered as an example of a bad decision (I strongly dissageree)

    I think that such a counter intuitive recommendation is unfair and dishonest. Look what happens with Slovenia (similar country to Croatia, within Euro from 2004) which is about to default. I am asking myself why and on which basis Mr. Krugman is proposing this idea?

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