Europe has another … yes, yet another … solution. But we have to wait until June for it so be fully revealed. Meanwhile Portugal is about to go under. There are simmering stories emerging that the banking system in Europe is teetering despite there being silence on the viability of the banking system in Europe from the Euro bosses. Despite the decisions (or rather non-decisions) of the European Council last week – the intent is the same – fiscal consolidation including retrenchment of safety net benefits supplemented with further labour market deregulation which will further reduce living standards, especially for the poor. Their position is a denial of basic macroeconomic understanding and doesn’t address the inherent design flaws in the monetary union. I predict things will get worse. The political leaders in Europe have the wrong goal in mind (stubbornly saving the euro) and do not even have an effective solution to defend that goal, flawed as it is. The problem is that Europe is still pursuing the wrong goal.

I was thinking about the recent European Council meeting today which was held in Brussels over the weekend. It is clear that the Eurozone bosses are choosing to ignore all the lessons that the current crisis has provided to them about the basic design flaws of their monetary system. They think the solution to their problems is to make it even harder for member governments to provide net spending to their economies at times of stress. They fail to articulate the most basic macroeconomic fact that confronts them – unemployment is rising across the zone and production generally is stagnant because there is not enough demand for sales of goods and services. If the private sector won’t provide that demand then the government sector has to given that they cannot rely on net exports to cure the deficiency. By deliberately restricting governments and effectively forcing them to engage in pro-cyclical fiscal responses the Euro bosses are not only prolonging the agony the citizens are facing but are also engaging in a self-defeating strategy. As we are seeing budget deficits are rising as austerity is imposed. The solution to the Eurozone problems is to disband the zone and restore individual currency sovereignty at the national level. It would be painful to do that but in the medium- to long-term it will be less painful than the trajectory they are following.

Last Wednesday (May 5, 2010) I wrote that Bailouts will not save the Eurozone in response to the miserable plan put forward to take the Greek government out of the bond markets for a period. Yesterday they announced a major ramping up of the credit line they are offering which is more characteristic of a fiscal rescue than anything else. However, it amounts to the blind leading the blind. The euro funds to finance the credit line are coming from the same countries that are in trouble. There are no new net financial euro assets entering the system as a consequence of this €750bn bailout plan and, ultimately, that is what is required to ease the recession and restore growth. The restoration of growth will also ease their budget issues. But this is Europe we are talking about. Despite the nice cars and bicycles they make, they are not a very decisive lot and their institutional structures are hamstrung by an arrogant sclerosis that pervades their polity and corporate world.

We are back onto Greece again today as the crisis deepens. Overnight Spain is appearing to be under bond market pressure and the Germans are calling for even harsher fiscal rules to be applied to keep member states “solvent”. The point is that none of the remedies being proposed will ultimately work. What is needed in the Eurozone is a major boost to aggregate demand. However, the policy direction is to further undermine spending in the member economies as austerity measures are being imposed throughout. This foolish reverence of the Stability and Growth Pact will worsen things. The problem in the EMU is that the basic design of its monetary system is flawed and the accompanying fiscal rules only accentuate those design flaws. None of the remedies being proposed by Euro leaders will work and the bailouts will not save the Eurozone. It has to fundamentally redesign its system or disband.

First, devise a monetary union that is based on flawed notions of how the monetary system operates. Second, within that union invent nonsensical rules that give the system in general or member nations in particular the no capacity to deal with a damaging economic crisis. Third, allow countries within the union to game it to their own advantage at the expense of other member nations (for example, Germany – although the advantage was at the expense of German workers). Fourth, when a crisis hits elevate the nonsensical rules to the level of the sacrosanct and commit innocent citizens to years of unnecessary economic hardship. That is the level of sophistication that Europe has reached in 2010.

In past blogs I have indicated that nations were mad entering the EMU and surrendering their fiscal sovereignty. This is especially so for the so-called peripheral nations (Spain, Portugal, Greece, Ireland, to some extent Italy) who have become basket cases in a system that prevents individual member’s from using fiscal policy to improve the circumstances of their citizens. Indeed it is a system that forces aggregate policy to act in a pro-cyclical manner for nations that are undergoing crisis – that is, the politicians have somehow managed to convince their populations that it is a credible position for them to use their policy power to make things worse rather than better. So policy which should reduce poverty and empower the youth of a nation with education and employment opportunities is now doing exactly the opposite. As I noted last week, one statistic is enough to tell you the EMU system is a failure – 53 per cent of Spanish youth are now unemployed! So can a nation exit the EMU? What would happen if it did? I had some thoughts on this today.

I have been looking into underemployment data for Europe today as part of a larger project which I will report on in due course. But whenever I am studying European data I think how stupid the European Monetary Union (EMU) is from a modern monetary theory (MMT) perspective. Then I read the Financial Times this afternoon and saw that Diverging deficits could fracture the eurozone and I thought there is some hope after all although that is not what the journalist was trying to convey. This is an opportune time to answer a lot of questions I get asked about the EMU. Does MMT principles apply there? Why not? Is this a better way of organising a monetary system? So if you are interested in those issues, please read on.

As a brief follow up to yesterday, German labour force data came out yesterday (Tuesday) and reveal that unemployment rose sharply in December and the disgraceful barrier of a record 5 million unemployed is now highly likely in early 2005. In December there were 4.48 million unemployed or 10.8 per cent of the active population. This is the highest level since 1990 and the second highest level in the whole period since World War II.

In the UK Financial Times article by Darryl Thomson, Dollar falls to fresh lows in thin festive trade posted December 24, the continued slide of the USD against the Euro is put down to “disappointing US economic data” (mostly sharp slowdown in new home sales). However, a so-called currency strategist claims it is the “deficits rather than the data which were weighing on investors minds”. The hoary old neo-liberal twin deficits attack on public spending is making a comeback.