Leaving the Hotel Euro?

The eurozone is stuck in a surreal waiting room biding time until one member dies off. If leaders could introduce European Special Drawing Rights, a healthier future would be possible.

Americans aren’t known for irony or surrealism, but one of the enduringly surreal and ironic pop songs is The Eagles' "Hotel California”. Written as a satire of American excess, its lyrics bear an uncanny resemblance to the trap the nations of Europe now find themselves in – especially its final stanza: Last thing I remember, I was
Running for the door
I had to find the passage back
To the place I was before
"Relax," said the night man,
"We are programmed to receive.
You can check-out any time you like,
But you can never leave!"
I don’t know whether the architects of the euro smoked any
colitas as they drafted the Maastricht Treaty, but surely something hallucinatory was involved in an agreement which, once signed, allowed for no exit. Even marriage allows for divorce, despite the "let no man put asunder” bravado of the ceremony.

The nations of Europe now resemble a truly unhappy marriage, sans divorce, with the spouses desperately wishing the "'til death do us part” section of the ceremony would hurry up and arrive – and despondent that, unlike spouses, nations don’t die.

Figure 1: Unemployment in Europe


Citizens of nations do die however, and there are many instances now of economic suicides as people end their lives because of the European economic crisis. With austerity policies making a bad situation worse, it would hardly be a surprise to see political parties who pay no regard to treaties take power and tear this one up.

So is there any way out of the Hotel Euro before the stormtroopers blow up its walls? One possibility is to realise that, rather like a marriage contract that enforced celibacy inside the marriage as well as faithfulness outside, the euro was never really a currency. A currency requires a nation, and there is no nation called Europe – nor will there ever be. Instead the euro is at best a common currency for international trade, but not one that should have ever been used as a domestic currency as well.

It is therefore a continental version of the IMF’s 'Special Drawing Rights' a currency invented to enable trade between nations, and issued by a supranational authority (the IMF) under strict rules in proportion to the size of national economies.

It should never have been any more than this, as even economists with worldviews as removed as Wynne Godley and Milton Friedman argued long before that fateful day in 1999 when the euro came into existence. Godley, like me a critic of conventional economics and one of the handful of economists to foresee the Global Financial Crisis, scoffed that the euro was designed in the belief that capitalism was inherently stable:

"The central idea of the Maastricht Treaty is that the EC countries should move towards an economic and monetary union, with a single currency managed by an independent central bank. But how is the rest of economic policy to be run? As the treaty proposes no new institutions other than a European bank, its sponsors must suppose that nothing more is needed. But this could only be correct if modern economies were self-adjusting systems that didn’t need any management at all.

"I am driven to the conclusion that such a view – that economies are self-righting organisms which never under any circumstances need management at all – did indeed determine the way in which the Maastricht Treaty was framed… All that can legitimately be done, according to this view, is to control the money supply and balance the budget…"

Since he saw this view as delusional, he foresaw – in 1992! – that disaster lay ahead:

If a country or region has no power to devalue, and if it is not the beneficiary of a system of fiscal equalisation, then there is nothing to stop it suffering a process of cumulative and terminal decline leading, in the end, to emigration as the only alternative to poverty or starvation.

Milton Friedman clearly was one of those delusional individuals who believed that capitalism was inherently stable (though in the delusional stakes Friedman has nothing on more recent Nobel Laureate Edward Prescott, who in 1999 argued that the Great Depression was, in effect, an extended voluntary holiday). But even he didn’t think that the euro made any sense, for the simple reason that Europe was not a country:

"Europe’s common market exemplifies a situation that is unfavourable to a common currency. It is composed of separate nations, whose residents … have far greater loyalty and attachment to their own country than to … the idea of "Europe."... goods move less freely than in the United States, and so does capital. The European Commission … spends a small fraction of the total spent by governments in the member countries. They, not the European Union’s bureaucracies, are the important political entities… wages and prices in Europe are more rigid, and labour less mobile. In those circumstances, flexible exchange rates provide an extremely useful adjustment mechanism."

So if Europe’s leaders could just take a step back and realise that their currency isn’t really a currency, they could perhaps convert it into what it most closely resembles – a European SDR – and reduce at least the government-mandated part of Europe’s modern tragedy. This would not be painless – any more than divorce is cost-free – but it would be less painful than enduring today’s continuing extreme crisis.

The first step would be to re-introduce national currencies as sub-species of the euro on a one-for-one parity with the euro, and to denominate all debts in them: Greeks would owe debt in euro-drachma, Spaniards in euro-peseta, and Germans in euro-marks. Then the market could be allowed to revalue these sub-currencies – which would drive down both the exchange rates and the debt of the PIIGS.

After a period of free movement when national banks would need to be recapitalised by national governments (since the value of, for example, German bank holdings of Spanish and Greek debt would plunge), the exchange rates could be frozen once more, and the euro would then become the reference currency for international trade within Europe, and between Europe and the rest of the world. The Maastricht rules against deficits, which are currently applied to government deficits, would then be directed instead at trade deficits – though with the possibility of devaluation if a country ran persistent trade deficits.

This system would re-institute the three wings of national policy that the euro forbade: exchange rate variation, fiscal policy, and differential monetary policy. It would also directly reduce the debts that are currently paralysing both the private and public sectors of the PIIGS.

This shift could be undertaken in concert with or after the "modest proposal” that Yanis Varoufakis and Stuart Holland have long championed, and have just recently had republished in the Financial Times online. This would convert bonds issued by the nations of Europe into bonds issued by the European Central Bank, up to the 60 per cent of GDP level currently allowed by the Maastricht Treaty. These bonds would continue to be serviced by the relevant nations, but with the backing of the ECB the rates on those bonds would fall dramatically:

This debt conversion program, which involves no debt monetisation, will instantly engender large interest rate reductions for fiscally-stricken states without any concomitant rise in the long-term interest rates that Germany pays (since Germany is not guaranteeing the program).

Will either of these things happen? The current political impasse in Europe implies no. But impasses have a way of collapsing all at once when The Unthinkable happens.

And in the master's chambers,
They gathered for the feast
They stab it with their steely knives,
But they just can't kill the beast

Welcome to the Hotel California…


Steve Keen is a professor of economics and finance at the University of Western Sydney and author of Debunking Economics and the blog Debtwatch.

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