When economies are fucked over by insufficient demand, there are a couple ways of fixing it. One way is borrowing money, the other way is making more money.
There is insufficient demand in Yurp.
Borrowing money? The debt load is already high and rising in too many countries. A big fiscal stimulus – borrowing a lot more money to build things and give to people – is not an option. Making more money? The countries in the eurozone do not have control over their own money. The European Central Bank is in Frankfurt, subject to stringent monetary union rules. This was in the belief that the Germans are a responsible people who would provide the credibility of low inflation for the euro, which would keep interest rates for places like Italy low.
Let’s talk about Italy for convenience. Interest rates in Italy are not low. The yield on Italy’s bonds are far too high now, because interest rates are not just about inflation, but also about perceived risk. When the economy is fucked over by insufficient demand, there are a couple ways of fixing it, and Italy has access to neither option. The debt load can be reduced, in real terms, by a bit higher inflation. The slack in the economy can be picked up by a bit more money bouncing around. Italy’s exports could get a boost from a bit of a currency devaluation compared to their neighbors. All of that requires flexible exchange rates and new money which they can’t make. The typical safety valve is gone. Instead of the pressure being relieved by the easing force of the currency, the pressure is building and building and building.
Italy can’t reduce the debt load through a bit higher inflation. They don’t have control over their own money. Italy can’t pick up the slack in the economy with more money bouncing around. They don’t have control over their own money. Italy can’t get an export boost from a slightly devalued currency on the foreign exchange markets. They don’t have control over their own money.
Interest rates are high enough now that they aren’t sustainable. There isn’t enough taxation coming in to meet the debts, and more taxes would depress the economy’s demand even further. That’s a notable vicious cycle of macroeconomics. A country with its own money could just print the money to pay off maturing debt. A big dose of inflation, sure, but if the fundamentals of the economy are strong enough – and they are – you don’t have to have a hyperinflationary case. But they don’t have control over their own money. The euro is a fixed exchange rate between all the eurozone members. In the old system, the Italian lira would lose value against the German mark, and things could potentially balance out. Italy’s euro, however, can not lose value against the German’s euro because it’s the same bloody euro. It’s 1 for 1 between Germany and Italy. That is, unless the system collapses.
There is fear that the system will collapse. And justifiably so. What can’t go on forever won’t go on forever.
If Italy were to break away from the euro, its “new lira” would depreciate rapidly in value against what was left of the euro. Well, that’s actually the new money that is needed. That would seem to provide the solution… except people holding money in Italian banks would suffer the effects of that loss of value. People wouldn’t want to lose a significant fraction of the value of their bank deposits overnight in that manner. And it’s not like the government can declare out of the blue, with no plan, that it’s done with the euro, thankyew. It would have to take some measures, think it out a bit. But that’s impossible, too, because the very act of announcing an intention to leave the euro would cause the biggest collective bank run in the history of the world.
Italy can’t tell the world it’s done with eurobucks without every single euro-denominated bank in the country, without exception, becoming insolvent. It would be the utter destruction of the Italian financial system. They’d have to declare a massive bank holiday, and shut down all transfers of euros/lira until the new system was in place. The flow of funds, the life blood of the economy, would seize entirely. There would be literally no access to Italian money. People would not have access to their funds for however long it took them to jury-rig a “new lira” system in place. No one knows how that would work.
So leaving the euro is not an option… That is, unless the mother of all bank runs happens anyway. If we’re already looking at the collapse of the Italian financial system, then hey, might as dig a new lira system out of the rubble.
All of this, by the way, could be avoided by more money from the ECB. If the central bankers in Frankfurt were doing their jobs correctly, instead of legally, then we could avoid the worst financial crisis ever. But as they like to inform us ad nauseum, they are bound by a sole “mandate” of price stability. The caretakers of the euro do not have the legal authority to save the euro. Those of us who tend to ignore the law and focus on the economics then call the ECB crowd a bunch of filthy pig-dogs. After all, we’ve read history books. The Bank of England ignored the law when it was necessary in the 19th century. Clear financial precedent there. It stands to reason this can be done again, right? Right? We can cite chapter and verse on the functions of a true lender of last resort all day long, but the ECB doesn’t listen.
They’re the only ones who can help. There’s already too much debt, which means this is a money solution, and yet the money people announce on a near hourly basis that they’re not legally authorized to help. What I’m saying here is that you should expect the mother of all bank runs in the not-so-distant future. There is no apparent will to avoid it.
And that’s the euro problem. Essentially. Every country has its own interesting wrinkles, the ins-and-outs could be explained in ten thousand times the depth, but bottom line is that they need more money, the countries need a reliable backstop, the banks need more funds to survive a massive run – in other words, they need a genuine lender of last resort – and yet the only institution with the technical ability to stop this mess refuses to do anything substantive about it. I tend to look at the end of the eurozone in its current form as a foregone conclusion, but I guess technically they still have time to change their minds. Technically.
In fact, their minds will be forced to change eventually. When the dominoes start falling and Germany’s own banks are next in line, the legal arguments will vanish. But by then, it will be too late to save the eurozone as it exists now, and similarly too late to avoid depression.