The European Model: Broken Beyond Repair?

I am really tired of the German bashing!

The model for the Euro was unsustainable. But, the lessons learned from the effort should not be taken lightly.

The major lesson from the experiment with the Euro is that a currency area cannot be set up without a central political body that is strong enough to enforce the rules of the currency area. One can have separate states within the area, but, as in the United States, there must be a political union with enough authority to dominate the individual components of the area.

A second lesson from the experiment is that the economic model based upon “social engineering” is not sustainable. The German economic model of low inflation, high labor productivity, and fewer government handouts has worked better than the model that includes substantial credit inflation, an inefficient private sector, and bloated government payrolls.

And, as usual, the “losers” in the game cry foul against the successful.

“The press review from around Europe does not make pleasant reading for the German foreign ministry these days. ‘Look at this stuff, it’s just unacceptable,’ laments one diplomat—pointing to a front-page article from Il Giornale, an Italian newspaper owned by Silvio Berlusconi. The piece links the euro crisis to Auschwitz, warns of German arrogance and says that Germany has turned the single currency into a weapon. The Greek papers are not much better. Any taboos about reference to the Nazi occupation of Greece have been dropped long ago.

Across southern Europe, the ‘ugly German’ is back—accused of driving other nations into penury, deposing governments and generally barking orders at all and sundry.

There is also a much more polite form of German-bashing going on at the official level.’ (link)

Economics, at one time, was defined as the study of the allocation of scarce resources. That is, there are limits to what a country can attain given the amounts of human capital and physical capital that are available to it.

Over the past fifty years, many countries came to believe that they had overcome these limitations and through credit inflation and social engineering they could achieve something beyond the boundaries set by the amounts of human capital and physical capital that existed.

Some of these programs included government created credit inflation that kept workers locked in jobs that were becoming legacy positions and that also promoted a home ownership scam that seemingly created middle-class piggy-banks; government hiring practices that resulted in excessive overstaffing of bureaucratic agencies (about one-third of the Greek workforce is in the public sector); and pension benefits that allowed for very comfortable early retirements.

The economies of these countries just did not have the resources to sustain these programs.

If everyone is following these policies then everyone is basically in the same boat.

However, a problem occurs if one or more other countries do not follow the same policies.

The eurozone is having a problem because Germany, for one, has not taken the path most travelled. And, over time, their more disciplined approach came out on top.

Germany now has the wealth, the resources, that others don’t. Consequently, those that don’t have the wealth and are now struggling believe that Germany should compensate them for Germany’s success.

The article quoted above states that the weaker countries in Europe are asking three things from the Germans: first, to commit more money to a European “bailout” fund that would be “so large that it would frighten the markets from speculating against southern European bonds”; second, to commit to Eurobonds to make the debts of individual countries the debts of the eurozone itself; and to stimulate the German economy so that Germans would buy more goods from southern Europe.

These requests, in my mind, are totally off-the-wall!

The Germans should not give in on these issues and they should maintain their position of strength. And, the German-bashing should stop!

The eurozone is not going to get stronger by making every one of its members weaker!

This is because the eurozone is not the only game going on in the world.

Other areas in the world are maintaining their discipline and can only benefit, competitively, from a weaker eurozone. Need I mention China? And, Brazil?

And, these other areas of the world are growing in relative economic strength as Europe fights its own little family fights. The pressures coming from this competition are not going to go away and Europe, as a whole, may have already postponed dealing with its problems for so long that it may still be years away from a resolution in which it becomes as competitive as it needs to be in the world of the 21st century.

I still fail to see anyone in Europe that I would call a leader. Consequently, I find it hard to defend the continued existence of the Euro, as we now know it. At this point in time, I see several countries leaving the Euro over the next couple of years. I see a much-diminished role for the eurozone in the world, both economically and financially. I also see economic social engineering receding as a government policy in the western world even though Paul Krugman and Joseph Stiglitz will still be around. The era of economic social engineering is past its prime, even though this fact is not fully recognized yet.

The United States should be grateful to the eurozone for the way it has conducted itself, otherwise we would be talking more about the fifty-year weakness in the value of the US dollar.

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