It’s time to lose the Euro

Why the Euro is a bad idea & how it broke Greece

Imagine a car with two drivers. Now give both of these drivers their own steering wheel and a destination to reach, but no specific instructions on how to get there. Sounds like a train-wreck right? Well, pile in 750 million people in the backseat and that’s the Euro.

Monetary & Fiscal Policy: The 2 Drivers

The fundamental problem that lies at the heart of the problem is the structure of the Euro itself and how it creates a discrepancy between a nation’s monetary and fiscal policy.

Before the introduction of the Euro, an individual nation’s monetary and fiscal policy was established internally. Smaller states in Europe with a weaker currency had certain limits on their deficit spending: a weaker currency led to higher interest rates thus lower lending, curbing the smaller states spending. On the other hand, larger and more economically powerful states were more trusted, thus had lower interest rates and hence had more capital flowing into the state. This was an effective way of countries staying within their limits and creating sustainable economic policies.

But by creating a currency that was adopted by states of varying economic power and centralizing the monetary policy of 18 different nations, a weak state’s currency was, all of a sudden, backed by powerful economic nations, allowing it to borrow at unfairly lowered interests. This permitted states to increase their deficit spending (mainly for increasing their domestic ratings or political capital) and created an economy that would never be able to sustain itself. This gap between a state’s monetary and fiscal policy was dangerous: a country could borrow more than it could actually afford, and would spiral into unforgiving sovereign debt.

Greece: You knew this was coming

Before the introduction of the euro, Greece had always been had a relatively weak economy. In the early 1990’s the interest rate on Greek 10-year government bonds was around 20% but was steadily declining due to increased integration with the European economy But in 2001, Greece was finally accepted into the Eurozone, allowing it to borrow in Euros. This lowered the interest rate on 10-year government bonds down to 3%.

This is largely because lenders believed that if Greece was unable to pay back its debt, a larger state like Germany would always be willing to step in and help because both Greece & Germany were tied to the Euro. Because of this, Greek government spending skyrocketed.

Greek Spending & Tax Revenue

Greece maintained an unsustainable debt-to-GDP ratio after introduction to the EU, thinking it was too big to fail: always floating over 100%.

This complacency of having the Euro always finance your deficit led to the sovereign-debt crisis Europe faces today.

When the housing market crashed in 2008 and led to a global credit crunch, lenders stopped buying Greek government bonds because of worldwide market volatility. Greece desperately needed to borrow money to pay back its previous debts, thus borrowed money at higher interest rates. Greece’s credit ratings began plummeting, and interest rates kept rising, thus Greece had to increase their deficits to pay back their newer debts, all creating a vicious cycle. Greece’s debt-to-GDP ratio rose to nearly 175%.

Greek Debt-GDP Ratio

Someone has to save Greece

This put the Euro on the verge of a crash and threatened every other nation that used the Euro as its national currency, thus economic leaders such as Germany, along with the IMF, resorted to bailing out Greece.

But Greece was just one case of a much larger and more threatening problem to the entire European economy. The Eurozone’s debt-to-GDP ratio, as a whole, has skyrocketed to unprecedented rates.

You can’t have two drivers

The fundamental root of all of the problems caused by the European debt crisis is ultimately the discrepancy between an individual nation’s monetary and fiscal policy.

Greece and Germany have and always will be completely different countries, not only in their economic policies but on on their cultural and social structures as well. And tying the economic power of such vastly different countries to one currency changes their respective ability to create fiscal policy: countries become complacent with the lowered interest rates and increased access to capital and continue to borrow at unsustainable levels as long as the credit is available. But as soon as the credit disappears for even a short period of time, the state is unable to continue without the crutch of investments and faces collapse.

This problem is personified in Europe through Greece, Spain, Italy, & Portugal and will continue to exist and reoccur, even after bailouts, because of the nature of the structural institution that allows states to create a gap between financial and monetary policy. There is ultimately only one possible long term and effective solution to this problem: abandon the Euro.