Chartalism and the Euro

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

The euro is unique in that it is the only currency in history that
serves as legal tender in multiple sovereign states.  The establishment
of monetary union before political union is unprecedented. Although
members states of euroland have surrendered certain macro-economic
sovereignty, such as deficit and inflation, to the EU in order to adopt
the euro, the implication of a single currency over economies of
different cultural/political/social characteristics has been left
unresolved.  Citizens within each state still hold the elected official
responsible for such economic performance as unemployment,
competitveness, demand management, investment allovation, etc.  Such
performance is traditionally managed by government through interest
rates, exchange rates and tax policies.  With the euro, EU member
governments are deprived of such sovereign policy options which enjoy
the widest flexibility under Chartalist principles. Is Gernmany prepared
to see all its manufacturing relocated to Spain or Italy, or the pending
new members of lower labor cost?  The necessary link between currency
and sovereignty become more pronounced through the example of the euro.

Henry C.K. Liu

Sharp divergences in performance by eurozone economies this year are
likely to put their politicians under pressure over the single currency

Heather Stewart
Thursday January 10, 2002
The Guardian

Something at last seems to have gone right in the eurozone: the
long-awaited launch of crisp new notes and freshly minted coins seems to
have passed off without a hitch. But economically - and this is an
economic project, after all - the timing could not be worse.

Survey evidence released yesterday shows business confidence across the
eurozone is at its lowest since 1996 as firms prepare for a difficult
start to 2002. With little sign of the US staging a quick recovery and
stepping in as importer of last resort, Europe's economic difficulties
look set to continue.

Not that the deteriorating state of the eurozone can necessarily be
blamed on the introduction of the euro, of course.

The current downturn is the first synchronised contraction in the
world's three largest economies since the 1970s, and even the inveterate
weakness of the euro over the last year could not have been expected to
protect the single currency zone as a whole from the fallout. (Although
the European Central Bank has been loudly criticised for placing
establishing its inflation-busting credentials ahead of quick-footed
rate-cutting in the style of the Federal Reserve.)

Deteriorating economic conditions are informative, however, because the
different way in which eurozone
economies are being affected strikes at the heart of the project of
establishing a single currency zone across a continent.

Take Germany, Europe's largest economy. Analysis by David Brown of Bear
Stearns suggests that if measured in terms of industrial output - the
main basis on which the National Bureau of Economic Research dates US
downturns - Germany entered recession in the early months of 2001, even
before America. Official figures show GDP growth slipped into reverse in
the third quarter of 2001, and there were reports yesterday that the
government is about to downgrade its estimate for expansion in 2002 from
1.25% to an anaemic 0.75%.

Fresh data published yesterday showed the unemployment rate climbing to
9.6%, with the jobless total just below the politically sensitive 4m
mark, and expected to break through it soon. The pressure is already
telling on Chancellor Schröder, who is facing re- election in September,
and announced new job creation measures yesterday in a bid to head off
criticism that his economic policies are failing.

Analysts give a number of specific reasons for the fact that global
slowdown is hitting Germany especially hard. Although its economy is no
more export-dependent than that of neighbouring France, where growth in
the third quarter of 2001 held up at 0.5%, its exports are
disproportionately made up of capital goods - machine tools,
manufacturing equipment, and so on.

And a collapse in business investment has been a key feature of this
downturn, as the hi-tech bubble has burst.  So as firms across the world
retrench, the German economy suffers. Secondly, the construction sector
is still struggling with over-capacity, the legacy of the
post-unification building frenzy, which subsequently folded.

There are more reasons than this - David Brown more controversially
cites the conservative nature of the German consumer, rushing to put
money under the mattress at the first sign of a cash crunch, for
example. What this quick glance at the German economy illustrates,
though, is that the eurozone is made up of a jigsaw of quite different
economies.

Spain is likely to be disproportionately affected by the devaluation of
the Argentine peso, because its banks are  heavily exposed there; France
(where there are also elections this year) may escape the worst of the
slowdown in the rest of Europe if its consumers can keep their nerve;
Ireland could insulate itself if it can continue to attract inward
investment and maintain its healthy growth rates.

In the long, long term - probably decades - the growth rates of the
countries and regions in the eurozone should begin to converge. Putting
it simplistically, companies will exploit the single market by siting
their operations where labour is cheap, transferring resources and
technology from richer areas to poorer, and - hopefully - raising the
standard of living of the poorest.

Some analysts cite this as one reason Germany is underperforming now -
because GDP per head is higher
than across most of the rest of the single currency area, so
"convergence" for Germany means covergence
downwards".

Which is where the political pact underlying the single currency
experiment could start to look wobbly. As Mr Schröder may find to his
cost in the autumn, in a much less extreme and more sedate version of
the Argentine public's rejection of its government's economic strategy,
there is a limit to how much economic pain the public will be willing to
endure.

The eurozone governments have surrendered their ability to offset the
differences between their economies by adjusting interest rates; and the
markets can no longer offset those differences with move ments in the
exchange rate. The differences are significant, however, as a simple
comparison of growth rates shows. And when the region as a whole is
suffering from a slowdown, differences between growth rates hurt much
more, because they can translate into higher jobless figures - or a
longer recession.

So eurozone politicians may have a fight on their hands in 2002 to
persuade their electorates that signing up to the euro was worth the
price.

If, as expected, the apparently unstoppable spending spree of the
British consumer helps the UK economy to escape the worst of the
downturn across the channel - and across the Atlantic - in 2002,
convincing the electorate here that they are losing out by missing the
euro-party could be a difficult task.

· Heather Stewart is the Guardian's economics reporter.
heather.stewart@xxxxxxxxxxxxxx