Tuesday, June 7, 2011

Rogoff on the euro and common currencies

Ken Rogoff wrote a peculiar op-ed (subscription required) on the euro.  He correctly points out that the euro is very close to breaking up, and that the alternative would be to "deepen into a fiscal union."  His comment on what exactly the fiscal union would mean is criptic.  He says that the euro would fail "because European leaders are constitutionally incapable of making tough decisions on how to trim periphery debt burdens."  Does he mean that the fiscal adjustments imposed on the periphery are not tought enough? Or is he favoring a renegotiation of the debts, admiting that they cannot be paid?  It seems that his options are either more fiscal adjustment or default.

Default could be an option, don't get me wrong, in particular, because the ECB is not going to monetize the debt of the periphery.  But the interesting thing is that, either way, he does not even consider that the debts in the periphery are in euros, and the ECB can actually print euros.  And I won't explain again why that shouldn't be a problem (like in the US; read more here).  The 'debt' problem in Europe is only a problem, because the ECB allowed a domestic debt, in which there is no default, to become an external debt problem.

Rogoff also muses about the possibility of a common North American currency bloc "possibly extending to include a significant part of Latin America."  I would assume that he does not mean a common currency, or votes in a common central bank, but just dollarization.  Or is the former chief economist of the IMF suggesting that the US will reliquinsh its own currency? Not very likely!

He concludes, in very conventional fashion that:
"Having a smaller number of currencies is a phenomenon that makes a lot of sense economically, economising on transactions' costs and leveraging economies of scale.  The real questions is whether common currency is sustainable politically."
In other words, the economics would be fine, but it is the lack of political will to make tough decisions as he said before, that make the euro unsustainable.  This is nonesense.  Common territorrial currencies are not important because they reduce transaction costs, and that is not the reason why they appeared.  Territorial currencies appear because a strong State can enforce the use of particular token to promote domestic expansion (in general of a particular class), and guarantee the secure functioning of the financial system (to fund the State) providing a default free asset.

At this juncture the problem of the euro is an economic one.  The countries in the periphery eliminated one instrument to deal with their external problems (current account deficits), and are forced into adjustment for that reason.  No amount of political will would solve that under the conventional logic according to which monetization of debt is inflationary.  At a deeper level common curreencies are always a political project, and once political unity exists  there is no economic problem with having a common currency, because fiscal transfers allow for subnational units to avoid default, and the federal government becomes responsible for fiscal policy.

This is not the story of weak and corrupt politicians destroying the good functioning of the market economy; this is a story of haywire markets forcing politicians to do terrible things. Some politicians wanted to do this terrible things even in the absence of the euro (see the fiscal adjustment in the UK, for example).  Shame on them for doing it, but shame on economists for pushing this sort of intellectual drivel.

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