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Italy will Kill the Euro - Not Spain or Portugal

By Sam Vaknin - posted Tuesday, 4 January 2011


It is often argued that a single fiscal policy is not only unnecessary, but potentially harmful. A monetary union means the surrender of sovereign monetary policy instruments. It may be advisable to let the members of the union apply fiscal policy instruments autonomously in order to counter the business cycle, or cope with asymmetric shocks, goes the argument. As long as there is no implicit or explicit guarantee of the whole union for the indebtedness of its members - profligate individual states are likely to be punished by the market, discriminately.

But, in a monetary union with mutual guarantees among the members (even if it is only implicit as is the case in the eurozone), fiscal profligacy, even of one or two large players, may force the central monetary authority to raise interest rates in order to pre-empt inflationary pressures.

Interest rates have to be raised because the effects of one member's fiscal decisions are communicated to other members through the common currency. The currency is the medium of exchange of information regarding the present and future health of the economies involved. Hence the notorious "EU Stability Pact", recently so flagrantly abandoned in the face of German budget deficits.

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Monetary unions which did not follow the path of fiscal rectitude are no longer with us.

In an article I published in 1997 ("The History of Previous European Currency Unions"), I identified five paramount lessons from the short and brutish life of previous - now invariably defunct - monetary unions:

  1. To prevail, a monetary union must be founded by one or two economically dominant countries ("economic locomotives"). Such driving forces must be geopolitically important, maintain political solidarity with other members, be willing to exercise their clout, and be economically involved in (or even dependent on) the economies of the other members.
  2. Central institutions must be set up to monitor and enforce monetary, fiscal, and other economic policies, to coordinate activities of the member states, to implement political and technical decisions, to control the money aggregates and seigniorage (ie, rents accruing due to money printing), to determine the legal tender and the rules governing the issuance of money.
  3. It is better if a monetary union is preceded by a political one (consider the examples of the USA, the USSR, the UK, and Germany).
  4. Wage and price flexibility are sine qua non. Their absence is a threat to the continued existence of any union. Unilateral transfers from rich areas to poor are a partial and short-lived remedy. Transfers also call for a clear and consistent fiscal policy regarding taxation and expenditures. Problems like unemployment and collapses in demand often plague rigid monetary unions. The works of Mundell and McKinnon (optimal currency areas) prove it decisively (and separately).
  5. Clear convergence criteria and monetary convergence targets.

The current European Monetary Union is far from heeding the lessons of its ill fated predecessors. Europe's labour and capital markets, though recently marginally liberalized, are still more rigid than 150 years ago. The euro was not preceded by an "ever closer (political or constitutional) union". It relies too heavily on fiscal redistribution without the benefit of either a coherent monetary or a consistent fiscal area-wide policy. The euro is not built to cope either with asymmetrical economic shocks (affecting only some members, but not others), or with the vicissitudes of the business cycle.

This does not bode well. This union might well become yet another footnote in the annals of economic history.

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About the Author

Sam Vaknin ( http://samvak.tripod.com/cv.html ) is the author of Malignant Self Love - Narcissism Revisited and After the Rain - How the West Lost the East as well as many other books and ebooks about topics in psychology, relationships, philosophy, economics, and international affairs. He served as a columnist for Central Europe Review, Global Politician, PopMatters, eBookWeb , and Bellaonline, and as a United Press International (UPI) Senior Business Correspondent. He was the editor of mental health and Central East Europe categories in The Open Directory and Suite101. Visit Sam's Web site at http://www.narcissistic-abuse.com

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