From euro to zero: Lessons from Greece and Italian crises

As Italy teeters on the brink of a collapse, it is a good time to sit back and draw some lessons from it all - and make some predictions about the future.

The predictions first.

One, the eurozone is over. A grouping built on the false foundations of a common currency, an uncommon fiscal policy, and with members retaining political sovereignty was never workable. If Greece did its own thing and Germany its own, you need to have separate currencies. If Maharashtra borrowed as much as the government of India on the assumption that it is a sovereign power, the Indian rupee would collapse, too. The rupee holds only because India limits the fiscal sovereignty of its states.

Looking ahead, one can see the eurozone being restricted to Germany, France and the Benelux countries, or the emergence of two eurozones - with northern Europe being the stronger half with a stronger euro and southern Europe - assuming it sticks together - having a weaker euro (called zero, maybe?) The southern euro, or successor national currencies, have to depreciate against the northern ones, assuming the euro itself stays.

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Two, as the western world goes into recession, it is the less externally-vulnerable countries that will benefit most. India and a few Latin American countries, the oil-producers, and Russia will be the top gainers from a global slowdown - for different reasons. America will also benefit, because it imports more than it exports and it retains sovereignty over the dollar. A global slowdown will bring down the price of its imports faster than the slowdown in its export earnings.

[caption id=“attachment_128198” align=“alignleft” width=“380” caption=“The biggest losers will be the highly export-driven economies of Germany and China. Reuters”]  [/caption]

India will benefit for the same reason - and for the fact that it will still be growing faster than many other countries. The oil-producers (including Russia) will gain because oil priced in dollars will not fall too much - and because commodities become valuable real assets to hold. Their high currency reserve surpluses will allow them to invest in cheap Greek, Italian and European assets at advantageous exchange rates.

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Three, the biggest losers will be the highly export-driven economies of Germany and China, which will now have to find markets in new areas. Or they will have to grow their internal consumption markets through a painful process of saving less and spending more. Less affected, but affected nevertheless, will be the export tigers of Asean and Taiwan. Needless to say, all of them will slow down dramatically - if not slip into recession.

Now, for the lessons.

One, globalisation and absolute sovereignty are inimical to one another. One or the other has to dominate. If we want free trade, we cannot have political barriers to trade - and by trade we mean not only the export of goods and services, but also capital and labour. Globalisation will work perfectly only if all the factors of production move freely - and markets adjust constantly to this flow.

But this is an impossibility when political power remains national. The euro experiment is failing because Europe tried to graft a political project (to achieve a peaceful continent) based on economic interdependence. It would have worked if Europe also had a sovereign government which redistributed resources from the rich to the poor. In such a scenario, Germany would subsidise Greece and the other PIIGs to improve their economic conditions and competitive abilities. Eurozone is failing because this did not happen - and Germany hogged the benefits as long as it could.

Two, countries running excess fiscal and current account deficits over long periods of times will get into serious trouble. But the reverse is also true. Countries running external surpluses for long periods of time are equally the cause of the problem. This has been the world’s blind spot so far where exporters and surplus countries were hailed as heroes and the rest castigated as zeroes and profligates. The latter characterisation is rubbish: borrowers need lenders, and if borrowers keep on borrowing, it is because the lenders benefit from it - it is not done out of human kindness.

Put another way, it means when countries run prolonged deficits, both parties - the surplus economies and the deficit ones - must do opposite things. The adjustment cannot be done by the deficit people alone. By wrongly categorising Germany, China and Japan as surplus heroes we created a lopsided world in which they were being eulogised for being “virtuous savers” when the “profligate” spenders were actually responsible for their growth.

An example with show why: if Germany is in export surplus, someone else is in deficit. A surplus economy can sell to the deficit one only by lending it money - its own money is what is creating demand for its products in the deficit economy. Put another way, this means Germany’s surplus is fictitious.

The world’s problems will be solved today only if the saver economies now agree to spend lavishly (instead of lending) to right the balance. They will have to do this by sacrificing some of their old firepower and growth.

Three, welfarism has serious limits. Both the US and Europe are capitalist economies that took on excessive burdens on social security - Europe more than the US - which cannot be sustained by economic activity. The US economy is sinking under the weight of its unaffordable social security (mainly medical benefits) and pensions. Ditto for Europe - where the welfare state is even worse. Till recently, Europe’s inflexible economy was willing to tolerate high unemployment by doling out more by way of state benefits. This is unsustainable.

As for Japan, its economy is being held back by its demographics - too many old people, and a cultural unwillingness to make Japanese women contribute to economic growth by making workplaces more women-friendly - and inflexible immigation policies. And, of course, it is too export-dependent.

India is headed the Greek way, too, unless it learns the above lessons. The fiscal deficit and the current account deficits need to be brought under control by tightening belts and reforming spending by reining in waste and corruption. It is odd that Manmohan Singh, who rescued the Indian economy in 1991-92 from bankruptcy under Narasimha Rao’s guiding hand, has landed the economy today in precisely the situation he found it in 20 years ago.