Paul Krugman’s epic walk through of the eurozone crisis, due to appear in the New York Times Magazine this weekend, has already made its way online.
It is an effective review of what’s going on in Europe and what may come next in terms of the potential solutions for the current crisis. We have the quick break down for you.
First, how did we get here:
- Krugman says that European leaders, in their desire for greater unity, put together the euro project without thinking of the dangers the monetary union could pose.
- The euro provides an increase of 10 to 15% in trade between euro countries, but sacrifices currency independence that would allow for individual competitive adjustments.
- American economists have have been critical of the euro project since its inception over its lack of fiscal union and the absence of labour mobility in the region.
- Euro denominated sovereign bonds became a bubble, based on euphoric interpretations of appropriate yields for each sovereign’s debt.
- The bubble has burst in the wake of the housing bust; now fringe states are facing falling prices and wages, but retaining debt. Unlike the U.S. and UK, they cannot use monetary tools to combat this, as they have no control over monetary policy.
Where are we going next, four possible outcomes:
- Eurozone members could choose the path of internal devaluation, but this will lead to high levels of unemployment (current course).
- Members could restructure their debts; markets already assume Ireland and Greece will; if such an outcome was to occur in Belgium and Italy, the impact would be massive.
- Eurozone members could pull an Iceland, reducing the value of the currency and becoming more competitive. They would have to leave the euro first, which would result in a run on the respective country’s banks.
- The creation of E-bonds and move to a transfer union in Europe.