EURO CRISIS

Euro crisis reflect fundamental flaws in the euro area's design

Euro crisis reflect fundamental flaws in the euro area's design

Introduction

The fatal defect in the eurozone project was that it was informed by a neoliberal view of leaving policy entirely to market forces, say George Irvin and Alex Izurieta. EURO notes and coins were launched with great expectations in January 2001, the product of a decade of negotiations between the original participants, all 12 of whom were signatories of the Maastricht Treaty of 1993. For nearly a decade the experiment appeared to prosper. A common currency, combined with the 'borderless travel' agreed earlier between Schengen area signatories, appeared to turn Europe from a disparate group of neighbouring states into a seamless giant whose combined population and gross domestic product (GDP) placed it at par with the United States.

Today, in contrast, the euro is under attack from the financial markets, with Greece on the verge of default, Portuguese and Irish Eurobonds demoted to junk status and Italian and Belgian bonds under speculative attack, with Spain next in line. What is more, the real fear is that a default in one country will trigger a domino effect and bring down some of Europe's major banks. Although the Greek and Portuguese economies account for only a small percentage of Euro Area (EA) output, were default contagion to spread to Europe's larger countries, the entire euro edifice could be brought down. Why has this happened? Are we witnessing the combined effect of a string of economic accidents, or were there potentially fatal flaws in the EA's original design?

In essence, our argument is that the euro, aimed at removing nominal exchange rate fluctuations in a wide free-trade area, was informed by a neoliberal view of leaving policy entirely to market forces. In consequence, by way of its specific design, it removed three essential policy instruments at once from the domain of national policymaking - exchange rate management, monetary policy and fiscal policy - and it intrinsically weakened labour and welfare policy.

While the loss of exchange rate flexibility for individual countries is part of the common currency construct, exchange rate management of the euro for the EA as a whole was made to fall outside the remit of the European Central Bank (ECB). Nor was the ECB allowed to act as 'banker' for the EA in a manner analogous to the Bank of England (BOE) or the US Federal Reserve since it cannot issue its own bonds or engage in open market operations. Issuing government debt - in the form of national Eurobonds - is left entirely to the individual member states who must sell them on the financial markets; until quite recently, the ECB could not even purchase national bonds.1 Indeed, for the ECB even to hold these as collateral against its short-term liquidity operations, national bonds must be well-viewed by the main credit rating agencies (CRAs). In the words of Thomas Palley (2011), '...the euro's architecture makes the bond market master of national ...