With French and Greek voters saying “au revoir” and “andio” to their governments, the big question now is what will happen to the euro, the currency shared by almost two dozen European countries.
These results could spell economic demise for Europe. The rescue loans from the International Monetary Fund and the European Central Bank, which are conditioned on the austerity measures voters rejected, may evaporate. Then again, perhaps the change in leadership will make it easier to walk away from the euro, helping Europe to recover.
Although America’s growth is stagnating at about 2 percent of gross domestic product and U.S. unemployment rates have been above 8 percent for longer than three years, Europe’s problems are far worse. And they are exacerbated by the common currency, which will eventually have to unravel.
To understand why the euro is a disadvantage, consider that the Federal Reserve has kept America afloat by pumping out dollars and driving down interest rates to practically zero. This is not a good long-term solution, but useful in the initial stages of a recession. The troubled eurozone nations do not have this option.
The euro is impeding the recoveries of Portugal, Ireland, Italy, Greece and Spain, countries known (regrettably) as the PIIGS. Since PIIGS share the currencies of strong economies such as France and Germany, they cannot weaken their currency in order to attract foreign investment and tourism.
The European Central Bank has been making loans to the PIIGS, and Ireland and Greece have already been bailed out by International Monetary Fund. The conditions imposed on these countries as a price for the bailouts have resulted in increased unemployment and political disturbances, increasing the possibility of more defaults on loans.
The IMF and the European Union have thus far committed to a Greek bailout of about $312 billion, on the belief Greece will reduce its deficit by 7 percent of GDP by 2014. So Greece is required to implement significant tax increases and spending cuts. That means lower public-sector wages and fewer public-sector jobs in a country where the public sector is the major employer.
In Spain, unemployment is now at about 24 percent. Construction loans outstanding are about 45 percent of GDP. The ECB has discounted $166 billion of bank loans.
So the Euro is making it harder for Greece, Ireland, Italy and Spain to recover. They must cut their budgets, even as unemployment is high and while the value of housing is still falling.
The simplest solution would be for the PIIGS to drop out of the eurozone, or set up a second-tier euro, so as to let their currencies depreciate. That would allow wages some flexibility to decline, and exports to rise, as they did in Argentina in the early part of this decade.
With Nicolas Sarkozy in charge of France, this was impossible. The unity of the euro was sacred.
And it is to preserve the euro that German Chancellor Angela Merkel has bucked public opinion, incurring losses in local elections, by having Germany support bailouts for Ireland and Greece. Merkel will not be able to continue bailing out weaker European countries if they abandon their austerity packages.
The bailout funds from the IMF and ECB are just a down payment on the problem, because the stronger European countries have substantial exposure to the debt of the weaker ones.
French banks and financial institutions had more than $678 billion of exposure at the end of 2011 to borrowers in the PIIGS, according to the Bank for International Settlements. German banks have more than $553 billion. America holds about $760 billion in claims and other potential exposures to the PIIGS.
If the French and Greek elections facilitate some dismantling of the euro, they could be a blessing in disguise.
Examiner Columnist Diana Furchtgott-Roth ([email protected]), former chief economist at the U.S. Department of Labor, is a senior fellow at the Manhattan Institute for Policy Research.
