Breaking news out of Brussels today reports that talks to further Greek financing have broken down according to the Wall Street Journal. Some economic backdrop on the situation, Greece is in a dire financial situation and needs financing in order repay debts and keep their government functioning. The Greek government, however, is not fond of the terms in which Greece will receive financing from the European Central Bank. Greece feels the terms put a further damper on their economy. But maybe the problem isn’t with Greece or the terms laid out by the officials of the ECB. Maybe the problem much deeper and is brought on by the existence of the Euro itself.
Last semester, I took a course on the European Economy that covered everything from just before the creation of the Euro to present day struggles. When the Euro was first introduced, it served as a unity symbol for all of Europe. The theory was that in order for European countries to be a leading global macroeconomic power, they needed to bind together. The Wall Street Journal has another article which discusses the Euro as a unity symbol and further describes the current Greece issues which can be viewed here. But surely 28 European countries did not form a single currency just to show they were united as one. Rather, the initial economic thought was that the Euro zone would benefit from economies of scale and that individual countries would benefit from a removal of trade barriers.
Now for the reality. There are also many harsh implications when uniting multiple diverse countries (and economies) into a single currency. First and foremost, monetary policy dissolves. The ECB still has control over monetary policy, but the needs of Germany may be very different from the needs of say Greece. When Greece is struggling with net exports, they are unable to set a more accommodating monetary policy via quantitative easing. This is a built in failure of the Euro zone. And it goes both ways. Former Fed chairman William McChesney Martin famously coined the phrase that the job of the Fed is to take away the punch bowl right before the party begins. The reason for this is to temper inflation. So if a country is experiencing tremendous growth with low interest rates, they are at risk of inflation. The Fed can simply raise the nominal interest rate. The German Bundesbank, however, has to leave that power up to the ECB. Ultimately, the Euro zone is too economically diverse to function as a single unit. It may take Greece falling out of the Euro zone to start a domino effect, but eventually, the Euro will fail.