The Tragedy Of The Euro

Despite this fudge, ten of the twelve Maastricht signatories went ahead and adopted the euro in 1999 and as circulating currency in 2002. The UK had dropped out of the EMU in September 1992, and Greece was so obviously non-compliant its entry was delayed by two years.

Until the Lehman crisis, national interest rates had converged towards Germany’s under the aegis of a common monetary policy. The ECB’s interest rate policy was necessarily a compromise. At one end of the spectrum were the low rates previously enjoyed by the economies with solid savings rates. These were Germany, Luxembourg, Finland, the Netherlands and Austria.

At the other end were the bad boys: notably Greece and Italy. In 1992, when Maastricht was signed, Greece’s overnight lending rate was 28%. By 1996, when the Commission released its first convergence report, it had fallen to 12.8%. When Greece joined the euro in 2001, it had fallen to 3.3%. Italy’s 3-month interbank rate fell from 13% to 9%, and then to 3.4% at these same times.

The ECB’s task was not helped by the careless assumption that savings rates were a drag on consumption. Capital which had originated as credit expansion instead of genuine savings migrated to nations with higher bond yields, first as a trickle but then in increasing quantities as confidence grew that monetary unification under the euro was there to stay. This being the case, it was believed by investors that investing in Italian and Spanish debt was as safe as investing in German and French debt for less return.

The capital flows into these savings-starved nations boosted their asset prices and GDPs. And the more that credit-originated capital flooded into them, the more asset prices and GDPs benefited. This meant that based on improving statistics, the euro was deemed a great success, lifting the Mediterranean nations out of poverty. The reality was that capital flows ended up in malinvestments and government profligacy. No one thought to complain, and Germany’s sound-money men were silenced by those who pointed to Germany’s growing exports to the high-spending euro members.

In this manner, the ECB’s monetary policy gave impetus to localised credit cycles, particularly for the PIGS and Ireland.[iv]Asset booms were turned into bubbles, which finally burst in the wake of the Lehman crisis. The EU’s monetary system was then saddled with trillions of euros of debt that could never be repaid, and the PIGS suddenly found further finance from the markets was unavailable. Interest rate convergence was reversing. Furthermore, the whole Eurozone banking system was threatened with collapse, which always happens when extreme credit bubbles go pop.

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