Thursday, 19 July 2012

Euro zone: avoiding the bottomless pit

The United States of America shares one currency, the dollar. The 50 states and 1 district vary markedly in their structure, culture and financial competence, and the USA as a whole has a total debt of 3 times its GDP, and some states are virtually insolvent. California has a debt level of $9,225 per person and unemployment of 12.4%. In contrast Wyoming’s per capita debt is $4,310 and unemployment is 6.8%. On top of these problems the US banking and financial services have been badly, even fraudulently run.

 Yet the dollar works as a means of exchange across all the borders within the USA and is so valued by the world as a whole that it is welcomed almost everywhere, even after the recent Wall Street debacles.

The Euro zone comprises 17 countries and shares one currency, the euro, and has, on average, considerably lower debt in relation to the size of the economy than the USA. Yet the profligacy of Greece, Spain, Portugal, Italy and Ireland (the ‘PIGS’ countries), and the recklessness of some European banks within them, has affected the euro more than the equivalent factors in the USA have affected the dollar.


Partly it is because the dollar has a long history as an international reserve currency used for buying oil and raw materials. This stems from the inventiveness, relative freedom from corruption, vigour and risk taking of its industry (especially in extracting the oil and minerals needed by all countries but also in new technology) of the USA, unequalled anywhere else in the world for decades, and from its military power. All countries needed to trade in dollars and so they built up large reserves in dollars for convenience and security. And because so much of their own wealth was stored in dollars they have an interest in maintaining its value.

After the euro was launched at a price of about $1.05 dollars in 1999 it rose in value to a maximum of $1.58  in 2008, after which it fell to its present level of $1.22 (July 2012). So before the bank problem the euro was gaining on the dollar as a reserve currency.  See history of dollar/euro exchange rates.

Why is the dollar now winning against the euro instead of losing?

 It may well be a result of the way the USA protects depositors in its banks. The USA helps failed banks centrally rather than leaving individual state governments to do so.  This avoids pouring money into profligate states and expecting them to rescue their own banks. In the case of California, Nevada, North Carolina and New York this is done via the Federal Deposit Insurance Corporation (FDIC), to protect customers, not shareholders. During the sub-prime mortgage crisis the US Treasury rescued banks through its Troubled Asset Relief Program (TARP).  Also, the Federal Reserve is able to stimulate the national economy even while individual states go into recession and put pressure for reforms on the banks it is supporting.

In the July (2012) issue of Prospect C. Randall Henning proposes a possible way for the eurozone to allow  member countries with diverse financial structures but using the same currency, the euro, to work together in a sustainable  way: copy the US model. Instead of providing individual indebted countries with huge sums of money originating from various jointly financed central funds like the IMF (International Monetary Fund) and ECB (European Central Bank), regulate the banks more rigorously and use the IMF and ECB directly to protect the deposits of customers, leaving shareholders to bear the risk of commercial operations as in any other industry, rather than get involved in financially rescuing indvidual governments from overspending and under taxing.

In the 1840s nine American states defaulted on repayment of their loans after Congress rejected requests for them to be bailed out. Subsequently the federal government has assumed no responsibility for the debt of any state.

I’m not sure why some states are unable to balance their budgets but in the case of California (the biggest one with the biggest debt - $15 billion) it is because all decisions aimed at significantly raising taxes or reducing expenditure have to be put to the electorate, either
  • directly by a referendum, or


  • indirectly by the State Legislature

In the latter case this means getting the support of 2/3 of the Legislators. Not surprisingly, very few voters support a proposal to have their tax increased or their public services cut or both. Hence the crisis in finance, a crisis from which no Federal support is expected.

In the eurozone, unfortunately, the individual countries have to rescue their own problem banks. This means cutting public services and throwing people out of work, which stifles economic growth and the associated tax revenue which countries like Greece and Spain desperately need.   It also disrupts or ruins the lives of tens of millions of people. Central bank protection would be accompanied by rigorous regulation of the banks and give Europe the confidence to invest in measures to stimulate the European economy.

Now it appears that a summit meeting in Brussels held at the end of June has taken one step in this direction. The situation is still far from being put right but the eurozone and the global economy are looking signifcantly more stable than before the June summit.


see also

World debt: getting a grip
The US debt mountain
The age of debt: the party's over

Reach me at