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Analysis: How the Euro Threatens Stability
By Humphrey Bo | January 22, 2009
The Euro economy is currently at war with itself. The present recession is an unpalpable conundrum for ECB leaders and Euro-zone Heads of States. It is convivial to think this phase of the Euro currency integration is one that would have a happy ending cosidering the EUR strength. In this powerful article, David Blair of the Telegraph explained..
Every European government is under intense popular pressure to boost their economies with expansionist policies. The easiest way to do this is by cutting interest rates, which encourages domestic spending and helps exports by depreciating the national currency. Hence the Bank of England has reduced the Base Rate to its lowest ever level, 1.5 per cent, and the pound has fallen accordingly
But the 16 members of the Eurozone have deliberately sacrificed this option. They have ceded control over their interest rates to the European Central Bank (ECB), a remote institution, staffed by anonymous economists in Frankfurt, lacking any vestige of accountability or democratic legitimacy.In the teeth of a global recession, the governments of the Eurozone find themselves in the same position as a prizefighter with one hand tied behind his back.
The ECB has responded to the downturn by cutting its interest rate to two per cent and allowing the euro to fall against the dollar – although it has risen strongly against the pound.
Yet for Eurozone members like Greece, Ireland and even Germany, an interest rate of two per cent is probably still too high. Jean-Claude Trichet, the ECB’s French president, now faces an impossible dilemma. Whatever interest rate he chooses will serve the interests of some Eurozone countries and inflict immense damage on others.
Even the cleverest economist would find it impossible to come up with the right interest rate for Austria, where unemployment is only three per cent, and Spain, where it exceeds 12 per cent. How can Greece, where the recession is especially severe put up with the same interest rate as Holland, where the economy is far stronger?
The most logical option would be for Greece and Spain to leave the euro. If the situation continues to worsen, their electorates may ultimately demand nothing less.
The possibility of the euro breaking up under the strain of the present recession is taken seriously by the financial markets. The Maastricht treaty, which established the single currency in 1999, contains no legal route for a country to leave the euro. In practice, however, there would be no way of stopping a government from choosing this course.
But the costs imposed on any country leaving the euro would be overwhelming. The markets would take fright and demand a far higher premium for holding the government’s debts.
Yet if the recession deepens, some European leaders could face this terrible conundrum. They can expect no sympathy from their electorates. By joining the euro, they chose to bind themselves in a straitjacket of their own design..
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