August 22, 2012
It may come as a surprise to some of our younger readers, that the Eurozone, and its associated currency, is merely the latest in a long series of failed attempts to create a European currency union and a common currency. Three of the most notable predecessors to the EUR include the Hapsburg Empire, the Soviet Union, and Yugoslavia. Obviously, these no longer exist. Just as obvious, all of these unions, having spent time, energy, money, and effort to change the culture and traditions of member countries and to perpetuate said unions, had no desire, just like Brussels nowadays, to see these unions implode. The question then is: what happened after these multi-nation currency unions fails. VOX kindly answers: “they all ended with disastrous hyperinflation.”
Just in case anyone missed it, here it is again from VOX:
In the last century, Europe saw the collapse of three multi-nation currency zones, the Habsburg Empire, the Soviet Union, and Yugoslavia. They all ended in major disasters with hyperinflation. In the Habsburg Empire, Austria and Hungary facedhyperinflation. Yugoslavia experienced hyperinflation twice. In the former Soviet Union,ten out of 15 republics had hyperinflation (e.g. Pasvolsky 1928, Dornbusch 1992, Pleskovic and Sachs 1994, and Åslund 1995).
So… trying to pull infinite demand from the future to the present once the ability to fund said present deferred demand ends, has consequences? Oh yes, Virginia. It does indeed:
The output falls were horrendous and long lasting. The statistics are flimsy, but officially the average output fall in the former Soviet Union was 52%, and in the Baltics it amounted to 42% (Åslund 2007, 60). Five out of twelve post-Soviet countries – Ukraine, Moldova, Georgia, Kyrgyzstan, and Tajikistan – had not reached their 1990 GDP per capita levels in purchasing power parities by 2010. Similarly, out of seven Yugoslav successor states, at least Serbia and Montenegro, and probably Kosovo and Bosnia-Herzegovina, had not exceeded their 1990 GDP per capita levels in purchasing power parities two decades later (World Bank 2011). Arguably, Austria and Hungary did not recover from their hyperinflations in the early 1920s until the mid-1950s. Thus half the countries in a currency zone that broke up experienced hyperinflation and did not reach their prior GDP per capita in purchasing power parities until about a quarter of a century later.
What was the catalyst:
…systemic change, competitive monetary emission leading to hyperinflation, collapse of the payments system, exclusion from international finance, trade disruption, and wars.
It’s all good though: Europe has a beneficial donor with an endless sack of money – Germany – and 80 some million people who will never, ever consider voting out those politicians who jeopardize their standard of living (regardless how it was obtained, but hard work is a distinct possibility). Ever. Or maybe they will? Maybe they will realize, as they should have over a year ago, that each passing day that nothing changes, and the broken status quo persists, simply means the pain in the inevitable end will merely be that much greater? If recent elections are any indication, Europe should probably be very concerned. Of course, this being Europe, and the market being the market, the fact that there is reason to worry, will provide the market with reason not to worry. After all someone else will make everything better: the central planners made risk of failure illegal.
Sinn (2011) has argued that “the Eurozone payments system has been operating as a hidden bailout whereby the Bundesbank has been lending money to the crisis-stricken Eurozone members via the Target system.” He has alternatively proposed to cap the Target2 balances, settle them in hard assets, or transform them into short-term Eurobonds. Karl Whelan (2011) and others oppose Sinn, arguing that the Bundesbank has claims on the ECB system as a whole, not on individual national central banks. Whelan points out that limiting a Target2 balance would amount to cutting out a country from the euro system.
Some will say that this €700 billion + contingent liability is not really a liability until what has to happen – a member country departing – finally departs. Which it will. Sooner or later. So all debate is absolutely idiotic in this regard.
If one country (Greece) departs from the Eurozone or if its Target2 balances are capped, the current slow bank run from the south will accelerate quickly and become a massive bank run from most banks in southern Europe, and the banking system would stop working. The Eurozone payments system would stop functioning because it is centralized to the ECB. To re-establish a payments system is both politically and technically difficult. In the former Soviet Union, it took three years to do so. Currency controls would arise and a liquidity freeze would occur. If the drachma were reintroduced in the midst of a severe financial crisis, its exchange rate would plummet like a stone by probably 75%-80%. High inflation would result and mass bankruptcies ensue because of currency mismatches. Output would plunge and unemployment soar. Greece would experience a new default and other countries would follow.
For all these reasons, Greece or any other financially weak country is unlikely to depart from the Eurozone. In the three hyperinflationary currency union collapses, it was small, wealthy counties that left first: Czechoslovakia from the Habsburg Empire, Slovenia and Croatia from Yugoslavia, and the three Baltic states from the former Soviet Union. The countries that departed early and resolutely were most successful. Hence, the main concern should be whether small, wealthy northern countries want to abandon the Eurozone.
Finally considering the article was written by a member of the status quo who stands to lose his tenure, and his livelihood, if the voodoo he preaches is found to be hollow, the conclusion is obvious:
The conclusion is that the Eurozone should be maintained at almost any cost. All the economic problems in the current crisis can be resolved within the Eurozone. In order to maintain the Eurozone Eurozone-wide clearing must be maintained in full. The Target2 balances should be resolved by reforms, not by capping national balances. The only reasons for a breakup of the Eurozone would be that Eurozone governance fails completely or that one nation decides to leave. If the breakup starts, it would be better to agree on a complete and speedy dissolution into the old national currencies.
The “any cost” of course, has to be bourne by Germany. Which this time around is expected to merely stand there as its deadbeat neighbors continue to mooch off its generosity. Oddly enough, all the previous failed monetary regimes had a strong and supposedly munificent hegemon too, to pull a Realpolitik term.
What is certainly obvious is that in none of the previous occasions of monetary union collapse did the member countries think anything else. In fact, we can say what tenured economists said about the specter of the Hapsburg, the Soviet and Yugoslav collapse with absolute certainty: “the conclusion is that these should be maintained at almost any cost.”
They weren’t. And “disastrous hyperinflation” followed.
This time will surely be different though.
This article was posted: Wednesday, August 22, 2012 at 3:14 am