Special Report: Europe and the Euro (Part 2)

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Aug 14, 2012 11:02:57 AM

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Balancing Europe and the Euro

As I discussed yesterday, the U.S. has been able to survive as a monetary union because the fiscal union supports weak areas and population mobility allows labor to move where it is needed. Balance can be maintained at the federal level even though imbalances persist at the state level.

It was not always clear, however, that the federal level would be able to do the balancing. Before the Civil War, the federal government was weak. Before the Great Depression, many of the stabilizers and fiscal transfers we now take for granted did not exist. These two crises drove a common identity that made Americans politically willing to fund the transfers over an extended period of time. The construction of the union was thus precipitated by response to crisis, which forced the subordination of the regions—literally, in the case of the Civil War—to the whole.

When we try to transfer these lessons to Europe, each of the components represents a problem because Europe, of course, does not have a balancing mechanism.

The subordination of the regions to the whole
This is a problem that Europe has not solved even at the country level. For example:

Within Spain, semiautonomous regions have run up enormous debts independently of the central government and are now seeking independent bailouts.

  • Catalonia has aspirations to be an independent country and increasingly tries to operate as one.
  • In Italy, the central government has placed Sicily—referred to as Italy’s Greece—under fiscal constraints for operating independently and incurring massive debt.

The problem is not limited to the eurozone, of course. The UK faces a similar issue with Scotland, Canada with Quebec, and even the U.S. with Texas. (Remember, quite recently Rick Perry raised the issue of Texan secession.) The difference in Europe—and particularly in the eurozone—is that the regions are operating with autonomy similar to that of the countries’ governments; unlike the states in the U.S., the regions within the European countries are not fully subordinate to the country.

And the problem is repeated at the next level, as we saw with Greece, where citizens protested against the austerity measures that came as the price of the country’s bailout. In order for the European whole to operate like the U.S., countries like Greece and not-quite countries like Sicily need to show more willingness to subordinate to the federal level.

This is where we are right now, and it is where most of the political coverage is trending. Germany, for example, is pushing for political integration as the price for continued economic support. What would political integration mean, though, in this context? This, we’ll explore tomorrow.

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