With the euro as single currency, European countries can be compared to the US and its dollar. In this sense, Europe has two issues, instead of one for the US:
-As for the US, the economic slowdown means that European countries must dig their deficit.
-Unlike the US federal government with the 50 US states, some European states refuse to help other states with a deeper slow down.
The euro ended “competitive devaluations”
In the past, devaluations could help national governments with an excessive deficit. Countries such as Greece or Italy did it often with the drachma or the lira. A devaluation would speed up exports, help corporations hiring, and keep workers busy. Thus, taxes would increase, budgets for unemployment benefits would drop, and the deficit of the government would shrink. The only disagreement was to pay for imported goods not available locally, such as a PC or a mobile phone, because their price in the national currency would be spiking.
With the euro, such a strategy is not possible anymore. In fact, one of the goals of the euro was to end these so-called “currency wars” or “competitive devaluations”.
“PIGS” countries ignoring the “eurozone” deficit limits
With no devaluation possible, the logical alternative was to cut expenses or to make the economy more competitive in order to raise more taxes.
But, the so-called “PIGS” countries (Portugal, Italy, Greece and Spain) struggled to implement these unpopular measures. Instead, they chose to cover their deficit by borrowing (locally or abroad) through the sale of national Treasury bonds.
Deficit limits had been agreed within the eurozone (annual deficit of the government targeted below 3% of the GDP; accumulated debt to be below 60% of the GDP).
The intent of these limits was to avoid the crowding-out effect: borrowing by some countries could put inflationary pressure on other countries. For example, if Greece was borrowing in excess and spending in Germany, it was generating inflationary pressure in Germany. More money injected in circulation than goods produced, and inflation will start.
Before 2008, some countries such as Greece had even hidden their deficit by financial tricks. After 2008, these deficit limits were simply ignored by most eurozone countries.
“PIGS” countries in trouble
With the crisis of 2008, the “PIGS” countries started to see their accumulated debt reaching well over 100% of the GDP. Lenders were becoming reluctant to buy more Treasury bonds.
In 2011, troubles started with Greece and its bloating Treasury’s debt. Greece couldn’t find buyer for its Treasury bonds, because the embryonic European government (in Brussels) won’t guarantee them due to a veto from other European countries.
In the dollar area, Washington D.C. can help Alabama or Louisiana
Washington DC’s federal government collects around 40% of the GDP through taxes. Then, it redistributes this amount between the 50 states through education, social security, infrastructure or military budgets. Of course, struggling state economies will receive more than thriving economies (theatlantic.com).
In the eurozone, Brussels can’t do much for Greece or Italy
European authorities in Brussels have only a budget around 2% of the European GDP. Not much there to help Greece or Italy escaping the slowdown. No automatic European mechanism existed to face such an event. The rules have to be redefined, and Germany has its plan.
