What the euro’s current difficulties really mean

Greece’s current travails offer many lessons, but they are not those that some seem to believe. This is not a story about corruption or profligacy, even if there has been some of that, as there always is. Nor is it a matter of “Greek vice” and “German virtue.” It is a story about incomplete economic — hence political — unity among states. And this is a story that not only Europeans, but Americans and others, all should take heed.

{mosads}Begin with a fundamental datum: Some European economies — particularly those in the north — have long been commercial and industrialized. Others — particularly those in the south — remain to this day much more traditional and agricultural in character. This means that the northern economies produce and provide more in the way of high value-added, manufactured goods and services, while the southern economies produce or offer more in the way of low value-added, agricultural produce and tourism.

Now ordinarily, this state of affairs will result in northern currencies, like the goods that one purchases with them, being in high demand. Southern currencies, like that which one purchases with them, will be in correspondingly lower demand. And now for the kicker: This means in turn that if north and south share a currency, it will effectively be undervalued as a northern currency and overvalued as a southern one. A Deutschemark issued by Germany alone, in other words, would tend to be worth more than a euro that Germany issued in tandem with Greece, while a drachma issued by Greece alone would tend to be worth less.

But now note what this means: It means Germany will be able to export much more than it otherwise would, since its currency — the euro — is undervalued as a German currency. It also means Greece will have much more trouble exporting than it otherwise would, since its currency — the euro — is overvalued as a Greek currency. So Germany will tend to rack up huge trade surpluses, and Greece will tend correspondingly to incur deficits and debts — all thanks to the nature of their shared currency in relation to their very different economies.

This situation is not unfamiliar. Indeed, substitute “New York” for “Germany” and “Mississippi” for “Greece,” and you have essentially described matters in the U.S. if there is a single currency — like the dollar — shared by all of its states. Why, then, is Mississippi not in the same straits as Greece, with New Yorkers clucking complacently about their thrift and hard work in comparison to Mississippi’s profligacy?

The answer comes in three words: fiscal transfer union. The U.S., unlike the European Monetary Union (EMU) is not only a monetary union sharing one currency, but a fiscal union sharing one federal budget. The “transfer” aspect of that union takes the form of Mississippians (and others, primarily, though not solely, in the South) receiving more than one dollar in federal outlays for every dollar they pay in federal taxes. This in turn is made possible by the fact that New Yorkers (and others, primarily, though not solely, in the North) receive less than one dollar in federal outlays for every dollar they pay in federal taxes. In effect, funds are continually transferred from more commercial and industrial U.S. states to less commercial, less industrial U.S. states.

In the EMU, the same thing is happening, save there, the transfers take the form of loans rather than simple outlays. And therein lies the central flaw at the core of the EMU. The U.S. would suffer the very same travails as the EMU right now were New Yorkers, say, to be lending to Mississippians rather than transferring funds to them via the federal budget.

Why is it that the Europeans don’t see this and act accordingly in order to salvage their union? Why don’t they adopt a fiscal union, in other words, to stabilize their monetary union? Ultimately, it comes down to whom you are willing to include in your uses of the word “we.” Here in the U.S., New Yorkers and Mississippians are evidently willing to use the word “we” in a manner suggestive of their constituting one nation. This is a remarkable accomplishment, given our history, and heaven knows we worked hard to get here. Germans and Greeks aren’t quite there yet.

What, then, should be done? Here is what looks to be the most reasonable and feasible near-term strategy. First, creditor members of the EMU must offer debt restructuring — and even some debt forgiveness — in the near term for distressed debtor members like Greece. This should be without austerity-forcing conditions, since the latter simply shrink the distressed economies further and make debt repayment that much less likely. Immediate term debt restructuring and even forgiveness will amount to one-off transfers of the type I’ve described, which in the long run will have to become a central feature of the EMU if it is to endure.

Second, in the longer term, the EMU is going to have to do one or the other of two things. It can become a fiscal transfer union like the U.S. as described above, or it can divide itself into two or more eurozones that make better sense than the present one absent a shared federal fisc. We might envisage a northern eurozone — call it “Hanseatica,” for example — sharing a northern euro, while a southern eurozone — call it “Mediterranea” — shares a slightly less valuable southern euro. A measure like the latter can be expressly treated as temporary, until such time as either fiscal integration or developmental convergence is achievable.

There is one more lesson that Americans, in particular, should draw from the eurozone’s current travails, having to do with our relations with China. Owing to Chinese currency practices, there is effectively a single currency shared by the U.S. and China: the dollar, as kept artificially overvalued via Chinese currency trading activities on global foreign exchange markets. This currency is overvalued as an American currency, and undervalued as a Chinese currency, meaning that U.S. exports are artificially overpriced relative to Chinese exports. This in turn means that the U.S. continues to rack up trade deficits and bleed out manufacturing jobs of the kind that once sustained our great middle class.

If the U.S. is to avoid coming to look more like Greece in the future, it must do something about this. And what it must do is not what misguided austerians say Greece must do — i.e., cut federal spending and depress economic growth even further. No, what it must do is what Greece and the EMU more generally must really do: It must either end the currency arrangement pursuant to which China manipulates the dollar away from its natural value so as to advantage its own manufacturers at the expense of American industry, or it must declare a de facto transfer union by declaring future illicitly incurred debts to China to be “grants” instead.

Hockett, a regular contributor to The Hill, is Edward Cornell Professor of Law at Cornell University, senior consultant at Westwood Capital Holdings, LLC and a fellow at the Century Foundation.