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Spanish Crisis Points to Eventual Euro Breakup

I mentioned the new round of economic crises in Europe, but Howard Schneider highlighted it again. He mentioned that new conservative Spanish Prime Minister Mariano Rajoy highlighted the “extreme difficulty” in borrowing money in the financial markets right now, though he didn’t think back to the reason why – austerity and no hope for growth, not necessarily deficits and debt. In fact, the problem is that Spain is sitting in a negative feedback loop, where their austerity programs only increase their debt, rather than lower it as per the desired effect. Without economic growth it will be impossible for Spain to dig out of its hole.

There are ways out of this, but most of them involve doing things that European leaders are disinclined to allow. One more novel approach concerns a tax swap in the Eurozone, with the countries seeking growth swap a higher VAT for payroll tax cuts, and vice-versa in the core countries. But I see no reason to believe this kind of imagination exists in Europe (nor am I certain that will have the desired effect, as the VAT is a regressive tax on the same workers benefiting from the payroll tax cuts). Higher inflation targets by the European Central Bank, the third part of this analysis, is right out. And I think “labor market reforms,” meaning “making it easier to fire people,” are a red herring.

No, I think that we’re headed, if not toward a meltdown that will eat up all of the various Eurozone bailout funds, eventually toward a breakup of the euro:

Rogoff provides a good primer here, explaining that a single currency works for the United States because (a) workers can freely move from depressed areas to more vibrant ones, and (b) national tax policy automatically shifts resources from rich areas to poorer ones. This keeps the entire country in rough balance even though some states have better economic growth and more highly paid workers than others. States that run “trade deficits” with the rest of the nation will never get too far out of whack.

But Europe has neither of these things. Technically, workers in the EU can move freely between countries, but in practice language and cultural barriers are far stronger than they are in the U.S. Spanish workers in Seville just aren’t very likely to move to Frankfurt even if lots of jobs are available there. And although Europe does engage in a modest level of fiscal transfers, it’s nowhere near big enough to make up for the persistent imbalances between the core and the periphery. As a result, countries that run trade deficits with the rest of Europe can very decidedly get too far out of whack and end up in crisis mode.

The European conception of fiscal integration has been to force austerity on everyone without the transfer payments to alleviate mass suffering. Workers don’t all freely move around the Eurozone to find jobs because they have cultural and social ties to their native lands. Europe is not going to mimic a federal system anytime soon. As a result, the best and most desired option is for a breakup to end this vicious cycle that is chewing up Europe’s citizens.

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David Dayen

David Dayen