Will Euro Survive?

Last year, when I started to write this blog, (in May, 2010 - more than a Year Now!) in a post titled "Austerity Measures - everywhere around Europe" I had mentioned that I would not be surprised if EURO fails or dissolved. The current crises in Europe are showing some sign of Euro breakdown, even though it may not happen much sooner. Analyst and economist may feel this is a skeptic view, but, truth is always hard to accept.

Before going further, let me give a brief introduction on Euro "Euro is the official currency of the Eurozone which consist of 17 countries out of the 27 member states in the European Union. The euro was launched on 1 January 1999, when it became the currency of more than 300 million people in Europe. For the first three years it was an invisible currency, only used for accounting purposes, e.g. in electronic payments.  Euro cash was not introduced until 1 January 2002, when it replaced, at fixed conversion rates, the banknotes and coins of the national currencies like the Belgian franc and the Deutsche Mark" (Source: ECB website)

Coming back to the topic, that many economists and analyst now feels that Euro may fail and soon it may get dissolved. But, Professor Milton Friedman, Nobel laureate and Famous Monetarist, had this view even before Euro came into operation. In his interview to ABC Australia on 17 July 1998 that 

"In establishing the common currency area, the Euro, the separate countries are essentially throwing away this adjustment mechanism. What will substitute for it?

Perhaps they will be lucky. It may be that events, as they turn out in the next 10 or 20 years, will be common to all the countries; there will be no shocks, no economic developments that affect the different parts of the Euro area asymmetrically. In that case, they'll get along fine and perhaps the separate countries will gradually loosen up their arrangements, get rid of some of their restrictions and open up so that they're more adaptable, more flexible."

Friedman kept his view unchanged even in 2005, less than one year before he died (at age of 94 years)

"The euro is going to be a big source of problems, not a source of help. The euro has no precedent. To the best of my knowledge, there has never been a monetary union, putting out a fiat currency, composed of independent states. There have been unions based on gold or silver, but not on fiat money—money tempted to inflate—put out by politically independent entities. - Interview with New Perspectives Quarterly Magazine, 2005"

Some economist felt that Friedman was pessimistic in his view, and few said that Euro will not break-up or dissolve. They support their argument with the following stance that "Countries in the European member states are incredibly linked far beyond just sharing a common currency. The Borders of the countries have essentially been erased, the trade and even citizens can move freely between the Eurozone countries." It is true that Prof. Milton Friedman’s prediction is yet to come true, but it may happen sooner or later.

The current crises are showing the sign of break-up in Euro currency in the near future. The Greece crisis, which is slowly spreading to the rest of European member countries, will eventually make the member economies to move to their own currency after certain period of time. Still it’s too early to say how things will take its own shape.

Greece Austerity Measures - An Analysis

For the past one month, there is severe protest happening in Greece against the Austerity Measures. European Central Bank (ECB) and IMF had asked Greece to take essential Austerity Measures before they claim the bail-out package. ECB watched Greece very closely on their decision on austerity measures.

Let us have a look on the Austerity measures. The Austerity measures are mainly classified into 2 parts, one is Tax Increase and other is slash in Public Spending. They are as follows:
Tax increases include

• A solidarity levy: At 1% for those earning between €12,000 (£10,800) and €20,000 a year, 2% for incomes between €20,000 and €50,000, 3% for those on €50,000 to €100,000, and 4% for those earning €100,000 or more. Lawmakers and public office holders will pay a 5% rate.

• A lower tax-free threshold: People will now pay tax on income over €8,000 a year, down from €12,000. This basic rate of tax will be set at 10%, with exemptions for those under 30, over 65, and the disabled.

• Sales tax: The VAT rate for restaurants and bars is being hiked from 13% to the new top rate of 23%. This rate already covers many products in the shops, including clothing, alcohol, electronics goods and some professional services.

Spending cuts include:

• Public sector wages: Salaries will be reduced by 15%.

• The public sector wage bill: The goal is to cut 150,000 public sector jobs, through a hiring freeze and abolition of all temporary contracts. This should cut the total bill by €2bn by 2015.

• Social benefits and pensions: The retirement age is being raised to 65. Increased means testing, and cuts to some benefits, will reduce the total amount spend on benefits by €1.09bn in 2011, then €1.28bn in 2012, €1.03bn in 2013, €1.01bn in 2014 and €700m in 2015.

 (Source: Guardian.co.uk)

 The current Greece crisis raised few questions like, whether the Greece will take the Austerity measures despite of huge protest in the country? whether it will default or will continue with Euro?

Many economists and experts expressed that Greece have only one solution and that is to leave EURO and Default. But, leaving EURO is not easy and unfortunately, not an option for Greece at this point of time. In 1998, the founding members of the euro-area agreed to lock their exchange rates at the then-prevailing levels. Leaving the Euro means breaking its commitment and the very  motivation for leaving would be to change the parity. Leaving Euro will not only allow Greece to deal with sovereign debt crisis, but also it will be in middle of a bank run, while everyone would be trying to avoid ending up with devalued drachma (Greece currency before joining EURO).

If Greece leaves, then the other countries like Ireland, Portugal and may be even Spain might also follow on the same line (because they are also looking for the bail-out package since their economy is also in tussle to pay off their debts). This will lead to banking crisis in all these countries, by holding their debts which might lead to banking crisis in UK and German (because they are the major creditors for these countries), which will put entire Europe in crisis. These are the some major constraints and problems why Greece cannot leave EURO.

But, the economist who expressed their views that Greece should leave EURO have their own reasons. If the Greece does not leave EURO at the this time, when the economy is already very weak, then there is a risk that the economy will spiral down further in the crisis. It's hard decision which Greece had made for Austerity measures, since they did not have any other better option.

I remember a famous line of Ludwig Von Mises in his book Human Action, which is as follows:

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

How True it is, a voluntary abandonment or later as a Final and Total Catastrophe of Currency System, even though he said this for credit expansion, this line is perfectly suitable for Greece.