The implications of the Irish Crisis for fans of the Euro

November 18, 2010

And so, the pot of gold is emptied. The bubble caused by a low corporation tax combined with low interest rates has finally burst, and the Irish have been forced to admit that even their stringent austerity measures will be insufficient to save their economy from investors wary of the prospect of a Celtic default.

Of course, the fact that this bubble was in part caused by interest rates over which the Irish had no control has opponents of the Euro jumping up and down and saying, “We told you so!“. You really can’t blame them for this; a large currency area with significant economic disparities between regions will always have difficulties when the interest rate set by a central bank is inappropriate for some areas using that currency. For example, some areas of America have historically experienced significant difficulties, partly due to structural factors but also due to the interest rate set by the Fed.

The difference is broadly political. Ohio is unlikely to leave the dollar any time soon to revive its economy. The advantages of membership far outweigh the consequences of leaving, not least not starting a second civil war. In contrast, the Euro is a recent invention put in place across a range of mature economies with highly disparate factors to consider. The strength of the European Central Bank is a historical consequence of the influence of Germany on the currency’s creation; the Germans remain terrified of weak currencies as a consequence of the Weimar Republic’s fun with inflation. Their reaction to the current crisis is telling, inasmuch as it’s been to attempt to put in place further fiscal constraints upon members of the Euro. This will, of course, only serve to cause further distortions across the Eurozone, as the fiscal conditions appropriate for Germany are rolled across a range of very different economies.

Nonetheless, I remain a fan of the Euro, because currency risk is a strong factor in commerce. Currency fluctuations have recently caused imports of wind turbine components to cost up to 20% more, as the Euro plummeted against the pound. Large companies will hedge against fluctuations, of course, but SMEs will be partly excluded from breaking into international markets as a consequence of the additional costs incurred by such fluctuations. Currency union decreases the cost of international trades, and helps SMEs expand. The question is whether this advantage is worth the risks attached to it – risks which are currently being ably demonstrated.

This is not a question that can be settled easily. The key to making the Euro worthwhile is to reduce this risk, which can only be achieved by weakening the ECB, in line with the weak correlation of economic circumstance across the EU. At present, the Germans are in no mood to countenance this.

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