The Path to European Stability
June 15, 2010
Niall Ferguson is arguably today’s leading economic historian. A member of both Harvard’s Faculty of Arts and Sciences and the Harvard Business School faculty, he is also a Senior Research Fellow at Oxford University and a senior fellow of Stanford University’s Hoover Institution, and he has been named one of the world’s 100 most influential people by Time Magazine.
Ferguson has authored numerous books on war and on economic history, the most recent being The Ascent of Money, which was turned into a television series that won the 2009 International Emmy for Best Documentary. He also writes extensively for periodicals and newspapers in the UK and the US, and he is a contributing editor to the Financial Times.
Dan Richards interviewed Ferguson on May 25 in Boston at the CFA Institute Annual Conference. Below is part one of a two-part series, in which Ferguson discusses the current troubles and future outlook of Europe. Part two will appear next week.
A video of this interview appears here.
I want to talk about your outlook for the Eurozone in light of recent turbulence. Clearly there is some real tension between northern and southern Europe. What do you see happening in the period ahead in terms of the Eurozone as an entity?
You are asking the right person this question, because 10 years ago Larry Kotlikoff and I wrote a piece for the magazine Foreign Affairs called The Degeneration of EMU, in which we said that if you create a single currency without any fiscal coordination mechanism – in other words if you have monetary union, but no federal fiscal system – it will fall apart.
We said that would happen in about 10 years.
Right on cue the Eurozone has fallen apart for just the reasons that we envisioned: a huge divergence in fiscal balance has essentially destroyed what was called “the stability and growth pact,” which was supposed to regulate how much governments could borrow.
Everyone’s deficit is wildly over the 3% of GDP threshold. In the case of the Greeks, they are over it by more than 10 percentage points of GDP.
So that didn't work. The question is now what?
Europe has a very difficult choice. Choice one is to go the next step and have a federal fiscal system like the United States has. That means that there can be transfers through regular taxation and expenditure between rich flourishing states and the poor backward states.
That would entail giving up more control. Right now members of the Eurozone have already given up control over their currency. So what you are suggesting is you now have to give up control over the other great lever, which is spending and taxation.
Exactly, and this is the more important of these two things – sovereignty is more than anything else about taxation and expenditure.
Decisions about taxation and expenditure have been firmly in the grip of national parliaments and executives throughout the postwar period.
Anybody who knows any history knows that when you give that up, and you create some central authority that has the final say on taxation, then that central authority will grow. That has been the case in every federal system ever created.
So the likelihood that Europeans and particularly Germans will vote in a massive new treaty that creates a United States of Europe is a 0% probability. It's not going to happen.
So the question then is whether the status quo is sustainable – where you have a monetary union, but not fiscal union, and those kinds of pressures that we've seen in Southern Europe?
It's sustainable, but only under certain very important conditions.
Many people talk in a rather alarmist way about countries leaving the euro. Some people say Greece should leave and other people say that the Germans will leave.
This is probably wrong, because the costs of exit are prohibitively high, and it was designed to be that way.
If Greece were to leave, they could restore and then devalue the drachma, and that would be business as usual for Greece. It's the way Greece has been run for many, many years.
The problem is that would destroy a very important sector of the Greek economy, including their banks, which would have a huge mismatch between their assets suddenly being in drachmas and their liabilities being considerably more in euros.There is no real incentive for a weak country to exit. It would get killed by the financial markets the moment that it stepped out into the market with its old currency and its old credit rating.
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