18 February 2013

Hans-Werner Sinn: The collateral damage of Europe's rescue

Europe's rescue policy is making the eurozone's most serious problem – the troubled countries' profound loss of competitiveness – even more difficult to solve, comments Sinn in this Project Syndicate article.

The eurozone is now in its sixth year of crisis – and of efforts by the European Central Bank and the international community to end it. Policymakers are becoming ensnared in a creeping interventionism that, as British Prime Minister David Cameron has put it, may alter the eurozone “beyond recognition” and violates Europe’s basic economic and political rules.

The newest demand, loudly voiced by French President François Hollande, is for the ECB to manipulate the exchange rate. Hollande is alarmed by the rapid appreciation of the euro, which has risen from $1.21 at the end of July 2012 to $1.36 in early February this year. The strengthening exchange rate is putting additional pressure on the rickety southern European and French economies, undermining their already low competitiveness.

The ECB can curb the euro’s appreciation through purchases of foreign currency. But, ultimately, it would have to do so by inflating its own currency until confidence in the euro falls back to the level that it had before the assurances were made.

That is why ECB President Mario Draghi rejected Hollande’s suggestion almost instantly. Draghi is well aware of the enormous sums that were lost during the 1970’s and 1980’s, after the collapse of the Bretton Woods system, in futile and costly interventions to stabilise exchange rates, and he does not want to jeopardise the ECB’s goal of maintaining price stability.

The euro’s appreciation lays bare the huge collateral damage that Europe’s rescue policy has caused. The measures taken so far have opened channels of contagion from Europe’s crisis-ridden peripheral economies to the still-sound economies of Europe’s core, placing the latter’s taxpayers and pensioners at great financial risk, while hindering long-term recovery in the troubled countries themselves.

True, Europe’s rescue policy has stabilised government finances and delivered lower interest rates for the over-indebted economies. But it has also led to currency appreciation, and thus to lower competitiveness for all eurozone countries, which may yet turn into a debacle for the southern eurozone and France, which are too expensive anyway, and for the euro itself.

Full article

© Project Syndicate