Friday, February 05, 2010

Why the PIGS might end the EMU

I've meant to talk further about the link between savings and investment brought up in the previous post, but have not had time.

Next week will be interesting as we see what happens with the PIGS, and the European Monetary Union. PIGS stand for Portugal, Ireland, Greece, and Spain, for Euro countries with weak economies, high unemployment, and large public deficits. European Monetary Union means that these countries cannot issue currency the way the US, or Switzerland can, and operate with real budget constraints, much like US States. But US States can at least hope for Federal largess -- there is no Federal currency issuer in the EU who can write a cheque to the PIGS and bail them out. So they have to choose between debt deflation, and Great Depression level unemployment, or exiting the EMU, reclaiming national sovereignty, and if their obligations are euro denominated, defaulting.

Interest rates have gone parabolic today, as the logic of Diamond-Dybvig pushes those countries toward their only, stable equilibrium.

You'll see columnists talk about how the EMU would be fine if there was more labor mobility etc. This is nonsense. What they need is a super-currency issuer who knows what they are doing. You will also see columnists talk about how the PIGS debt default (if it comes to that) also foreshadows risks in countries like the US and the UK. This is also nonsense, because those countries retain a sovereign currency and thus need never default.


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