Friday, November 25, 2011

The Euro Crisis: Revisiting Pitfalls Of The Gold Standard

The current issues impacting the Eurozone countries harkens back to the problems with the gold standard in the 1930s. Many believe the U.S. depression in the 1930s was worsened by the fact the U.S. and many other countries were on the gold standard. With the gold standard exchange rates were fixed i.e., depreciating ones currency was not an option. The gold standard did not create the depression; however, it most likely pushed the country into a depression. For more on this, one can read, "The Gold Standard and the Great Depression" in Contemporary European History by Barry Eichengreen and Peter Temin.

With the Euro, currency depreciation is not available to countries like Greece. As a recent Bloomberg BusinessWeek article noted, the option available to these stressed countries is cutting wages and government benefits. Now I am not saying this is a bad idea; however, significant economic contraction occurs. BusinessWeek notes,
"The most unfortunate difference between then and now is that the euro, unlike the gold standard, is a raccoon trap: Its designers deliberately left out an exit procedure. That means you can get in, but you can’t get out without leaving a part of yourself behind. Eichengreen points out that Britain was growing again by the end of 1932, just over a year after abandoning gold under duress. Today a country—say, Greece—that quit the euro would take far longer to right itself. That’s because unlike Britain, to get relief Greece would have to default on its euro-denominated debts and damage its credit rating. "The Greek government," Eichengreen says, 'will be hard-pressed to find funds to recapitalize the banking system. Greek companies won’t be able to get credit lines. The new Greek government is going to have to print money hand over fist. At some point they would be able to push down the drachma and become more competitive. But the balance is different now.'"
In the end, the worst part of the Euro union was the fact it was/is a monetary union and not a fiscal union. The decisions in Europe will be difficult; however, in order to prevent a contagion, the ECB will likely need to structure a facility not too dissimilar than the unpopular TARP program in the U.S. For the ECB though, they would be making loans to countries like Greece and Italy. The alternative is kicking out profligate countries and this would be economically difficult for Europe.


The Euro: As Good (and Bad) as Gold
Bloomberg BusinessWeek
By: Peter Coy
November 17, 2011

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