Problems of the Euro Zone

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Wednesday, 29 August 2012 04:47

The Post had an interesting piece discussing the structural problems in the construction of the euro. While the basic points are largely accurate, it does misrepresent a couple of issues.

First, contrary to what the piece suggests, there was no general recognition at the time that the euro was created that Germany's economy would somehow dominate the euro zone. In fact, in the 90s and even at the start of the last decade, Germany's economy was viewed as seriously troubled. For example, Adam Posen, a prominent economist who now sits on the Bank of England's monetary policy committee worried in 2002 that Germany was turning Japanese (that wasn't a compliment).

The fact that Germany's economy did turn out to dominate the euro zone was a major surprise. This shows the ability of economies to turn around quickly or at least in ways that are unexpected by economists (i.e. the people who are the expert sources for these pieces).

The other major misrepresentation or understatement in the piece was that the euro's founders did not anticipate that the European Central Bank (ECB) would be run by ungodly incompetent people. The ECB ignored the growth of enormous housing bubbles in Spain and Ireland that were leading to enormous imbalances in the euro zone economies. It was 100 percent predictable that these bubbles would collapse and lead to enormous adjustment problems when they did. However the ECB opted to ignore their growth.

Remarkably, even today it takes zero responsibility for the failure to recognize the dangers posed by these bubbles and the consequences from their collapse. Any currency needs competent people to manage its central bank. If these cannot be found (a skills mismatch?), then the currency will face serious problems.