william flew over the euro banks
April 11, 2011 § Leave a comment
Lessons from the Latin American crisis
Portugal is only the latest eurozone country to be mired in a debt crisis. Not many commentators would claim that Portugal, Greece and Ireland are in a stronger position as a result of their membership of the euro. It’s true, though. These countries’ policymakers know that, whatever economic and political squalls lie ahead, there is no danger of a collapse in the currency. Their problem is, however, the terms of the respective bailouts.
It’s almost as if the anti-capitalist invective of Noam Chomsky and George Galloway has been proved right. The conditions of the Irish and Greek bailouts punish wage-earners and protect bankers. If these terms are not renegotiated, the agreements will do great damage to the eurozone economies and to the cause of European integration.
The crises of Greece, Ireland, Portugal and Spain have different components but all come down to the same thing: too much spending and not enough revenue, leading to an accumulation of debt. In a bond auction this week, Portugal found that investors were demanding unsustainably high interest rates of well over 5 per cent on short-term debt, to compensate them for the risk of not getting the money back.
The only way to remedy the problem is a squeeze on living standards. But what these financially strapped countries can’t do is devalue the currency. If they had retained their national currencies rather than join the euro, then in theory they could have let these currencies depreciate. This would have raised import prices and thereby cut real incomes while keeping nominal incomes constant. Such a policy might work in theory but it rarely does in practice: competitive gains are speedily lost as labour unions put in higher wage claims. But that course isn’t open to eurozone countries in any event. Their only option is internal devaluation: austerity measures to reduce costs.
This will cause hardship and won’t work. The practical problem is that the debt burden will increase as living standards fall. There is no way to avoid the economic pain of restoring the public finances, but the debts need to be restructured.
There is a precedent. The Latin American debt crisis of the 1980s was eased by the proposals of Nicholas Brady, the US Treasury Secretary. He offered the banks three options: partial debt forgiveness; cutting interest rates on the existing debt; or providing new loans. Combined with economic reforms in the debtor countries, the Brady Plan worked. European policymakers need a similar approach now.