Bubbles, Deficits and European Arrogance

Excessive government spending, nor European integration, is responsible for Greece’s debt crisis.

With Greece in despair and worries about mounting national debts rampant throughout Europe, it is easily presumed that those eurozone members still struggling with recession can all blame their troubles on deficit spending spun out of control. Paul Krugman notes however that there are different circumstances to be taken into account.

Spain, for instance, unlike Greece, is no victim of fiscal irresponsibility, opines Krugman. Its problems mainly stem from a decade-long housing bubble that ultimately burst in 2007. Up until then, its economy grew steadily with 4 percent a year, driven almost exclusively by a rapidly expanding real estate market. Now that construction has come to a standstill, millions of Spaniards are left unemployed with so much as two million of them living off unemployment benefits.

Krugman blames the situation on the euro. He cites the “arrogance” of the political establishment that “pushed Europe into adopting a single currency well before the continent was ready for such an experiment.”

If Spain still had its old currency, the peseta, it could remedy [its problems] quickly through devaluation — by, say, reducing the value of a peseta by 20 percent against other European currencies. But Spain no longer has its own money, which means that it can regain competitiveness only through a slow, grinding process of deflation.

The inflexibility of the euro, writes Krugman, “not deficit spending, lies at the heart of the crisis.” He doesn’t tell the whole story however. Although he is correct to point out that Spain’s massive deficit spending is more of a result than a cause of its current predicament, that same plunging into the red is doing very little to alleviate the crisis. Also, the supposed inflexibility of the euro deserves further attention.

Well before the euro went into circulation, European governments agreed, in 1997, to protect the stability of the Economic and Monetary Union through fiscal responsibility. Member states are bound by the Stability and Growth Pact to keep deficit spending under control. Greece and Space, however, among others, repeatedly violated this decade-old agreement. There is no mechanism in place to punish these countries or even stop them from doing so, which might be argued is a shortcoming of the European system.

Other member states are understandably reluctant to bail out Greece. Doing so would create the same moral hazard the banking sector, especially in the United States, is now confronted with: the expectation that if one screws up, a bailout will always be available.

This is not inflexibility; it is European countries looking after their own interests before anything else. If helping out Greece comes at considerable expense of their own prosperity, there is no reason why they should suffer for the sake of rescuing a neighbor that repeatedly disregarded treaty and behaved in an irresponsible matter that now threatens to harm all of the eurozone.