The Wreck of the Euro

 

By Walter Russell Mead

What does it mean for the euro that, on paper at least, Spaniards, Italians, and Cypriots are much wealthier on average than Germans? That’s the question Wolfgang Münchau tackled in a must-read column in the Financial Times, and it’s one that VM readers would do well to spend some time thinking through.

Here are the outlines of his argument. A new survey by the European Central Bank has concluded that median German household wealth ranks among the lowest in the entire Eurozone. The median German family is worth €51,000 whereas the median Cypriot household is worth €267,000. Those are eye-popping figures, and the German press is apoplectic over them. Münchau cautions that the median is not the best measure in this case. But even if one were to look at the mean, Germans are worth €200,000 per household, while Spanish net wealth is somewhere around €300,000. There’s another correction to take on board; Germans haven’t bought into home ownership the way many Europeans (and Americans) do. But put in all the caveats and corrections you want, and the numbers are still striking and, to many Germans, infuriating. Why should German households be paying tax money to bail out rich Cypriots?

But anybody who’s traveled in Europe understands that these numbers have something wrong with them. Germans are significantly richer than Italians and Greeks. The answer, says Münchau, must be that varying price levels across the eurozone are responsible.

On the surface, this is not actually as bizarre as it might seem. Price levels vary. The American experience with the dollar is not totally different. A dollar in New York isn’t the same thing as a dollar in other parts of the country. A salary of $150,000 in Manhattan is worth a lot less than a salary of $150,000 in Omaha or Baton Rouge. And while $500,000 can’t buy you a decent sized apartment in Manhattan, it can buy quite a nice house in much of the country. European countries work like this, too. Milan is a lot more expensive than most of the rest of Italy, for example.

But there is a perverse European twist to this state of affairs. In America, it’s the richer parts of the country that have the highest price levels. But in Europe it’s the other way round. Prosperous Germany has lower prices than the dead broke Club Med countries. In American terms, imagine that real estate in Manhattan was cheaper than in Detroit, or that prices in Buffalo, New York, far outstripped prices in Silicon Valley.

There are two ways to solve this problem within the eurozone: Germany can let its prices inflate to match Club Med levels, or the Club Med countries can deflate to match German prices. But the first option is closed: since the Germans are dead set against inflation, prices in the south will have to come down.

They will have to come down a lot. For the eurozone to survive as it now stands, house prices, wages, the cost of meals in restaurants, groceries, and so on would all have to fall by as much as 50 percent in the periphery. That can’t happen without massive losses to banks, which have lent money based on current price levels. These loans cannot be repaid if prices fall that far. And this kind of price adjustment also means massive unemployment, probably dragging on for many years.

As Münchau points out, this situation means that Europe’s single currency has in effect already failed. €300,000 in Germany is not the same as €300,000 in Italy or Spain, and there is no way to equalize values without years of wretched and ruinous pain.

There are lots of consequences, but the one that may cause the most trouble fastest has to do with banking.  If a Spanish euro is really worth much less than a German euro, sooner or later bank deposits in Spain are going to be worth less than bank deposits in Germany. Intelligent people will realize this and start moving their bank deposits out of Spanish banks and into German or even non-eurozone banks; those who fail to do this stand to lose a lot of money when the system finally snaps. Stupid people (some of whom may be operating central banks) will increasingly be the ones whose bank deposits keep the south European bank systems functioning, and there are probably not enough of them to keep the system running indefinitely.

We have no way of knowing how this all ends. One problem is that the smartest solution—having Germany and perhaps a handful of other northern countries leave the euro for a new currency (the Deutche Mark 2.0, or a “neuro” for northern Europe)—would make life easier in the south. The south based euro would fall in value, but since debts and contracts are denominated in that currency, the adjustment would be the same as in a normal devaluation. This course would likely lead quickly to a new burst of growth in the south, though inflation and other problems would take a toll over time.

But the euro’s break up day would cause a lot of problems for Germany and its northern friends. First, the new currency would rapidly appreciate, killing their export markets. Second, all the assets their banks and companies held in the south (loans, etc.) would suddenly be worth much less. This would quickly create a major and expensive banking crisis in the north. The resulting bailout might well bring the neuro back to earth for a while, helping exporters, but it would be an ugly and expensive mess and the German government would end up with a large pile of new debt.

So we’re in an interesting situation. The crisis is crippling the south, but the south has no power to resolve the crisis. The crisis isn’t comfortable for the north but still looks less painful than the solution. So the north, which has the ability to resolve the crisis, doesn’t have the will to do it and the south, which has the will, lacks the ability.

And meanwhile everything in Europe gets worse. As we’ve said before, with the exception of communism itself, the euro has been the biggest economic catastrophe to befall the continent (and the world) since the 1930s. Politicians in Europe thought they were living in a post-historical period in which mistakes didn’t really matter all that much. They were horribly wrong, and the wreck of the euro is blighting lives and embittering spirits on a truly staggering scale.