Saturday, May 8, 2010

Euro Currency Zone to Downsize?

The Euroland euro common currency zone is experiencing growing pains. The value of the Euro currency (EUR) has declined from the 1.50 USD to 1 EUR level one year ago to hitting the 1.27 USD level last week. Why the decline?

Greece and its weak country sisters of Spain and Portugal are in the midst of a debt economic crisis. Spain itself remains in a depression with 20 percent unemployment.

And of course, the natural level of purchasing power parity suggesting a 1.20 USD to 1 EUR is the current natural trading level.

The idea of Germany bailing out and subsidizing the Greeks does not sit to well with many Germans. Many in Greece particularly in the public sector have generous benifits and lofty wages. A bail out is a short term band aid solution but it will not solve the problem. Greece's total debt load is exploding as its fiscal shortfall estimated at 14 percent of GDP. If a proposed bailout from Germany takes hold, Greece's total debt to GDP will rise upwards to 150 percent of GDP which is unsustainable.

The concept of the euro and a common currency makes sense if trade between one or more countries is extensive and if they have similar living standards and GDP per captia output. With Greece, they should never have been permitted entry into the euro zone in the first place. At least not now, perhaps in 20 years? Their economy is inefficient and not productive.

The choice for Greece is simple. Either roll back wages for public servants as they did in Latvia. That is, devalue the cost structure if they wish to remain in euro wage purchasing power parity while promoting tax and trade policies to boost foreign direct investment. The goal would be to increase national wealth via private sector investment. Or, the other option is to leave the euro zone and return the Greek drachma as national currency. The drachma will accordingly devalue in relation to the euro and public servants can be paid in local currency without a nominal pay cut.

Tough choices are ahead for Greece, Spain and Portugal. In our view, the euro will survive but not before growing pains are addressed. The EUR currency zone grew to quickly, too many countries too fast. The zone should downsize, stabilize and then gradually propel forward in the years ahead as new prospective member countries be in a stronger economic position for potential membership from the outset.