The Risk of the Euro Zone Breaking Up Is Real, but It Is More Political Than Financial.
Italy is obviously on the front line in terms of political risk.
During the debt crisis in the eurozone in early 2010, there was a fear that the euro would break up. Suddenly, after the subprime crisis, countries with external surpluses (Germany, and the Netherlands) refused to continue lending to countries with external deficits (Spain, Italy, Portugal, and Greece).
This led to a considerable rise in interest rates in countries with deficits, which was necessary to reduce domestic demand and, in a few years, make the external deficit disappear, at the cost of a recession and considerable impoverishment.
Questions are again being asked today about the risk of a new crisis in the eurozone.
This potential new eurozone crisis would mainly concern countries with high-interest rates, large public debts, and low potential growth, in particular Italy. The crisis would be triggered by the loss of sustainability of public debt in these countries, where the long-term interest rate would rise above long-term nominal growth (this is the case today for Italy and Greece).
Italy is on the front line
For public debt to remain sustainable, these countries would have to generate a large primary budget surplus (excluding interest on public debt), whereas they have a primary budget deficit. The fear is therefore that a public debt crisis will arise from the loss of fiscal solvency in countries with high long-term interest rates, as part of the general rise in interest rates in the eurozone.
But in reality, it is unlikely that this type of crisis will occur.
Indeed, the crisis of 2010-2013 was in reality a balance of payments crisis linked to the inability of the peripheral countries of the eurozone to finance their external deficits. Italy no longer has an external deficit and is no longer threatened by the cessation of the ability to borrow the excess savings of the Germans or the Dutch.
Italian domestic investors would have to stop buying Italian public debt for a debt crisis to occur. This is highly unlikely, as Italian investors are attracted by the high-interest rates on Italian government debt.
A financial crisis in the eurozone is therefore unlikely. But a crisis of political origin is possible.
This crisis of the eurozone, which has its origin in politics, would be due to a lack of understanding of a central mechanism of a monetary union. In a monetary union, the disappearance of the exchange rate risk allows member countries to exploit their comparative advantages, and thus specialize according to these advantages, whereas before, they had to produce most goods locally to protect themselves from the exchange rate risk.
Monetary unification thus triggered a major movement of product differentiation. After unification, the economies of the member countries of a monetary union become much more different than before unification. It is therefore normal that the creation of the euro has led to increasing heterogeneity in the economies of the countries in the zone.
Italy is one of the big losers, with a lower level of GDP today than when the euro was created, and a decline in per capita income. The risk is not financial, but political. Italy's impoverishment relative to the others is leading its inhabitants to prefer a government that promises to leave the euro, with the return of the possibility of devaluing, becoming competitive again, and stopping the loss of economic substance.
The only way to avoid the break-up of the eurozone will be for the prosperous countries to accept increased solidarity with the impoverished countries, in the form of federal transfers and jointly financed investments.
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