Saturday, 6 December 2014

Why The Euro Cannot Work: Flow of Wealth to the Core, by Martin Prior

When I look at the prevailing threats to democracy, not least from the EU, the IMF and ever since 1951 in Iran, the United States, I wonder if we are approaching a turning point, just as the Roman Republic did when it became too unwieldy to match vested interests, and became an Empire.

When I recently stood for the Compass Management Committee I issued the following supporting statement:

As a democrat,

(1)            I am a member of the Labour Campaign for Electoral Reform, with a preference for STV,
(2)        I believe, along with Unite, my union, that the TTIP should be torn up.  There are in fact likely to be disadvantages for lower-than-median incomes: this is a multinational stitch-up, which will also represent a neo-colonial blueprint for future deals with the Third World.

As an erstwhile econometrician,

(1)        I argue that austerity is counter-productive, note Greece in particular and of course here, see my blog at .
(2)        To my mind the Euro cannot work.  It attracts wealth to the centre, i.e. Germany, and those on the periphery inevitably lose out.  Certainly their problems cannot be overcome with fantasy and neo-liberal panaceas.

In fact, CAPITALISM IS A CANCER and in particular we must dismantle the neo-liberalism of the EU.

As regards democracy, I could say a lot about STV as an effective mechanism for choosing the choices, including preferred candidates within a party, and I feel the key thing wrong with the TTIP and its like is that in a world where there are so many dangers to the environment, standardising regulations with somebody who is climate-change denier half the time – i.e. the US - is something we need like a hole in the head, let alone the ozone-layer. 

I would like to turn to my statement that the Euro “attracts wealth to the centre, i.e. Germany, and those on the periphery inevitably lose out.”  In a blog three years ago, in 2011, I argued that the Euro was inherently unsound.  I stated:

However I have a further objection [to the question of economic heterogeneity], which to my mind is extremely serious: I feel that when you have an economic area operating under a market economy, wealth will always flow from the periphery to an economic centre of gravity. This leads to lower inflation at the centre and a depreciation of currencies at the periphery. This is apparent in Europe, and we also see for example in the Antipodes that the New Zealand Dollar slowly but inexorably depreciates against the Australian Dollar...

As I felt at the time, the deficit in Greece, among other countries, has not gone away, and indeed there is concern about economic heterogeneity that spans the political spectrum from left to right in this and many countries.  But now I feel it time to look at the statistical evidence.  The following graph relates the depreciation of various mainly Western countries’ currencies against the Deutsche Mark, versus the distance of the capitals from Frankfurt.  This is the 16-year period 1963-1999, the eve of the Euro:

Two curves are shown, the green fitted to all countries in the EU in 1999, on the eve of the Euro, and the white one fitted to the original signatories to the Treaty of Rome in 1958.  (SF is Finland.)  Germany is not part of the fit, since the rise against itself would have to be +0% and the distance perhaps zero.   Where the curve goes through +0% could be an average distance within Germany from Frankfurt, either in geographic, population or economic terms.  Here it is around 250-265m, reasonably consistent with my own calculation of 215km for the mean, which would go up to 260km with re-unification, though this latter covers only the last nine years of this period.

Now these curves are perhaps the simplest curve fit, which is known as a log-linear fit.  Let us look at the example of two countries, one which is twice the distance of the other from Frankfurt, at least at the capitals.  We have Italy, where Rome is 959km from Frankfurt, whereas Paris is 471km.  And Athens is 1804km from Frankfurt, almost twice that of Rome.  Let us look at the change in currency values for Greece and Italy: in 1962, the Drachma was worth 20.83 Lire, but in 1999 it was worth only 6.42 Lire, well below half its previous value.  The white curve, extended as yellow beyond the original six signatories, gives a halving time of 25 years for countries where one country is half the distance of the other from Frankfurt.  In 1987, the Drachma was worth 9.80 Lire, just under half its 1962 value.  Both currencies lie close to this curve.

In fact we have a very straightforward idea: double the distance, halve the strength.  For the green curve the halving rate is roughly 33 years.

Now clearly there is not enough data to refute the hypothesis of halving times related to distances from a centre of gravity.  There are indeed irregularities.  But we may also note that the graph suggests that the Netherlands exerts a pull on Belgium, and also Spain on Portugal, since in each case one is above the curve line and the other below, or much closer to the curve line.

The graph also shows that the more recent a country’s accession to the EU, the less their currencies have fallen.  All countries acceding after the first six in 1958 – with the exception of the UK - have depreciations above the white line, and countries that acceded 1994 onwards are well above both lines.  This suggests that the greater the economic integration, the greater the gravitational pull.  Nevertheless one has to be careful with this figure, since before accession, their circumstances will be varied.

Now what we can see here is that all the countries that have had deficit difficulties, i.e. the ‘pigs’ - Portugal, Ireland, Italy, Greece and Spain – are those at the bottom of the chart.  It doesn’t matter that they are on or above one of the curves, and Spain and Ireland are above both curves: a deficit is a deficit.  It is clear that the pressures to devalue in the latter half of last century are still there, and that all the things that devaluation is meant to avoid will still happen in the new Euro environment.

As I said in my blog:

Now if what I say is correct, then we cannot put Greece and other southern countries on a firm footing once and for all, but rather the slippage will occur indefinitely.

It is clear that economic union cannot really happen effectively until the wealth of the EU starts to converge, but within the present scenario, the inequalities will in fact worsen, and it has to be the case that if an economic union needs intermittently to mercilessly punish its weakest members, there has to be something wrong with the underlying philosophy of that economic union.

I have in this short paper tried to look at currency movements, since the problems of the Eurozone directly relate to currencies.  Clearly more detailed analyses are required.  For example the volatile movements between 1973-83 led to halving rates of around 12-14 years – probably due to exceptional transport costs – but returned to more like 40-50 years in the remainder of the century.  But this suggests that the following depreciations against the Deutsche Mark might have occurred from 1999-2013, had there been no Euro:

from Frankfurt(km)
[German av’ge 260km]
predicted change
(50-year halving rate)
predicted change
(75-year halving rate)

This table clearly shows the slippage within a free-trade zone over a 15-year period.  Italy was showing signs of sluggishness around 2007, eight years after the start of the Eurozone.  And now, 15 years after the start, France is having difficulty recovering from the recent slump.  Austerity measures are likely to aggravate France’s problems, both in terms of trade and the deficit.  Italy too.

And according to the model, London’s distance from Frankfurt lies in between that of Paris and Rome, so we would have started having trouble over the Euro around 2010, had we been in.



  2. Nice post, things explained in details. Thank You.