The fact that implementing a single currency could create a series of cascading continent-wide debt problems wasn’t exactly unknown to the Eurozone’s architects. They’re plan for dealing with it was something called the European Stability and Growth Pact which was support to limit budget deficits to 3 percent of GDP and keep the Italians in line. It didn’t work. Indeed, the Germans themselves were among the first to break the pact which swiftly came to look like a dead letter. Today in her speech (PDF) to the Christian Democrats’ party conference, German Chancellor Angela Merkel paired a stirring rhetorical defense of the European project to a strident call for a more robust version of the pact going forward.
“We want to have automatic sanctions,” she said calling on European states to establish a legal “right of action” against countries who violate the terms of the pact. Good idea?
Well, not really. The crux of the matter is that Ireland and Spain weren’t running large budget deficits before the crisis hit. What they were running was large current account deficits. Much as happened to Nevada and Florida, funds were pouring in from abroad to finance real estate loans. This influx of money pumped up wage and price levels. Then the flow of money halted, leaving unemployment high and then the high unemployment created budget crises. It’s true that Portugal and especially Greece also had unsound budget practices, but this wasn’t the real issue. The countries doing well in Europe today are the country that were running trade surpluses, and the countries that are doing poorly are the ones that were running trade deficits.