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Dimitri B. Papadimitriou

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Endgame for the Euro

Posted: 09/18/11 03:16 PM ET

The grand experiment of a unified Europe with a shared common currency has entered its endgame. If the current trajectory continues, the disintegration of the euro is inevitable. It's certainly not too early to ask: What would a post-euro Europe look like... and what are the alternatives?

Athens is, of course, at the center of the vortex. The newest 'rescue' plan accepted by Greece certainly won't save the system, though, and it won't save Greece from a sovereign default. The bailout conditions demanded by the troika that holds the purse strings -- the International Monetary Fund, the European Central Bank, and the European Union -- include a review, now delayed, before it will release the next payment. But the late September review will reveal that Greece has no hope of meeting its targets.

EU economy commissioner Olli Rehn has announced that the Greek government's latest measures "will go a long way in" towards resolution, and the newest European Commission taskforce in Athens, sent to work on another rescue package, is reportedly upbeat and "impressed". Meanwhile, the ECB is keeping the show on the road by making even more austerity demands.

Despite this climate of denial, the tottering Greek government is going to fall and -- Presto! -- a complete default will follow. As the results cascade across the continent, credit ratings, interest rates, and political fallout will quickly become unworkable for both stronger nations and weaker ones.

The collapse of the euro project will break in one of two ways. Most likely, and least desirable, is that nations will leave the euro in a coordinated dissolution which might ideally resemble an amicable divorce. As with most divorces, it would leave all the participants financially worse off. Wealthier countries would be back to the kinds of tariffs, transaction costs, and immobile labor and capital that inspired the euro in the first place; poorer nations could kiss their subsidies, explicit and implicit, good-bye.

Less likely, but more desirable, would be a major economic restructuring leading towards increased European consolidation. The EFSF -- the European Financial Stability Facility, which is the rescue fund of the European Central Bank -- has access to €440 billion. Thus far, the real beneficiaries of the EU bailouts have been the banks that hold all the debt (you haven't seen this movie before, have you?).

But with some restructuring and alteration of regulations, that wouldn't need to be the case. The doomed rescue plans we're seeing don't address the central problem: Countries with very different economies are yoked to the same currency. Nations like Greece aren't positioned to compete with countries that are more productive, like Germany, or have lower production costs, like Latvia. Any workable plan to save the euro has to address those differences.

The best structural changes would even out trade imbalances by "refluxing" the surpluses of countries such as Germany, France, and the Netherlands in to deficit countries by, for example, investing euros in them. Germany did this with the former East Germany following reunification. This kind of mechanism could be set up very quickly under the EFSF if it had a deeper well to draw from, probably one trillion euros.

The European Parliament, led by its premiere leaders, Angela Merkel and Nicolas Sarkozy, could authorize the EFSF to take over the entire sovereign debt of the expanding periphery, which, in addition to Greece, would include Ireland, Portugal, Spain, and possibly Italy. It's possible that the EU will eventually take this path, or a similar one, in recognition of the value of maintaining the euro zone.

The current approach is unsustainable, with French and German taxpayers furious about footing the bill, and residents in the peripheral nations angrily resisting cutbacks. And it's remarkable that Merkel has not already recognized that, as the EU's largest net exporter, Germany's insistence on fiscal austerity for its many troubled neighbors is a losing proposition.

Ideally, the EFSF would ultimately be responsible to the elected European Parliament. The arrangement could replicate, in some ways, the US Treasury's relationship with the states, but with more control by Europe's nations. Yes, the European Parliament has long engaged in payments to poorer nations, but its total budget has remained below one percent of GDP, which is clearly too small to work.

The founding of the EU was a political venture propelled by the ambitious heads of the two leading continental powers, Germany and France. Their creation grew into a promising economic laboratory. It's ironic that it is the absence of a true political union -- an entity with a unified fiscal policy as well as a unified currency -- might be the cause of its death.

Dimitri B. Papadimitriou is president of the Levy Economics Institute of Bard College and Executive Vice-President of Bard College.