Remember the eurozone crisis? You don't hear much about it anymore, which could easily lead you to the conclusion that the problems have been solved. And to an extent they have been. Nobody thinks the eurozone is going to collapse anymore, and nobody thinks there will be a worldwide banking panic.
The only problem is vast swathes of the continent remain an economic disaster area. They saved the eurozone, but not the economies that it comprises or the people who live there.
The eurozone has ten countries — including big ones like France, Italy, and Spain — that are doing worse than Rhode Island. Greece has 11 million people — making it more than 10 times the size of Rhode Island — and an unemployment rate of almost 27 percent. Meanwhile, Finland is considered one of the healthy eurozone economies but only Nevada and Rhode Island have unemployment rates higher than Finland's, and they're close.
Saving banks and politicians
So what happened? Well, recall the problem. A bunch of countries that had previously been considered substantially less creditworthy than Germany joined the euro, and immediately saw a huge reduction in their borrowing costs. That led to irresponsible budgeting in Italy, a lot of private borrowing in Spain and Ireland, and a bit of both in Greece. Then after the global financial crisis hit, all these countries wound up in recession.
The bad economic climate started to push budget deficits up. And it became clear that contrary to the hopes of international investors, the German government had no interest in guaranteeing southern Europe's debts. The combination of rising deficits and reduced confidence led investors to demand higher interest rates to lend money to these governments. The higher interest rates made the deficits worse. A downward spiral was under way.
In stepped Mario Draghi, chief of the European Central Bank, with a speech and a plan. The plan was called Outright Monetary Transactions and the speech said Draghi would do "whatever it takes" to prevent a eurozone government from being forced into default or out of the eurozone.
What it meant in practice was that as long as a national government was committed to a fiscal austerity plan — tax hikes plus spending cuts — the ECB would commit to potentially unlimited levels of bond-buying in order to prevent its interest rates from spiking. In one of those magical moments of monetary policy, the existence of the commitment meant Draghi never really had to test it. Speculators stopped betting on default and collapse, governments wrote austerity budgets, and interest rates steadily declined.
The result was that banks that owned eurozone government debt were saved, and so were institutions around the world that relied on the European banking system not collapsing. All in all, a job well done. Meanwhile, politicians got to take credit for keeping their countries in the Eurozone and for falling interest rates while pushing the blame for unpopular austerity policies on Draghi and German Chancellor Angela Merkel.
People left behind
The only problem is that the downward spiral didn't start with high interest rates, it started with bad economic conditions. When people don't have jobs, they can't pay taxes and that puts pressure on government budgets. But the budgetary consequences of sky-high unemployment are only scratching the surface — the real problem with sky-high unemployment is the widespread human misery.
So what caused the economic problems? Conservatives will point to high taxes, a generous welfare state, strict regulations, and other structural policies they don't like as the source of Europe's woes. And it's true that Europe has long had a higher unemployment rate than the United States perhaps for these reasons (though America's unemployment edge is partially offset by having far more people in prison, where they don't count as unemployed) but the gap shifts over time:
Europe didn't suddenly turn socialistic over the past four years. If anything, the opposite. Since the onset of the crisis, Europe has been doing market reforms and the United States has been expanding its welfare state. The gap is growing because as America recovers from the economic crisis at a frustratingly slow pace, Europe is recovering even more slowly.
The failure of austerity and reform
Eurozone officials have preached a gospel of budget austerity and "structural reform" to ailing economies as the cure for the crisis. By making central bank assistance contingent on willingness to adopt a plan that the European Central Bank approves of, the ECB has in part managed to turn this into a self-fulfilling prophesy. Everything has gotten better since governments agreed to the ECB plan, and a government that tried to abandon austerity would likely find itself abandoned by the ECB and thus worse off than ever.
The success of these programs, oft-claimed by European officials, has largely come by setting the bar low. What is true is that among the hardest-hit countries, the ones who've most enthusiastically embraced the austerity and reform agenda have done the best:
At the same time, even plucky Ireland has an extraordinarily high unemployment rate. It is true that the scale of the construction bubble and subsequent bust in Ireland made a considerable amount of economic pain inevitable, but Iceland outside the eurozone had an even bigger bust and unemployment is now down to below six percent.
A country doesn't manage to achieve Greek or Spanish levels of economic misery without some complicated political and economic problems. But the striking thing about the eurozone is how poorly the countries that are "doing everything right" are nonetheless doing. Underneath the particular pathologies of the crisis areas is an overarching pathology — the single currency.
The sudden stop
The eurozone's troubled economies suffered from a version of what's known in international economics as a sudden stop. The way it works is that first global investors get really excited about a particular country for some reason, and start pumping money into it. Typically this happens without a lot of detailed local knowledge, so rather than financing specific projects they lend to local banks who presumably do have the knowledge about what to finance. But as the local banks get pumped-up with more and more foreign money, they start getting sloppy. For a while, it doesn't matter. So much money is rushing in to finance projects that old investments tend to pay off regardless of the merit.
But then comes a Wile E. Coyote moment when everyone realizes that there's nothing but sheer enthusiasm backing all these flows. Suddenly foreigners don't want to invest anymore, and to the extent possible want to get their money back. Now the whole investment boom runs in reverse.
If this happens to your country, something bad is bound to happen.
The normal bad consequence — the one that's happened to Iceland — is that the value of your currency plummets. Suddenly vacations, imported cars, and even basic agricultural commodities get very expensive. Almost everybody needs to cut back their spending and live a more humble lifestyle. Fewer consumer goods, fewer trips, more rice and beans for dinner. But the falling currency does have some upsides. Suddenly it's cheap for foreigners to visit your country, and cheap for them to buy your export goods. So people who lost jobs in the collapse can gain new jobs in the sectors that benefit from a currency collapse. It's not pleasant, but it doesn't last forever.
A cross of euros
The problem for Ireland, Spain, and Italy is that they don't have currencies to collapse. They use the same currency, the euro, as Austria and Germany and the Netherlands and other countries that never had the inflows of hot money and thus aren't suffering from the negative consequences of a sudden stop.
If you're a Spanish person who hasn't lost his job — maybe you're a surgeon or you have a safe gig in the Finance Ministry — this is great news. The value of your euro-denominated salary doesn't collapse, so you can still afford that BMW or trip to London. But the fact that you're vacationing in England rather than locally is bad for your fellow Spaniards, and especially bad for Spanish people who lost their jobs when the crisis struck. And because Spain hasn't had a currency collapse, it doesn't suddenly become a discount vacation spot for Germans and Americans and demand for Spanish wines and ham doesn't surge.
The only way to regain competitiveness is for the sheer weight of unemployment to start dragging nominal wages downward across the economy. In an enthusiastic, well-behaved country like Latvia or Ireland this is a grinding medium-speed process. In a reluctant country like Spain or Greece it's agonizingly slow. Either way, it's much more painful than a currency depreciation because only some prices adjust — people with old debts or long-term contract obligations get totally screwed.
These problems of excessively valuable money used to occur globally during the gold standard era whenever there was a slowdown in global gold mining. In a famous 1896 speech, presidential candidate William Jennings Bryan alleged that American farmers and workers were being crucified on a cross of gold — made to endure avoidable suffering for the sake of the principle that gold was the only true judge of wealth. Today, unemployed Irish, Greek, Spanish, Italian, and Portuguese people are being crucified on a cross of euros. The single currency project has political motives that go beyond macroeconomic management, and keeping the project together requires someone's interest to be sacrificed.
Draghi's "everything it takes" is a commitment to save the eurozone as a political project, not to save the eurozone's citizens from mass unemployment.
Two more structural problems
The problems with the eurozone aren't simply the single currency. An American state like Nevada has the same inability to devalue its currency as you see in Ireland. Nonetheless, even the best-performing European crisis country is doing far worse than the worst-performing American states.
To understand why that is, you need to look for non-monetary factors — language and the welfare state.
Here in the United States it is relatively easy for an unemployed person in Rhode Island to try to move to a more prosperous area in search of a job. It's not easy by any means. But it's relatively easy. They'll speak English and watch the same TV shows wherever you go. It's much harder in both practical and psychological terms for a Portuguese person to go find a job in Munich. The eurozone has one currency, but a whole bunch of languages and national traditions.
The other issue is the welfare state. Both the USA and European countries redistribute income from those who have a lot to those who have a little. In the USA, this operates across states. So when a particular place suffers a particularly acute jobs crisis, it ends up with a lot of poor people and extra money flows in. This helps the local economy. If unemployed Rhode Islanders couldn't get food stamps, for example, local grocery stores would probably need to lay workers off and exacerbate the problem. In Europe, the welfare state redistributes money from rich Austrians to poor Austrians, but not from rich Austrians to poor Italians. So this kind of automatic stabilization doesn't take place.
On top of all that, a mistake
Something that's often missed in assessing Europe's economic mess is that problems are actually getting worse in countries that weren't originally hit by the sovereign debt crisis. Take a look at joblessness in France and the Netherlands, two countries that were never involved in the eurozone crisis' acute phase:
Because rich Americans tend to disapprove of France and to especially disapprove of Socialist Party President François Hollande's policies, you often hear France's woes blamed on Hollande's initiatives. But the Netherlands has followed the exact same pattern. Rising unemployment as the recession hit, then a slow recovery, then backsliding.
The issue is that over and above the inherent difficulty of a whole bunch of countries sharing the same currency, the European Central Bank has implemented monetary policies that are too tight for Europe as a whole. The ECB is supposed to be targeting an inflation rate of 2 percent, but actual inflation has plunged far below this target:
For the crisis countries to recover without independent currencies, local nominal prices need to fall so that those countries can improve their competitiveness. But the math is a bit tricky. While the eurozone as a whole averages 2 percent inflation, inflation has to be higher than 2 percent somewhere else for it to all work. That would be uncomfortable for German citizens and politicians, and the ECB is widely thought to cater to German preferences (for example it is located in Frankfurt, Germany rather than in Brussels with the other major European Union institutions).
But this explanation only gets us so far. German inflation has been above average recently, but still below the ECB's 2 percent target.
High unemployment and below-target inflation aren't unique to Europe by any means. The same pattern exists in the United States due to somewhat hazy concerns about financial stability. But the Federal Reserve has been much more aggressive than the ECB in attempting unconventional monetary policies and it's no coincidence that Europe's unemployment rate is higher and inflation rate is lower as a consequence.
How does this end?
European policymakers have largely lost interest in what their critics on this side of the Atlantic have to say, primarily because widespread predictions that the eurozone would break up absent more dramatic integration measures have been debunked. But the reason American economists tended to underrate the viability of the European approach is not that they misread the economics — they misread the politics.
Both the European Union in general and the eurozone in particular are foreign policy projects that happen to have large economic implications. For Finland or Latvia, membership in the eurozone is an implicit guarantee that (unlike Ukraine) Europe will have their backs in a showdown with Russia. For Spain and Portugal it's a symbol of their successful transition to democracy and developed country status in the 1980s. For Greece it's something to hold over Turkey. For Ireland it's a sign of independence from the United Kingdom. In the face of these political imperatives leaders throughout Europe have decided that economic pain is bearable.
Nevertheless, the economic aspects of the situation look untenable. Economic forecasters project that crisis-stricken countries will grow in 2014 and 2015, which some take as a sign of a return to normalcy.
But earlier this month the European investment bank Natixis observed that this is wrong. On the current course, Italy should regain its 2007 level of unemployment sometime around 2020. Portugal will have to wait until 2036 and Spain until 2029.
The politics of this look untenable. And yet no major political party in any country favors withdrawal from the eurozone. In turn, one consequence of this has been a rising tide of support for a range of unorthodox political parties ranging from Greek neo-Nazis to Catalan separatists to a surge in votes for the far-right in France in the latest European Parliament elections.
But thus far in countries where upstart parties that deviate from the consensus have won support, mainstream parties have proven willing to set aside their differences with traditional rivals and form grand coalitions in defense of the status quo. For all the problems, the consensus around the European project has proven remarkably durable. Europe's leaders — starting with Draghi and Merkel but extending to an extreme wide range of policy elites in a range of countries — have done the seemingly undoable. They saved the single currency without fixing any of the problems that seemed to make it unworkable.