The structure of the euro worsened divergences naturally arising from the differences between the countries.
The Dutch and Germans felt poorer than they actually were, the Spanish richer – and the low interest rates that were perceived as a benefit became a curse. The effects of the perverse interest regime were naturally most evident in capital markets and housing.
The natural buoyancy of housing and house prices was hugely boosted in Spain, and in Greece, Portugal and Ireland, into a housing bubble.
Had they been outside the euro, these economies would quickly have seen this boom curbed by higher interest rates in their separate currencies, while Germany and The Netherlands would have enjoyed lower interest rates than those experienced under the euro.
Instead, the common interest rate, and the delusion that differences between countries would be ironed out quickly by natural economic forces, underpinned unbridled housing bubbles.
Ireland’s had already started to collapse before the US subprime crisis stopped the whole process from mid-2007 onward. In Spain, Greece and Portugal the damage would have been even more extensive had not the US bubble collapsed.
German policy reinforced already dangerous divergences. Severe wage restraint in 2002-05 held down labour costs – with labour cost deflation – and cut into consumer incomes.
With a separate currency, its appreciation would have rewarded workers for their restraint with cheaper imports and foreign travel, as happened in the 1980s and 1990s.
Likewise with separate currencies, the fast-growth countries like Spain and Greece, as well as having appropriate interest rates, would have been curbed by rising import costs, and would have had more cost-competitive exports and buoyant core European consumer markets to sell into.
The crisis simply would not have occurred: individual country adjustment would have been forced by financial markets at a much earlier stage. But with the euro the problems were both aggravated and masked by a fallacious, laissez-faire belief in the Eurozone as a self-correcting continental economy like the United States.
The euro added to the natural divergences between countries, as well as distorting their growth patterns.
Special Report – March 5, 2012. pp.4-5