Who should leave the eurozone?

In a recent issue of The Economist, a fictional "lost" memo to Angela Merkel is published which reveals contingency plans for the breakup of the euro.  The memo considers two possible exit groups: 1. Greece alone, and 2. Greece, Portugal, Ireland, Cyprus, and Spain.  The memo outlines how a currency exit could be accomplished and how much it would cost. The coffee mug stain is a nice touch.

The Economist (8-11-2012 ) "The Merkel memorandum"

This memo follows many of the suggestions presented in the winning submission for the 2012 Wolfson Economics Prize, "Leaving the Euro a Practical Guide" by lead author Roger Bootle. In the following interview, Bootle explains why he thinks the eurozone will break up. He goes a step further and argues that the eurozone should break up.



Bootle touches briefly on the possibility of France and Italy leaving the eurozone too, so that only northern countries are left. Many others have suggested that the northern countries in the eurozone (including Germany, Netherlands, and Finland) should form their own currency zone. Here is one such article.

NYT (6-26-2012) "To save the euro, (Germany should) leave it "

Discussion Questions for Students:
1. Which countries if any do you think should leave the eurozone?
2. How might a big devaluation of reinstated currencies in Greece, Portugal, Spain, and possibly Italy, affect your industry?

For the truly dedicated here is a link to the winner of the Wolfson Economics Prize MMXII:

"Leaving the Euro a Practical Guide" by Capital Economics, Lead author: Roger Bootle

Entrepreneurs needed

According to a  recent article in The Economist, Europe's failure to nurture entrepreneurs is the ultimate source of its economic problems.

See Les misérables (http://www.economist.com/node/21559618)

Even successful Germany is not immune from criticism. In Germany, one episode of bankruptcy may prevent an entrepreneur from ever holding another senior executive position in a big company. In addition, the entrepreneur may have to wait six years to discharge all bankruptcy debts. Given the high rates of failure of new business establishments, Germany's policies create a powerful disincentive to become an entrepreneur.  Limited venture capital and convoluted labor laws raise additional hurdles.

In the U.S., only about 50% of new businesses still exist after 5 years. This statistic is surprisingly stable across time and the business cycle. If you are interested in more fun facts on the survival rates of new business establishments in the U.S. go to:
http://www.bls.gov/bdm/entrepreneurship/entrepreneurship.htm/

 For a pep talk on the importance of entrepreneurs and how to get more of them, see Cameron Herold's TED talk (March 2010):



Questions for Students (pick one):
1. In the article in The Economist, WWII is presented as a pivot point. Before WWII entrepreneurship was a major force in Europe. What changed? Why? How could it be changed back? Show off as many facts as you can.

2. What did you think of Cameron Herold's talk? Take a stab at an entrepreneurial proposal - that you haven't done yet.

Greek austerity

The above clip (at the 7 minutes 35 second mark) features a debate between Paul Krugman (Nobel laureate) and George Papaconstantinou (Greek Minister of Finance).   Paul Krugman thinks Greece should leave the euro area in order to have a chance to grow.  Krugman acknowledges that leaving the euro would be very destructive for Greece, far worse than the current austerity package. Nonetheless he advocates exiting the euro so that Greece has a chance to grow (presumably by devaluing currency). George Papaconstantinou argues that Greece is better off staying in the euro area, assuming Greece can negotiate a growth package from the rest of the euro area. This is clearly a big assumption.

If the countries in the euro area could miraculously and quickly agree to trade sovereignty for financial security ( The Economist (5-26-2012)), perhaps a deal could be brokered in which Greece adopts more market oriented policies in exchange for a generous growth package. Greece would have to overcome political resistance to later retirement, fewer vacation days, smaller pensions, less guaranteed employment, and a smaller government sector.

Both Krugman and Papconstantinou agree that austerity alone (cutting government spending and raising taxes) is not going to get Greece growing.


The following Forbes article notes the parallels between the European Union and the early United States. Warren notes that in the early 1800's many states were unable to pay their debts and defaulted. As a result the U.S. economy plunged into severe recessions.  The U.S. relied on high import tariffs to promote domestic industry and to recover from the state debt crises.  Warren ponders whether high import tariffs could help Greece stay in the euro area.

Forbes (6-4-2012) "Looking For Euro-Saving Ideas In U.S. History" by Randy Warren

There is at least one major drawback with this suggestion. The high tariff strategy would require rewriting EU treaties and would likely lead to disputes with other members of the World Trade Organization (WTO).

Alternatives to high import tariffs that would also result in import substitution industrialization (ISI) include: cheap currency (i.e. exit euro and devalue the drachma), quotas on imports, and government investment in infant industries. The case for fiscal and regulatory ISI policies has grown less compelling. India started dismantling its ISI policies in the 1980's, leading to rapid growth. Many countries in Latin America have also abandoned ISI, at the urging of the IMF.  Corruption and inefficiency plague this strategy.

 If European politicians fail to act decisively and very soon, the cheap currency option grows more likely.

Why do U.S. politicians want to see the yuan appreciate and what does that mean?

Many U.S. politicians have accused China of keeping its exchange rate artificially low. These politicians are primarily concerned about U.S. jobs.  All else equal, if goods made in China became more expensive (due to currency appreciation) people in the U.S. would buy more domestically produced goods and fewer Chinese goods.  Factories in the U.S. then might hire more U.S. workers.

So that you can impress interviewers, make sure you use the right vocabulary when discussing Chinese currency. The official name of the Chinese currency is the Renminbi (RMB) and a unit of this currency is the yuan. Yuan should be pronounced something like U.N. (for an audio clip go here NPR audio clip). To further complicate matters, the symbol for the RMB is ¥ and it is quoted on currency exchanges as CNY, short for Chinese Yuan. 

This 3 minute news clip was made 6 months ago, when the U.S. Senate was considering a bill to punish China for an undervalued currency. Despite sympathy from President Obama, the bill did not make its way through the House and did not become law.  China warned that passage of the bill could cause a trade war. http://youtu.be/WQQtreKkljg


In the intervening months, China has let its currency appreciate. China just recently announced that it would let its exchange rate fluctuate in a wider band, which potentially could lead to more appreciation.  See this WSJ article for details.
WSJ (4-16-2012) China Loosens Grip on Yuan by LINGLING WEI

In this recent 3 minute clip from the English language news channel of China Central Television (CCTV News), two Chinese economists argue that the main problem for U.S. workers is not an undervalued Chinese currency, but rather factory automation.


This screenshot was taken at http://www.chinaknowledge.com/Travel/Currency.aspx on 4/16/2012. This table shows how many CNY (ChineseYuan) it would take to buy a unit of various foreign currencies (Other/CNY).  To learn how to read this table consider the USD/CNY exchange rate listed as 6.3199. This means $1 U.S. dollar costs 6.3199 Chinese yuan. Equivalently, the CNY/USD exchange rate = 1/6.3199 = .15823. This means that 1 Chinese yuan costs almost 16 cents in U.S. currency.

Self-quiz for students:
For extra motivation, questions like these will appear on your final exam.  Assume  1 yuan = .15823 USD or  equivalently, 1 USD =   6.3199 yuan.
1. What is the price in dollars of a coffee pot that costs 100 yuan?
2. What is the price in yuan of a coffee pot that costs $20?
3. What would be the new CNY/USD exchange rate if the RMB appreciates by 10%?
4. What would be the corresponding USD/CNY exchange rate?
5. After the RMB appreciates, what would be the new price in dollars of a coffee pot that costs 100 yuan?
6. After the RMB appreciates, what would be the new price in yuan of a coffee pot that costs $20?


          Post  Questions:
1. How might appreciation of the RMB affect employment for coffee makers in the U.S.?
2. How might appreciation of the RMB affect the trade balance, GDP, and unemployment rate of the U.S. (all else equal)?

3. Whose views on the CNY/USD exchange rate do you think are more valid, the U.S politicians or the Chinese economists?

Self-quiz key:

1. $15.82

2. 126.40 yuan

3. .174053

4.  5.7454

5. $17.41

6. 114.91 yuan