Eurozone has panacea for the euro

The diagnosis is: excessive debt. I am talking about the core problem of the eurozone. What causes tensions from time to time (when the economy is weakening or when things are going well and interest rates are rising) is the fact that many euro area countries are over-indebted.

In addition, it is often the same countries that do not have their budgets in order and therefore throw even more debts on an already too high mountain. Italy is perhaps the most famous and most recent example, but don't forget France.

The means that the currency union is currently using to solve these problems is to keep interest rates low. However, that is not a solution to the problem, but at most a remedy that can temporarily camouflage the pain.

Higher inflation
What I mainly fear is that the currency union (as a more structural solution) will opt for higher inflation. This is because inflation eats away part of the debt. The reason I fear this is because it is inevitable that large sections of the population will pay a price for it; for example through the erosion of the value of their income, savings and pensions, but also through a higher interest rate on the loans they take out.

It would then come as no surprise that dissatisfaction with politics and populism would increase further. This is also proven by history. The sad thing is that the eurozone has a means to solve the problem, without all those nasty side effects. However, she refuses to do so.

Dismantle the Debt Bomb
The best way to dismantle the 'ticking debt bomb' under the euro is to reduce debt through higher economic growth; if gross domestic product increases faster than debt, national debt falls. So what we need is, on the one hand, more budget discipline (so that the numerator does not get much higher) and, on the other hand, higher economic growth (so that the denominator gets much higher).

Usually there is no miracle cure that stimulates growth strongly, long-term and quickly. However, increased public investment can ensure strong and rapid growth, but not in the long term. Investments in education and research are driving growth strongly and for a long time, but not quickly. Except in the euro zone! 

The monetary union already has such a resource: the internal market for services. Although in practice it is not yet real. With this market, economic growth can be boosted by 5% to almost 9%, experts estimate. Suppose half of that is real, then growth rates of 4% and above would still be quite normal.

Budget discipline
For governments this would mean considerably more income from taxes and less expenditure (fewer unemployed, fewer benefits). Then you can count on that mountain of debt melting like snow in the sun, provided (and that is crucial) the European Commission (EC) does not allow the euro countries to squander that financial advantage.

So budget discipline (whichever way you look at it) is the key to success. Anyone who argues that the EC is doing something wrong when it takes action against countries that are (too) deep in the red (because enforcing fiscal discipline is the danger), is wrong in my view. Without that discipline, the coin, which is celebrating its twentieth anniversary this year, will not make it to its thirtieth anniversary, I fear.

Edin Mujagic

Edin Mujagić is an economist and manager at Beleggingsfonds Hoofbosch. He focuses on global central banks, and in his blogs he writes mainly about developments in interest rates and inflation. He has also written several books.

© DCA Market Intelligence. This market information is subject to copyright. It is not permitted to reproduce, distribute, disseminate or make the content available to third parties for compensation, in any form, without the express written permission of DCA Market Intelligence.