Euro Fetters

Bad stuff is happening in Eastern Europe. After the fall of the Soviet Empire most of these nations signed on to the Milton Friedman program of capitalist development. They opened their economies, borrowed heavily and sent workers abroad to earn wages in the booming economies of Western Europe.

Unfortunately they borrowed Euros and Swiss Francs and such and are now in a trap. Like everyone else in the world they face constrained demand and rising unemployment. To get out of this in a humane manner they would increase spending, cut interest rates and take steps to replace jobs that are lost as their export sectors shrink.

But this will worry their creditors who require a steady flow of Swiss Francs and Euros to pay the interest on their debt. They have to buy these with their domestic currency and foreigners will expect this currency to depreciate if government deficits rise and interest rates fall. See Krugman for the short version and here for a longer discussion.

So Hungary and Latvia are now in the paradoxical position of cutting their money supply in the middle of a slump to defend the "value" of their currency.

Much has been made of the perverse monetary policy - the great monetary contractions of 1932 - that extended and worsened the Great Depression. Barry Eichengreen documents these in his book Golden Fetters which is a worthwhile read for the energetic lay person.

These monetary maneuvers did not come out of nowhere.
In the 1930's gold held the same position in the international monetary system as the Dollar/Euro do today. As Great Britain, Germany and the US saw their currencies losing value with respect to gold they took steps to defend them by contracting the supply of money and raising rates.

Wonks Anonymous thinks that the world can ill afford a repeat of this particular disaster but he is not sanguine about the prospects. Avoiding it will require some willingness on the part of international bankers to adjust the debts of these nations and some agreement about who will get a haircut on this particular arrangement.

Wonks Anonymous would also like to note that Eastern and Central Europe have always been and still remain a center of ethnic conflict and misunderstanding. When we add worsening economic conditions to this sort of cultural baggage we get extreme nationalism. We saw this most recently if the disaster that was once Yugoslavia. Or you can go back further to Germany in the 1930's


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