Europe continues to languish in its economic conundrum and the question of what to do about the unsustainable debt levels and the detrimental effect this debt can have on the euro zone still has no answer. The recent meeting of state heads in Europe to come to agreement about the resolution of the economic crisis in Greece and on the continent only produced the next consecutive round of indecision.
There is one big catch – cutting countries out of the euro zone is not an option, because Italy, Spain, and Greece conduct all their transactions in euros. Should their membership be frozen, it is equivalent to suspending all transactions with those countries. The return to the old national currencies cannot be done immediately, and even if done, it would lead to rapid devaluing, hyperinflation and no investor confidence in purchasing portfolios in those currencies. The social outcomes are yet more unpredictable, because political violence, civil wars, and revolutions are not out of the question. In other words, breaking apart the euro zone is the blacker devil and should be avoided.
Bailouts for banks in Europe are a confirmation for two things – the risk of a run on the banks is still too high and there is still no viable idea about what will drive the next period of economic recovery. Cheap borrowing is already out as an option, which leaves a very limited set of choices.
A possible solution rests in the establishment of a two-tier monetary system in the euro zone. A potential default of Greece might start a domino effect in the rest of southern Europe and perhaps drag down France as well. At stake is holding to a precarious status quo that needs to change, but without compromising the fundamental economic integrity of Europe. A two tier monetary system would keep the euro alongside a proto-euro currency to isolate the systemic risks to the problematic countries without destroying the system. Put another way, it would be like having euro A and euro B.
The most important aspect is that if each problematic country is booted, the direction it will take is unpredictable, given the political risks outlined above. Keeping it together gives a better chance for a coordinated response. The main issue is that the debt loads of the weaker members of the euro zone would not overwhelm the more stable members, especially Germany, in maintaining Europe on life support systems. Euro B would devalue against euro A, which would also happen if the respective national currencies were reverted. The difference is that the process can happen in coordination rather than chaos to achieve the sought-after systemic equilibrium.
Inflation and even hyperinflation are still obstacles that will likely have to be overcome – on the flipside, that would devalue the worth of the total debt and be a temporary measure against the lack of economic activity on the continent by stimulating existing productive capacities and perhaps also improving demand resulting from a cheaper euro B. The underlying reasons are a complex brew of minimal investor confidence in unsustainable debts and deficits, underperforming economies, low public confidence in the banking systems and the existing transaction relationships within Europe, which would combine to bring high inflation to a euro B arrangement.
The main benefit of the two tier system will be protecting the euro zone from collapsing while containing the risks of high debt levels and allowing for coordinated inflationary trends and their systemic management over the unpredictable direction of an uncontrolled hyperinflation by country. The price of bailing out all problematic countries is too high and inflation is a possible way out of this state of affairs, but doable within the system rather than outside of it, to produce a base from which to think about the recovery of prosperity.
I invite PolicyMic’s community to add their thoughts on the matter.