Is Euroland the Next Argentina?
17 Pages Posted: 29 Jan 2014
Date Written: February 1, 2003
Abstract
This paper examines, from the perspective of sovereign versus non-sovereign governments, the financial implications of the European Community's adoption of a single currency.
The Euro has made traveling between countries more convenient, but there are larger problems: deteriorating public infrastructure, crumbling social services, rising unemployment, and simmering social unrest.
To the optimist, these costs are temporary: Once inflation and budgets have been controlled, the single currency is supposed to allow all of Euroland to enjoy the same interest rate by eliminating currency risks; further, sounder fiscal policy will ensure that the interest rate remains low.
How likely is this scenario?
I contend that the adoption of the Euro ignored the substantial costs to a nation of abandoning its own currency in favor of a foreign currency and, because of this, the proposed benefits will not be realized.
The ability of a sovereign government with a floating currency to make payments is not revenue-constrained, and it can issue securities at any rate it desires. In contrast, a non-sovereign government must obtain dollars/Euros before it can spend them, and it cannot exogenously set the interest rate. Rather, market forces determine the interest rate at which it borrows.
This paper examines the prospects of Euroland in the context of the Argentinian experience with a "dollarized" currency and of the debt ratios of Eurostates in comparison to those of US states.
Keywords: Euro, European Community, fiscal policy, currency risks, sovereign government, floating currency, dollarized currency
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