Friday, May 28, 2010

Barry Eichengreen Sees a Breakup of the Dollar Zone

Over at The Economist there is an interesting discussion surrounding the future of the Eurozone. Today Barry Eichengreen weighed in and made the case that the dollar zone in the United States will break up in the next 10 years due to state fiscal problems. Coming from Eichengreen, this piece has to be satire. There is no way he really believes the dollar zone will breakup in the next decade. Even I don't believe it and I have published research questioning whether the United States is truly an optimal currency area. I suspect Eichengreen is cleverly making the point that even though there may be problems with the dollar zone, that if taken to their logical conclusion would imply a break up of currency union, it is absurd to think it will actually happen. If so, then ditto for the break up of the Eurozone. Or maybe I am reading too much into this piece. Maybe the Eurozone crisis has Eichengreen in a funk and he has taken to heart the conversation among Paul Krugman, Ryan Avent, and myself that questioned the dollar zone as an optimal currency area. You decide for yourself:
[T]he dollar area will fragment over the next ten years.

Recent events have made it clear that the idea of monetary union is deeply flawed. Economic specialists have long pointed to the contradictions, but politicians pushed ahead for essentially non-economic reasons. We are now paying the price.

The coexistence of a single currency and a single central bank with a set of separate state budgets is a fundamental contradiction. The union lacks a mechanism for adequately co-ordinating those budgets. The result is the unseemly spectacle of some states (California, Nevada) chronically overspending while others (West Virginia, Wyoming) live within their means. Often the deficit states are the ones with high unemployment rates and serious competitiveness problems.

This unsustainable state of affairs has multiple causes, but it has been aggravated by the existence of a single currency. Without the risk of exchange-rate changes, the member states share a common level of interest rates, making it easier for the profligate to live beyond their means. So long as investors remain somnolent, the less disciplined member states are encouraged to throw "one big fat Greek party". When they finally awake to the fact that government finances are unsustainable, all hell breaks loose.

[...]

Creating a monetary union of the 50 American states was a mistake. The dollar area is sure to fragment in the next ten years.

Read the rest here.

4 comments:

  1. It is a satire, worthy of Jonathan Swift.

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  2. Of course, what we really want to know is your prediction for this:
    http://blogs.marketwatch.com/worldcup/2010/05/26/if-economists-are-right-spain-will-take-the-crown/

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  3. Have you seen the latest from Roubini ? He believes the continued depreciation of the euro may yet save the union. But of course it will add another contractionary screw to the already horrible American jobs situation. Its almost as if those crafty Europeans had planned this....
    http://www.businessweek.com/news/2010-06-05/weaker-euro-may-be-able-to-save-monetary-union-roubini-says.html

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  4. Adding to the cut and thrust is the first of the guest contributions, by Barry Eichengreen, a professor of economics at the University of California, Berkeley, whose view that euro membership is effectively irreversible was cited by Mr Wyplosz in his opening statement and is rejected by Mr Feldstein in his rebuttal. Mr Eichengreen tells a wry parable about the US dollar to highlight the weaknesses he sees in the motion that the euro area will fragment over the next ten years.

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