Published on June 29th, 2012 | by Katharina Obermeier
Image © [caption id="" align="alignnone" width="566"] © .m for matthijs[/caption]   When the euro was first introduced over a decade ago, I was too young to understand the economic principles behind a currency union. I just thought the euro notes and coins looked better than the German marks I was used to and appreciated being able to use the same currency in France, without the hassle of changing money and calculating currency conversions in my head. Later, when I became interested in economics, I applied the normal concepts of monetary policy to the euro, treating it as just another currency. Therefore, when the eurozone crisis started receiving media attention, I was confused. How could Greek and Spanish bonds fall victim to speculation, when they had the same currency as other, economically much stronger countries like Germany and Finland? Until that point, I had only been familiar with this kind of situation when countries had pegged their currency to gold or another currency and then were forced to use foreign reserves to buy up excess domestic bonds in order to try to maintain their currency’s value. It was then that I realised that while eurozone countries share a currency, they do not share debt in the form of jointly issued bonds. I had simply taken this for granted since that’s how it works on a national level: the value of the currency is normally strongly influenced by the government’s bond market. Except that for the eurozone, there are no bonds – the national equivalent would be like having a US dollar but no US treasury bonds. Why is this missing piece in the euro market important? The simple answer is that currencies and bonds are so closely interlinked that it makes no sense to have one without the other, just like no government would have a currency at national level without issuing corresponding bonds on its debt at national level. Economists have increasingly been pointing out the structural weaknesses of the eurozone. They see the crisis as inevitable due to the heterogeneity of eurozone members, drawing attention to the large current account (exports/imports) imbalances between the economically stronger, more competitive countries and their weaker counterparts. Their basic argument is that easy access to euros has prevented the less competitive members of the eurozone from readjusting  and that they will therefore continue to maintain unsustainable current account deficits (importing more than they export). Based on this reasoning, some draw the conclusion that the eurozone countries are simply too diverse to be in a currency union. This argument can be countered very easily by pointing to any number of countries that have extremely heterogeneous regions and yet – miraculously – have a single currency that works for all of them. The US is a particularly good example, as it spans a vast geographic area and incorporates everything from Silicon Valley to Wall Street to the Rust Belt. No one would suggest that the different US states should not share the same currency, despite their economic diversity, so why should the eurozone be any different? The answer is that it isn’t, except for the fact that it does not issue bonds at the federal level. Because the US collects debt at the federal level and issues bonds for the country as a whole, the less competitive states are not subject to the pressures of international financial markets in the same way that eurozone members are today. The monetary and fiscal policy at federal level can help smooth over the imbalances between states. This is exactly what the eurozone needs to fix its structural problems. If eurozone countries pooled their debt and then jointly issued bonds, it would immediately relieve the pressure that the extremely high bond yields are having on the Spanish, Greek and Italian governments and equalise borrowing costs across the eurozone. So while borrowing costs would rise for countries like Germany (which currently has very low bond yields and can afford to have higher ones) they would fall for countries where the crisis is most acute. Similarly, economists have suggested that eurozone debt mutualisation would increase inflation in the eurozone and cause the euro to lose value – both of which would be positive developments for the embattled countries and would allow them to overcome their current account deficits more easily, thereby mitigating the imbalances in the eurozone.