Term Sheet

The latest on private equity, M&A, deals and movements — from Wall Street to Silicon Valley

A great economist and euro-fan turns negative on the region

November 4, 2013: 5:00 AM ET

Greece's ills and growing imbalances between Northern and Southern Europe prompt Robert Aliber to make a surprising about-face.

130913152906-euro-620xaFORTUNE -- We're hearing a lot of talk these days about how Europe is staging a modest recovery that's sufficient to save the euro. So I was surprised when one of the top international economists of the past four decades, and a former euro-fan, told me that he's changed his view. "The chances are higher than ever that the what I call Teutonic Europe and Latin Europe will split into at least two currency zones," says Robert Aliber, now retired from the Booth  School of Business at the University of Chicago, where I was privileged to have him as a teacher many years ago.

Pay attention to Aliber, affectionately known by his initials "RZA" to his students. He predicted the disaster in Iceland in mid-2007, when the experts at the World Bank and IMF were still asleep. "Iceland was suffering from a very high level of indebtedness and very large trade deficits," recalls Aliber. "They got the money to pay the interest in the form of new loans." For his foresight in Iceland, Aliber won plaudits from Michel Lewis in his bestseller Boomerang.

Aliber cites two factors for his growing pessimism on the euro. The first is the EU's decision to keep Greece in the common currency at all costs. "That was a dreadful mistake," says Aliber. Greece, he says, was highly uncompetitive as a euro-member from its entry at the start of 2001. "Greece fudged the data to hide its problems in order to join the euro," says Aliber. "It used sham contracts to get lots of its debt officially off its books." He says that when the inevitable collapse began in early 2010, the EU should have forced Greece to exit, "So that its prices, which were set too high at the start because of the fudged data and only got higher, would be reset." A euro-escape would have made Greece's exports and tourist industry far more competitive, and avoided what Aliber calls "A situation resembling our Great Depression."

MORE: It's time for European banks to shrink

The second force is what he calls "the pattern of imbalances" between the northern "Teutonic" and southern, or "Latin," zones. Germany, Austria, Finland, and the Netherlands are all running big trade deficits by selling lots of cars and computers to their southern neighbors. France, Spain, Italy, and Portugal are running big trade deficits because their products are just too costly to compete with exports from the north. "The Latin trade deficits will not go away," says Aliber. "France's indebtedness will only increase. Germany has a vibrant export sector, France does not."

In the past, he says, the solution to the competitiveness gap was devaluation. "France would devalue every 10 years to get its costs in line with Germany's," says Aliber. It's worth noting that the rationale for the euro among responsible economists held that devaluation was a crutch, and that under the pressure of a single currency, France and Italy would be forced to restrain excessive wage and benefit growth to compete. It didn't happen, instead those countries papered over their cost problem with big borrowings when times were flush in the mid-2000s. "High levels of housing expenditures and large fiscal deficits offset what would otherwise would have been high levels of unemployment," argues Aliber. "But you can only borrow so much, and then the lack of competitiveness became clear and led to the high unemployment that was inevitable."

The southern countries now lack the currency tool to compensate for the gap between their own excessive labor costs and the strong productivity growth that's lowering or flattening the wage bill per auto and lathe in Germany. Hence, says Aliber, Europe faces a single option to saving the euro. "German prices would need to rise more rapidly than French and Italian prices over a number of years to bring the cost of competing exports from the north and south into line," says Aliber. He says it's feasible if Germany allowed wages to grow at around 3% a year, far above today's increases. That would cause culture shock and perhaps political turmoil, but, he says, the economics would work.

MORE: A sobering gut-check for the market

If that doesn't happen, says Aliber, the euro will fracture. "The unemployment rate in southern Europe will become so high that some politicians will say, 'This isn't tolerable' and will push to leave the euro." He's not guessing on the timing but says it will take years. The exception is Greece -- Aliber thinks its exit is inevitable no matter what Germany does but confesses he's thought that for four years. "Greece could go very quickly," says Aliber.

I agree with Aliber that the renewed optimism on the euro defies both the dreadful numbers, and the economic strait jacket that somehow must be lifted. We learned on Thursday that unemployment in the eurozone rose for the 9th consecutive quarter, to an all-time record of 12.2%. When a central authority with powers over vastly different economies sets the values of their currencies, and hence the prices of their exports at levels that are drastically wrong, the end game is the devastation we're now witnessing. It can be avoided only by the solution Aliber advocates. The world is watching.

Join the Conversation
About This Author
Shawn Tully
Shawn Tully
Senior EDITOR-AT-LARGE, Fortune

Shawn Tully has been writing feature stories for Fortune since 1980. He's covered stories as varied as the Vatican's finances, the exile of fugitive commodities trader Marc Rich, and the disastrous merger between Guidant and Boston Scientific. He specializes in banking, federal budget and spending issues, and health care. Tully holds a B.A. in English from Princeton University, an M.B.A. from the University of Chicago, and a master's in Applied Economics from the Universite Catholique de Louvain in Belgium.

Email Shawn
Current Issue
  • Give the gift of Fortune
  • Get the Fortune app
  • Subscribe
Powered by WordPress.com VIP.