Introduction:

Since the inception of European Monetary Union (EMU), the 17 members have built up strong and rising current account imbalances and corresponding financial imbalances. Among the 27 economies of the European Union (EU27) imbalances are even stronger. In this paper, I want to explore the driving forces for the imbalances, fathom their risks and their impact on the sovereign debt crisis of several member states. Next, I develop the proposition that the sovereign debt crisis of the peripheral countries (called GIIPS2) is mainly a reflection of European imbalances, and that the diagnosis of a sovereign debt crisis of the countries as the prime problem is misleading and respective policy conclusions do not address the fundamental issues. Although financial rescue efforts are urgently needed, they will be in vain as long as the underlying problems are not addressed.

Despite a number of similarities between the U.S. deficits vis à vis China and other emerging economies – often coined 'global imbalances' – and the deficits in some EMU countries, the EMU imbalances are quite different, much more explosive and have led the EMU to the brink of collapse. Without a thorough diagnosis and reforms that really address the root problems the EMU is doomed to fail.

In what follows, I will first give a short empirical overview on the European imbalances and then discuss eight different approaches to explain the EMU crisis. This leads to my own interpretation, based on the diagnosis of neo-mercantilism, which includes a digression on the role of diverging unit labour costs. Eventually I point out four Achilles heels in the design of the EMU that need remedy.