Martin Wolf, chief economics commentator at London’s Financial Times, has done us a service by outlining some recent academic comment about the effect on Germany if the euro collapses. Wolf’s comments appeared under the headline, “Why exit is an option for Germany” (Financial Times, UK, September 25, 2012).
Paul De Grauwe, a Belgian economist, currently at the London School of Economics, speculates about what Germany might lose from a break-up of the euro zone. Some clarification is needed before we examine De Grauwe’s arguments.
Professor De Grauwe does not discuss what might trigger any break-up. However, his comments have attracted Martin Wolf’s attention.
Wolf thinks it’s possible that Germany might leave the euro. That, however, is not strictly relevant to the matter of whether Germany would be left better off without the euro.
(For the record, the present writer believes that, however the euro crisis is resolved, all of the euro states — and, indeed, the rest of the European Union — will pay a price for what has been a disastrously misguided attempt to create a currency union. For the sake of the future of the EU, it is desirable that the necessary and painful policy adjustments be commenced as soon as possible. The first step along that difficult path is surely for the beleaguered economies to revert to their own currencies.)
Wolf has his own totally plausible reason for proposing a Germany exit from the eurozone. Important economic policy-makers appear to be troubled by some aspects of German Chancellor Angela Merkel’s attempts to reshape her country’s policy towards Europe.
In particular, these policy-makers fear that her wholehearted support for the European Central Bank’s decision to commit unlimited funds to promote financial stability in the troubled euro economies is against German interests.
They believe that it commits Germany to support a policy of loose money, a position at odds with the long-held view of Germany’s postwar central bank, the Bundesbank. Stable money has been a central pillar of the Bundesbank since its inception.
Jens Weidmann, whom Chancellor Merkel appointed last year to the prestigious position of President of the Bundesbank, has spoken against the decision of the ECB, which he sees as a basic departure from its former position as a lockstep supporter of the Bundesbank’s monetary policy.
Dr Weidmann, apparently incensed by this development, has become the leading conservative German eurosceptic. It would seem he is attracting increasing numbers of conservatives to his point of view. This new group totally rejects the “bail-out” policy of the European Central Bank. On this fundamental issue of financial policy, it would appear that Germany’s central bank is marching out of step with the nation’s Chancellor.
From the Bundesbank’s point of view, Euro-politics is taking Germany in entirely the wrong direction.
For now, all the available evidence suggests that Chancellor Merkel remains firmly in charge of German policy-making, and she makes no secret of her total commitment to the euro and to the idea of a united Europe. Should this be seen as the beginning of a rift in German conservative politics?
For the moment, no. But Germany has a long history of upholding stable money as its defining economic and political objective. The Chancellor risks trying the patience of German conservatism to breaking point if, in her efforts to hold Europe together, she appears willing to compromise the German economic fundamental of stable money.
Conservatives of the Jens Weidmann persuasion can imagine nothing more subversive to Germany’s economic health than a shift towards loose money and higher inflation. From that perspective, as Wolf observes, the eurozone is “set to be a miserable marriage” that Germany would be better to dissolve.
At heart, the German Chancellor is as firmly committed to stable money as the Bundesbank; but, for the moment, she is captive to what, for her is an equally important political priority — the need to preserve European unity. Germany has a key role to play in keeping Europe together.
It would appear that Chancellor Merkel has not succeeded in winning economic conservatives around to her view. Europsceptic conservatives of the Jens Weidmann variety see Europe differently. For them, German economic sovereignty trumps European unity as a political imperative.
Much of informed German economic opinion will endorse that view. Whether this emerging influence will strengthen to the point where the Chancellor will be obliged to give ground on Europe is not yet clear. What can be said is that if Chancellor Merkel is persuaded to give up on Europe, then the eurozone will certainly break up.
That does not necessarily mean the end of the European experiment. Indeed, a break-up, properly managed, might be the only way to put European unity back on a sustainable path.
What the experts believe a break-up might mean for Germany is important, but it is shrouded in too much technical detail.
Professor De Grauwe believes that, on the money side, nothing much would change. Germany’s accumulated export surpluses are safely salted away in the Bundesbank. The difficult position of German and other commercial banks, which are currently owed money by the troubled eurozone economies, would be neither better nor worse than now.
A euro break-up could trigger a flood of euros from other eurozone countries into what would undoubtedly become more highly valued Deutschmarks. Such a currency inflow could destabilise the German economy by further elevating the value of the new Deutschmark against the euro. This would make Germany’s exports dearer and its imports cheaper.
The obvious counter would be to allow only German residents to convert their euros into Deutschmarks. That would be a difficult and untidy exercise, but not impossible.
According to Martin Wolf, Charles Dumas, the research director of Lombard Street Research, has put forward an idea which is, for the most part, commonly accepted. Given the different stages of development of member-states of the European Union within the eurozone, the euro experiment was doomed to fail.
More controversially, Dumas contends that the initial euro’s value was set too low. The result was to convert Germany into an export-driven economy with adverse consequences for its domestic economy. It is unclear whether Dumas has given due weight to external pressures the economy faced when the Soviet Union collapsed in 1990, and West Germany undertook to absorb a bankrupt East Germany into its economy.
This proved an economically draining process, and those export surpluses undoubtedly played their part in helping Germany absorb its Eastern cousin.
That aside, whatever may have been the adverse impact of the euro experiment on the German economy, the economic consequences on the weaker eurozone partners has been much worse.
If the euro’s initial value was set too low for Germany, thereby making its exports cheaper and its imports dearer, the euro’s value was set too high for the weaker member-states of the eurozone, making their exports dearer and their imports cheaper.
The level of the currency was set too high to allow these weaker economies to compete with the more high-powered German economic machine. German export industries came to dominate markets within Europe, especially in the eurozone, a currency advantage which also helped Germany into export markets outside Europe.
Germany’s export surpluses, about which Professor De Grauwe has written, were largely the creation of the currency advantage Germany gained from the euro, and those surpluses became the debts of its European trading partners.
The resulting imbalance in trade and payments outcomes eventually destabilised the eurozone.
Germany’s drive into other markets also played its part in disrupting the world economy, as did China’s — and, to a lesser extent, Japan’s — aggressive exporting to the United States.
The world’s biggest exporters used their surpluses to bankroll customers. Economic growth came to depend on ever-expanding consumer debt. Worse still, the trade and payments system became hopelessly unbalanced as the world divided into two camps — exporters accumulating surpluses and importers racking up debt, both government and private.
This major imbalance was the major contributing factor leading to the global financial crisis (GFC). Irresponsible bank-lending certainly played a part, as did the US subprime mortgage debacle. But these were really by-products of a dysfunctional trade and payments system.
Why did the system go so completely off the rails? And how did exports and imports become so completely unbalanced? The blame lies with the world’s switch to a hybrid system of exchange-rate management (after the collapse 40 years ago of the 1944 Bretton Woods agreement) and the deregulation of international capital flows.
Many importing countries, including Australia, allowed their currencies to float freely — entirely at the mercy of money markets driven less by trade than by speculation. Exporting countries which managed their currencies were able to create and maintain an export advantage.
In the process, we have passed from a world economy whose growth was fuelled by debt to one now paralysed by debt overhang. Creating a new, sustainable growth engine won’t be easy, and will certainly be painful.
A starting point should be to declare that the experiment with a hybrid system of some countries floating their currencies and others manipulating theirs is unworkable. However, an international agreement on something better is not a realistic alternative. Countries will be forced to go back to managed exchange rates, which cannot be achieved without re-regulating capital movements.
No country will find this distasteful corrective medicine more difficult to swallow than Australia. Influential commentators in both Australia’s major parties have been trained to believe implicitly in the merits of free-floating exchange rates — something the world does not practise consistently.
As this piece is being written, these commentators seem content to watch unconcerned as our economy sinks under the weight of an exchange rate overvalued by some 20 to 30 per cent.
What will it take for them to change their views? A starting point would be to stop listening to what the Reserve Bank of Australia and the Treasury say should be happening and face what’s really happening — that our dollar is not falling in line with falling commodity prices.
Colin Teese is a former deputy secretary of the Department of Trade.