Tuesday, March 23, 2010

Germany is a bigger problem than Greece

At the moment all the attention in the eurozone goes towards Greece and its financial problems. For good reason: they cooked the books and they are now faced with a financial situation where they need help from the IMF or whoever.

However, as many people have noticed, Greece is just one of many euro states with troublesome finances: Portugal, Spain, Italy and Ireland are only in a little bit better state and may well face similar problems in the future.

The problem of all is the trade unbalance inside the euro zone. When the euro was introduced Germany was a country with slowly rising wages and conservative finance and a steadily appreciating currency. The Southern European countries on the other hand had fast rising wages and a freely spending government that they regularly had to compensate for by devaluing their currency. Unfortunately both continued to behave the same: the Germans frugally, the Southerners profligate. As a consequence an enormous gap has risen in competitiveness between the south and the north. And that result in a huge export surplus for Germany and import surpluses for those other countries.

It is easy to blame the south, as Germany likes to do, but Germany has done its own part to make the gap bigger. It started a policy of wage and budget cuts at the moment when the differences were already very big and it even continues to do so today. Even more explicit: German leaders claim that Germany has the right to have a huge trade surplus because it needs to save for its ageing population. Never mind that China, Japan and Southern Europe have an ageing population too and that if they all saved like Germany there wouldn't be enough people left to consume and the world would face a 1930 style contraction.

The German solution to the crisis is that the rest of Europe must be just as frugal as it is. Now the Greek budget deficit was excessive so I don't mind some sobriety. But part of the Greek problem is that it is in a currency union with Germany and that Germany keeps making budget cuts too. So Greece is fighting to reach a moving target. It would be much easier if Germany became a bit more free-spending and met Greece in the middle. It would not only help directly: it would also result in a lower euro and that too would make it easier for Greece to be competitive.

Germany nowadays likes to publish opinion polls that show that a majority of the German population is against a bailout of Greece. But aid doesn't make sense without a solution for the trade gap. The German population is just saying that given the German attitude in the eurozone they don't have faith that rescuing Greece will work.

Germany would hate to see the euro weaken. But it is perfectly possible for countries with a weak currency to be competitive.

I don't see much difference between China's policy of a predatory low currency and Germany's policy. If Germany still had the mark its currency would have risen considerably because of its trade surpluses and that would have led to a reduction of those surpluses. Now Germany is profiting from a rather low euro due to the problems of other EU states.

In this context is may be interesting to speculate what would happen when the eurozone fell apart and Germany (with possibly a few other countries) would have its own currency. In that case that currency would rise to reflct Germany's economic power. As a consequence Germany's trade surplus would be sharply reduced. Germany would find itself in the same position as Japan in 1985 or the US in 1930: the only way to reduce unemployment is to stimulate internal demand. Keeping this in mind it becomes clear how ridiculous Germany's claim is that it is entitled to huge trade surpluses.

Germany likes to point out that it already has a large government budget deficit and that it wouldn't be fair to ask it to enlarge that even further. This too misses the point. The problem with Germany (and China) is that it produces too much and consumes too little. Having government budget deficits is a very rude way to solve that - and it works only temporary. A real solution will mean policies that discourage saving by the population and promote consumption. It may well include policies of how people can save for their pensions.

As the situation is now Greece is just a footnote: it doesn't matter that much whether it gets help from the IMF or some European club. But the huge and growing German trade surpluses within the eurozone are a serious problem. If Germany is not prepared to recognize that it is a problem and if refuses to recognize that a solution of the present situation must be found somewhere in the middle I am pessimistic on the euro. It will probably survive the Greek crisis, but within a year or so other countries will get the same problem and then the euro will have to dissolve.

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